Calls For Fed Easing Are Real Trickle-Down Economics

Posted: Jun 26, 2019 10:47 AM
Calls For Fed Easing Are Real Trickle-Down Economics

Source: AP Photo/Manuel Balce Ceneta

Trickle-down theory is a derisive term for policies that cut taxes to stimulate the economy. It assumes that politicians want the very rich to get all the money, and then it will trickle down to the rest. The mockers think that only the poor and middle class should get tax breaks. That fails to consider, however, that the bottom 50% of earners pay only 3% of income taxes while the top one percent pays 37% of the total. Moreover, tax revenue has actually increased with an expanded income base.

It is true that decreasing tax rates gives the rich out-sized benefits if you consider not taking someone’s resources as giving them a benefit. Thieves give potential victims such a benefit every time they don’t steal. 

Wealthy people have money to invest, so they are the primary ones to start and grow businesses that hire people, pay wages, and increase the tax base, as we have been seeing over the last couple of years. Poor people don’t pay income taxes, and cutting zero in half is still zero.

Money creation is quite different. It is a direct injection of dollars into the economy at very precise, identifiable points. The relatively few banks and bond brokers at the top get all of the new money as it is created, and then it truly does trickle down through the many intermediate layers of the economy.

Injecting new money into the system dilutes and devalues the money that is already in existence, as adding water to lemonade dilutes it. Those who receive the money first, bond dealers and the government, whose bonds they buy and subsequently sell to the Federal Reserve Bank, are able to spend it before the devaluation, buying with more valuable dollars, but as it filters out to the rest, money already in existence loses purchasing power. In the end, it takes more dollars to buy things, i.e. price inflation.

Critics point to the fact that, even when the money supply was greatly expanded, as during the Great Recession, consumer price inflation didn’t budge. This, however, doesn’t take two things into account. One is that price inflation is not spread evenly throughout the economy, but rather different sectors experience different changes in purchasing power. Additionally, but related, new money isn’t spread proportionally among current money holders. It goes to particular people and firms.

The Federal Reserve creates new money when it buys government bonds on the private bond market. It uses what amounts to electronic checks drawn on a bank account with nothing in it, essentially a multi-billion dollar overdraft. When the government gets the money from the bond market, and the dealers and investment banks get new money from the Fed, they buy assets, goods, and services with it. The assets include loans to the public for houses and automobiles, but they also include investments in stocks, bonds, derivatives, factories, and so on.

With low interest rates, though, it makes sense not to invest in loans, but rather in corporate securities that will earn a higher return. We have seen this in action in the last ten or so years, when consumer price inflation was tame but average prices in investment markets tripled. The more new money that flows into investments, the less flows to consumer goods. The tremendous inflation of the past decade occurred in investments, not in food and clothing. There has been massive price inflation, but nobody calls it inflation. It’s called investment gain, even though it has no relationship to business productivity gains.

The holders of such investments get richer at the expense of the rest of the economy. It is redistributed inflation wealth rather than wealth from productivity, and is essentially regressive taxation.