My Lesson on How Big Government Creates Income Inequality

I teach classes in managerial skills and human resource management.  Both are linked to issues surrounding success, career progression, and wages.  My managerial skills teaching focuses on trying to get students from inner city backgrounds to think about how to modulate cognitive and interpersonal skills in order to achieve career success and how to manage themselves to become sufficiently wealthy to be financially independent. With respect to cognitive skills, I emphasize writing, which is one of several weaknesses of  the New York City schools. I cannot, unfortunately, remedy other weaknesses, such as mathematical and statistical skills. I cannot do everything, nor can I do more than show my students the way to learn to write competently.  In a sense I do what John Dewey claimed to be doing: giving them the tools to learn on their own.   

Understanding the Fed, its economic subsidization of asset owners, and its manipulation of wage earners is important to understanding how to invest and how to balance career effort with investing effort.

Another of the critical issues related to both skills building and human resource management is the effect central banking has had in generating income inequality and malinvestment.  Part of this involves overinvestment in financial and real estate markets and part involves overinvestment in technology and labor-saving and cost-reducing strategies like plant relocations. When capital costs are near zero, it costs little to invest in machinery to save labor costs. In the long run, big-government economics, whether it be monetarist or Keynesian, results in capital substitution for labor.  

I just sent an email to my two real time classes summarizing the class discussion, which of course is not covered in the textbooks.

Take a look at this chart, courtesy of the St. Louis Federal Reserve Bank, of the stock of M2 money supply (the broad definition of money) over time:  https://fred.stlouisfed.org/series/M2

 Also, take a look at this chart of the gross federal debt since 1940, also courtesy of the St Louis Fed: 


https://fred.stlouisfed.org/series/FYGFD

Also, take a look at the chart on this blog. The chart is of real (inflation-adjusted) hourly wages since 1964: 

https://www.pewresearch.org/fact-tank/2018/08/07/for-most-us-workers-real-wages-have-barely-budged-for-decades/

Also, take a look at this chart, which illustrates the rise of the valuation of the S&P 500: 

https://www.macrotrends.net/2324/sp-500-historical-chart-data

Notice that real wages began stagnating around 1971, which is around when the money supply began increasing at an increasing rate. President Nixon ended the gold standard that year.

Part of the increase in money supply may be offset by the aging of the baby boomers.  An aging population is deflationary because older people spend less. More importantly, the dollar has served as the chief reserve currency since World War II, so the demand for dollars from foreign central banks and businesses absorbs about one-half of the money supply. 

At the same time, the creation of debt and the creation of money are directly in synch because the money-creation process is part of the debt-creation process.  Notice, though, that the debt-and-money-creation pattern parallels wage stagnation.  Asset values escalate, but wage bargains lag. Keynes calls that money illusion.  Income inequality increases as asset owners, who are wealthy in the first place, become more wealthy.  Keynesian monetary stimulation, based on monetary creation, becomes counterproductive as low interest rates encourage substitution of capital and technology for labor.  Plant relocations and overinvestment in labor-saving equipment follows from sustained low interest rates, further encouraging low wages and income inequality.

Moreover, the widespread dollar reserve holdings are under threat from China, Iran, and Russia, which do not want to do business in dollars.  All modern monetary regimes have collapsed.  The first paper money inflation occurred in China after the invention of paper money during the Song dynasty in the 11 and 12th centuries. The Yuan dynasty, headed by Kublai Khan, adopted the paper money not long after and soon created hyperinflation.

The first US hyperinflation occurred during and after the Revolutionary War, and the first US currency, the continental, became worthless by the end of the Revolutionary War.  There was also hyperinflation during the Civil War, when the US Treasury and the Confederate Treasury both printed money and experienced double-digit inflation rates. Again, this occurred after the establishment of the Federal Reserve Bank in 1913 and World War I, after which there was a hyperinflation followed by the 1920-21 depression.

Some people become wealthy during monetary disorder; typically, they are debtors who own assets like real estate and hard assets. The precious metals, art, and similar kinds of assets retain value. Stocks may as well, depending on the particular stock and various circumstances.  Bitcoin and other cryptocurrencies may be additions to the list of hard assets.

Jim Rickards Describes Increased Global Interest in Blockchain and Gold instead of the Dollar

Alex Stanczyk interviews Jim Rickards in the June 2018 edition of Gold Chronicles.  Rickards’s thesis is that the dollar is going to collapse.  I agree, but while it is easy to know that this will happen, it is hard to know when—whether in three years or 35 years. 

I am accumulating gold gradually and plan to have about 20% of my portfolio in gold and silver, although I’m at about eight percent now.  I’m not totally convinced that the downturn in the gold price from the 2011 peak--due to monetary expansion and the Trump stock market bubble--is over.

Rickards says that gold production has flatlined.  We all know that the “peak” thesis was wrong for oil, and I have little reason to believe that it will be right for gold.  However, production is not a determinative factor in the long run. 

Rickards claims that there is a new axis of gold formed by secondary and tertiary powers who are looking a way out of the dollar system, and they will hasten the invention of an alternative monetary system that will include both blockchain technology [but not Bitcoin] and gold.  Incidentally, I have purchased a small amount of Overstock.com, which has become a blockchain incubator.

Stanczyk says that gold is migrating from the West to the East, especially from London to Switzerland and then to China and India.  Gold reserves held in emerging market central banks increased 91% from 2006 to 2017.  The Russian central bank has purchased over 600 tons of gold over the past four years.  The Keynesian claims that gold is a “barbaric metal,” defunct, and meaningless with respect to monetary policy, seems to have escaped central bankers around the world.

          “The dollar is still boss,” Rickards says, but “Russia buys [gold] like clockwork.” Still,  remember that the price of oil collapsed a couple of years ago [and gold can still do the same].  The oil collapse hurt Russia’s economy. In the 2014-2016 period,  Russian dollar reserves declined by 40% due to the fall in the price of oil, but Rickards points out that the Russians did not stop buying gold even during this difficult period.  It’s like you buy $100 a month in gold, but then you lose your job. Even then, you still buy the gold. That’s conviction.

China is less transparent than Russia, according to Rickards. China has purchased 600 to two thousand tons; Turkey has acquired gold; Iran has acquired gold; Kazakhstan has been acquiring gold. From 1999 to 2010 central banks sold gold. [They apparently sold into the gold bull market.] Since then, the central banks have been buying gold.  The last time the US sold gold was 1980, despite the scoffing of foundation-funded academics.

The big sellers after 1980 were the UK, Switzerland, and the IMF. Germany, France, and Italy never sold.  The central banks that were selling have stopped. Now, on net, banks are buying.  Miners are having difficulty finding new gold. “What’s going on is strategic,” says Rickards.

The US dollar is currently more than 60% of global reserves, 80% of global payments, and 90% of oil payments.  The Establishment (Ben Bernanke, Tim Geithner, John Lipsky) sees continued dominance of the dollar.  Currently the US is in financial wars with Iran, Russia, North Korea, and possibly China. 

          The ubiquitous dollar enables the US to be effective at enforcing economic sanctions. The problem is that these countries, at the short end of US foreign policy and trade policy, are trying to get around the dollar system.  Russia, China, Iran, Turkey, Venezuela, and Brazil are looking for an alternative to the US dollar system.

The Federal Reserve Goes Parabolic

When traders say that a security has gone parabolic, they mean its price is increasing at an increasing rate.  Naive investors are drawn to the security, but to experienced investors the rapid increases signal an incipient collapse. That's because the excessive price stimulates experienced investors to sell. The upward spiral ends, causing those who entered the market during the parabolic increase to sell too. The ensuing crash is excessive, and the price falls below the security's true value because investors who otherwise would have held the security sell from fear.

The Federal Reserve Bank  has increased the money supply at a parabolic rate. The money supply has been increasing regularly since the 1930s.  Once of the results of the money supply's increase has been excessive investment in real estate, especially in politically sanctioned projects.  The projects include the urban renewal of the 1950s and 1960s, the construction of the suburbs, the development of the suburban mall, the expansion of retailing, and the sub-prime crisis. Some of these would have occurred, but to a lesser extent, without the Fed.  Others, like the sub-prime crisis, would not have occurred at all.

The excessive real estate investment arose because the money the Fed creates is deposited with risk- averse money center banks that prefer guaranteed returns.  Besides the real estate bubble of the past seven decades, there has been a government bubble. Rather than rely on democracy, which would not have supported the current level of spending if taxpayers had been forced to pay the market value of the cost of government each year, the central bank facilitates issuance of bonds, allowing the public to vote for politicians who spend more than the public has in resources. The public lacks the intellect to vote otherwise--its taste for doing what seems right or beneficial prevails because it lacks the ability to analyze the costs.  The advent of Keynesian economics causes supposed experts to offer the irrational advice that the public favors on its own--to spend money it does not have.

Hence, the Federal Reserve is inconsistent with democracy because it permits the public to vote for politicians who spend more than the public would want them to if they were required to cover the costs, and to spend more than government can pay back.  The resulting debt is becoming too large to pay back. Government will then deprive bond holders of their wealth by debasing the currency.This will harm those whose assets are in dollars or who receive wages.

The public does not want a dollar collapse--but it votes for it because the media and the government-financed school system advertise a distorted view of the costs and cripple citizens intellectually so that they believe the claims of supposed experts even when they are repeatedly wrong. A case in point is the economics profession.  Few economists predicted the sub-prime crisis or the tech bubble. But, despite their history of error, economists and the news media continue to broadcast the same predictions.

 The money center banks tend to invest with risk-averse, large corporations. It is evident that the corporations are risk averse because executives need to be paid in stock options whose purpose is to stimulate risk.  Wall Street sanctions publicly traded corporations through the stock market.  Executives are rewarded if the stock price rises. The corporations, then, only take risks of which Wall Street approves. The result of hiring psychologically deviant, risk-averse executives and then  countering the risk aversion with stock options is that the nature of the risk the executives take tends to pander to Wall Street's needs.  As a result, mergers and acquisitions tend to dominate firms' risk taking. Firms do not serve product markets--they serve financial markets.   

The largest way that the Fed distorts risk taking is through its subsidies to the stock-and-bond markets, and, consequently, hedge funds through (1) direct lending to hedge funds and Wall Street banks, (2) issuance of government securities that Wall Street sells, and (3) depression of interest rates that cause the stock market to increase inversely.  The rise in the stock market since 1937 is due to the Federal Reserve Bank. That rise has come out of the real hourly wage.

In 2008 the Fed began a massive quantitative easing that has caused bank credit to increase three fold and may potentially increase the money supply thirty fold.  This is equivalent to a parabolic price increase in the securities market.  The effects of the parabolic increase are (1) trivialization of technology at an increasing rate, (2) increasing crony capitalism, and investment in frivolous public-private partnerships, (3) subsidies to hedge funds and other socially unproductive financial firms, and (4) the current stock and real estate market comebacks.

The trivialization of technology is seen in the massive stock price increases of firms like Facebook and LinkedIn.  In the 19th century, technology meant the invention of the automobile and A/C electricity.  In the 21st century it means a program by which you add people unknown to you, called  friends, to a computer program whose purpose is also unknown.  


Like all parabolic price increases, this one too shall pass. But the collapse of the dollar's value does not just mean that a few greedy investors will be harmed. It means that all working Americans, suckers who have voted for Democrats and Republicans, will be harmed.

2007 Video on Dollar Collapse

This is a video about the potential, long run crash of the dollar. It was made in 2007 and the makers could not have foretold the banking crisis of 2008. In the short run, the Wall Street dollar bulls have won the battle, and even in the past few days the dollar has been rising and gold has been falling. If gold falls to the $900 range there will be a significant buying opportunity. Given the management of the dollar by central banks around the world, the status quo has not changed and may not change for some time. On the other hand, a dollar collapse could come at any time. At the same time, banking collapses could mean a rising dollar in the short term.