Sunday, October 23, 2011

Fallacy of the Rich Getting Richer and the Poor Getting Poorer - Part 2

Studies that support the claim that income inequalities/disparities are increasing ignore the fact that income/money/currency does not equal wealth.  Money and wealth are not the same.  Money does not hold intrinsic value and wealth implies a greater quality of life.  For example, income inequality has been increasing, but quality of life (wealth) disparities have been decreasing.  Anyone that assumes that the rich is getting richer on the backs of the middle class or the poor is making linear and static assumptions in a non-linear and dynamic environment.  Every group of people in the United States has seen an increase in the quality of life over the past 200, 100, or even 20 years.  The income gap may be widening, but the quality of life gap has been narrowing considerably.  The middle and lower classes of today are far better off than the middle and lower classes of the past.  To state otherwise would imply incredible ignorance or purposeful manipulation for political and/or ideological purposes.

The "lower class" of today lives a far better life (and a significantly longer life) than the "lower class" of 100 years ago - this is due to to a market system prevailing, and a socialist system being stifled and subdued. If the statists/socialists/Marxists had their way; our society would regress and the "lower class" (along with every other class) would be far worse off.  The statists want you to believe that that there is a growing disparity in the wealth and quality of life amongst the "classes"; and this is an outright lie. There is a growing disparity in income/paper/currency; but this leads to a narrowing of the disparities in wealth and quality of life. Wealth (quality of life) is NOT the same thing as Income (paper currency).

Example: the richest 1% of our society (the "rich") may earn 50% of the INCOME, however the "rich" CERTAINLY do NOT own 50% of the housing; nor do they own 50% of the land. The "rich" CERTAINLY do NOT own 50% of the automobiles. The "rich" CERTAINLY do NOT consume 50% of the food. The "rich" CERTAINLY do NOT consume 50% of the water.  The "rich" CERTAINLY do NOT consume 50% of the country's medical and health care resources.  The "rich" CERTAINLY do NOT utilize 50% of the country's educational resources.  Land, housing, automobiles, food, clean water, medical and health care resources, and educational resources equate to wealth and a higher quality of living.  Those that wish to demonize the top 1% or "the rich" are attempting to mislead by using the rhetorical tactics of red herring politics.

Wednesday, October 19, 2011

Fallacy of the Rich Getting Richer and the Poor Getting Poorer - Part 1

The fallacy that "the rich are getting richer and the poor are getting poorer" is not only foolish, but dangerous.  This claim assumes that there is only a fixed amount of wealth in our society and that in order for the rich to get richer they must take from the poor.  This is also known as the zero-sum fallacy.

This is one of many fallacies covered in Thomas Sowell's Economic Facts and Fallacies (page 157):

There are various ways of measuring income inequality but a more fundamental distinction is between inequality at a given time- however that might be measured- and inequality over a lifetime, which is what is implied in discussions of "classes" of "the rich" and "the poor" or the "haves" and "have-nots".  Given the widespread movement of individuals from one income level to another in the course of a lifetime, it is hardly surprising that lifetime inequality is less than inequality as measured at any given time.  Moreover, medical interns are well aware that they are on their way to becoming doctors, as people in other entry-level jobs do not expect to stay at that level for life.  Yet measurements of income inequality as of a given time are what dominate discussions of income "disparities" or "inequities" in the media, in politics, and in academia.  Moreover, a succession of such measurements of inequality in the population as a whole over a period of years still misses the progression of individuals to higher income brackets over time.

To say that the bottom 20 percent of households are "falling further behind" those in the upper income brackets- as is often said in the media, in politics, and among the intelligentsia- is not to say that any given flesh-and-blood individuals are falling further behind, since most people in the bottom 20 percent move ahead over time to rise into higher income brackets.  Moreover, even when an abstract statistical category is falling behind other abstract statistical categories, that does not necessarily represent a declining real per capita income, even among those people transiently within that category.  The fact that the share of the bottom 20 percent of households declined from 4 percent of all income in 1985 to 3.5 percent in 2001 did not prevent the real income of households in these brackets from rising- quite aside from the movement of actual people out of the bottom 20 percent between the two years.

Even when discussions of "the rich" are in fact discussions of people who have large accumulations of wealth- as distinguished from high levels of current income- much of what is said or assumed is incorrect.  In the United States, at least, most of the people who are wealthy did not inherit that wealth as part of a wealthy class.  When Forbest magazine's annual list of the 400 richest people first appeared in 1982, people with inherited wealth were 21 percent of that 400- which is to say, nearly four-fifths of these rich people earned the money themselves.  By 2006, fewer than 2 percent of the 400 wealthiest people on the Forbes magazine list were there because of inherited wealth.  Despite the old saying that "the rich get richer and the poor get poorer," the number of billionaires in the world declined from more than a thousand to less than eight hundred in 2008, while the number of American millionaires fell from 9.2 million to 6.7 million.

Bond Vigilantes and Market Discipline

The bond vigilantes are being suppressed by the Fed.  Therefore, the Fed is also suppressing fiscal discipline that would otherwise be imposed upon the federal government by the bond market, as discussed by Ronald McKinnon in the WSJ:

In past decades, tense political disputes over actual or projected fiscal deficits induced sharp increases in interest rates—particularly on long-term bonds. The threat of economic disruption by the so-called bond market vigilantes demanding higher interest rates served to focus both Democratic and Republican protagonists so they could more easily agree on some deficit-closing measures.

For example, in 1993 when the Clinton administration introduced new legislation to greatly expand health care without properly funding it ("HillaryCare"), long-term interest rates began to rise. The 10-year rate on U.S. Treasury bonds touched 8% in 1994. The consequent threat of a credit crunch in the business sector, and higher mortgage rates for prospective home buyers, generated enough political opposition so that the Clinton administration stopped trying to get HillaryCare through the Congress.

In the mid-1990s, Democrats and Republican cooperated to cap another open-ended federal welfare program—Aid to Families with Dependent Children—by giving block grants to the states and letting the states administer the program. Interest rates came down, and the Clinton boom was underway.

In contrast, after the passage of ObamaCare in March 2010, long-term bond rates remained virtually unchanged at around 3%. This was despite great doubt about the law's revenue-raising provisions, and the financial press bemoaning open-ended Medicare deficits and the mandated huge expansion in the number of unfunded Medicaid recipients. Even with great financial disorder in the stock and commodity markets since late July 2011, today's 10-year Treasury bond rate has plunged below 2%. The bond market vigilantes have disappeared.

Without the vigilantes in 2011, the federal government faces no immediate market discipline for balancing its runaway fiscal deficits. Indeed, after President Obama finally received congressional approval to raise the debt ceiling on Aug. 2, followed by Standard & Poor's downgrade of Treasury bonds from AAA to AA+ on Aug. 5, the interest rate on 10-year Treasurys declined even further.

Since Alexander Hamilton established the market for U.S. Treasury bonds in 1790, they have been the fulcrum for the bond market as a whole. Risk premia on other classes of bonds are all measured as so many basis points above Treasurys at all terms to maturity. If their yields are artificially depressed, so too are those on private bonds. The more interest rates are compressed toward zero, the less useful the market becomes in reflecting risk and allocating private capital, as well as in disciplining the government.

To know how to restore market discipline, first consider what caused the vigilantes to disappear. Two conditions are necessary for the vigilantes to thrive:

(1) Treasury bonds should be mainly held within the private sector by individuals or financial institutions that are yield-sensitive—i.e., they worry about possible future inflation and a possible credit crunch should the government's fiscal deficits get too large. Because private investors can choose other assets, both physical and financial, they will switch out of Treasurys if U.S. public finances deteriorate and the probability of future inflation increases.
(2) Private holders of Treasurys must also be persuaded that any fall in short-term interest rates is temporary—i.e., that the Fed has not committed itself to keeping short-term interest rates near zero indefinitely. Long rates today are the mean of expected short rates into the future plus a liquidity premium.

The outstanding stock of U.S. Treasury bonds held outside American intergovernment agencies (such as the Social Security Administration but excluding the Federal Reserve) is about $10 trillion. The proportion of outstanding Treasury debt held by foreigners—mainly central banks—has been increasing and now seems well over 50% of that amount. Since 2001, emerging markets alone have accumulated more than $5 trillion in official exchange reserves. And in the last two years the Fed itself, under QE1 and QE2, has been a major buyer of longer-term Treasury bonds to the tune of about $1.6 trillion—and that's before the recently announced "Operation Twist," whereby the Fed will finance the purchase of still more longer-term bonds by selling shorter-term bonds. So the vigilantes have been crowded out by central banks the world over.

Central banks generally are not yield-sensitive. Instead, under the world dollar standard, central banks in emerging markets are very sensitive to movements in their dollar exchange rates. The Fed's near-zero short-term interest rates since late 2008 have induced massive inflows of hot money into emerging markets through July 2011. This induced central banks in emerging markets to intervene heavily to buy dollars to prevent their currencies from appreciating versus the dollar. They unwillingly accept the very low yield on Treasurys as a necessary consequence of these interventions.

True, in the last two months, this "bubble" of hot money into emerging markets and into primary commodities has suddenly burst with falls in their exchange rates and metal prices. But this bubble-like behavior can be traced to the Fed's zero interest rates.

Beyond just undermining political discipline and creating bubbles, what further economic damage does the Fed's policy of ultra-low interest rates portend for the American economy?

First, the counter-cyclical effect of reducing interest rates in recessions is dampened. When interest rates dipped in the past, at least part of their immediate expansionary impact came from the belief that interest rates would bounce back to normal levels in the future. Firms would rush to avail themselves of cheap credit before it disappeared. However, if interest rates are expected to stay low indefinitely, this short-term expansionary effect is weakened.

Second, financial intermediation within the banking system is disrupted. Since early 2008, bank credit to firms and households has declined despite the Fed's huge expansion of the monetary base—almost all going into excess bank reserves. The causes are complex, but an important part of this credit constraint is that banks with surplus reserves are unwilling to put them out in the interbank market for a derisory low yield. This bank credit constraint, particularly on small- and medium-size firms, is a prime cause of the continued stagnation in U.S. output and employment.

Third, a prolonged period of very low interest rates will decapitalize defined-benefit pension funds—both private and public—throughout the country. In California, for example, pension actuaries presume a yield on their asset portfolios of about 7.5% just to break even in meeting their annuity obligations, even if they were fully funded.

Perhaps Fed Chairman Ben Bernanke should think more about how the Fed's near-zero interest rate policy has undermined fiscal discipline while corrupting the operation of the nation's financial markets.