Wealth inequality is a hot topic. The Left is attacking the rich, and proposing taxes to drain away their wealth (and the wealth of the middle class). There is no economic or moral justification for a tax on those who earned their fortunes by producing and saving over generations. Yet, there is a serious problem to be addressed. The Federal Reserve has engineered a boom in asset prices, pushing up portfolio values of the wealthy.
I saw Dick Fisher, then president of the Dallas Federal Reserve, speak a few years ago. He was asked about the wealth effect—when consumer spending goes up due to rising asset prices. He said, “Let’s just say that the wealthy have been very affected!” The room full of one percenters erupted with a golf clap.
Even the people who run the Federal Reserve know that it cannot print wealth. They know it can only cause a wealth transfer. They are happy to believe that the rich get richer at the expense of the poor and middle class.
The truth is actually worse than that.
The poor don’t have any wealth. Therefore, if the rich got richer, their new wealth could not have come from the poor. The middle class, to the extent they have some wealth, also feel richer. Home prices and stocks have risen since 2009, and the middle class generally own both. So they aren’t the source either.
This is obvious, but now we get to the hard question. If the greater riches of the rich don’t come from those poorer than them, then where do they come from?
They don’t come from anywhere, as the rich are not actually getting richer.
What the Fed has engineered, is not a transfer of wealth. But an illusion of wealth. The Fed has driven interest rates down, which causes asset prices to go up. This is not an increase in wealth. Just ask Harry Householder Jr., who lives in the same little house in which he grew up. His dad paid $12,000 in 1965. Harry lives no better today, but now someone will pay him $1,200,000 for it.
No one wants to squander his inheritance. But, man, $1.2 million is a lot! Anyways, the Fed obscures it with the fog of a bull market. Everyone loves a bull market, and the gains make one feel like a savvy investor, and not the prodigal son.
$1.2 million is enough to pay for rent and groceries for the rest of Harry’s life. If he does sell, then there is a transfer. However, it does not come from “the poor” or “the middle class”.
It comes from savers and businesses, who give their capital to a bank. Thanks to the Fed, the bank need not pay them much interest. So the bank is enabled to lend their savings, dirt cheap, to the buyer so he can pay Mr. Householder $1.2 million for that little old house.
And Householder is enabled to spend their savings.
Dick Fisher sort of had the right idea. This is a transfer, but it is worse than a mere zero-sum game where one party gets richer and another gets poorer. It is a conversion of the savers’ capital into income, to be spent by those who sell assets.
Mr. Householder is spending his own inheritance, and he is also spending someone else’s savings.
The rich are not getting richer, though they may feel it while the boom lasts. Everyone is getting poorer, to the extent they have accumulated wealth.
Ludwig von Mises stated it this way:
“… Keynes did not teach us how to perform the ‘miracle [...] of turning a stone into bread,’ but the not at all miraculous procedure of eating the seed corn.”