Wednesday, October 19, 2011

The primary cause for the rich/poor gap? Fiat currency

The fact that the richest 1% of the population is getting richer while the middle class and poor are losing ground is becoming more obvious. The disparity is blamed on capitalism and greed. Some of the solutions proposed to bring things back into balance are:
  • Higher taxes on the rich
  • Raise minimum wage requirements
  • Stricter regulations on businesses
  • Tariffs and trade wars
Implementing any of these ideas will lead to unintended consequences. If you tax the rich, they will take their businesses and capital offshore which will lower employment. Raising minimum wage requirements will also lead to lower employment. Stricter regulations will lead to fewer start ups to challenge the big corporations which will lower employment too. Tariffs and trade wars often times lead to real wars. None of these solutions will deliver the promised outcomes. Why? The main problem has more to do with the elastic money supply than anything else. When the dollar (or any printed money for that matter) is backed by a tangible item, meaning the currency can be traded in at any time for a comodity such as gold or silver, it limits how much can be printed. It has value. It can't be printed on demand. When Nixon took the United States off the gold standard, it set up a system of credit expansion whereby those that owned wealth producing assets (stocks, businesses, etc..) saw their wealth grow dramatically. The working class on the other hand had stagnant wages and borrowed (because of easy credit) to finance their lifestyle. Bill Bonner explains:
 The post-1971 US dollar-based monetary system permitted an explosion of credit, which naturally favored the credit industry directly, and the entire financial asset-holding investoriat, indirectly. At the expense of the middle and lower classes. In other words, the expansion of credit, caused by a flexible, expandable money regime, set the whole economy ablaze. The middle and lower classes went deeply into debt to buy things. The “rich” — or at least those who owned stocks and bonds — got richer, as consumer spending lit up the business world, and particularly the financial industry itself. Profits from the financial industry were only about 10% of the total profits on Wall Street in 1970. By the time the credit bubble blew up in 2007 they had grown to 40%. Wages for working stiffs were flat for 40 years. But earnings on Wall Street soared. In 1970, the typical salary in the financial industry was about the same as for equivalent positions in the rest of the economy. But, by the 21st century, Wall Street salaries were nearly twice as high.
People who complain about “greedy” executives and rich people miss the point. People — rich and poor — are always greedy. But they don't always have a monetary system that encourages debt and favors investors over working people. This money system was created in 1971 by the Nixon Administration, which probably didn't know what it was doing...and it was later perfected by subsequent Federal Reserve chairmen.
In addition to stretching the gap between rich and poor, the non- gold monetary system had one other notable consequence. It undermined the working classes' ability to compete in the modern world. This it did by moving more and more production to the emerging markets. In pre-1971 days, nations had to settle up on their trade balances. That is, when one nation sold more to a neighboring nation than it spent with it, the nation in surplus ended up with an excess of the neighbor's currency. This surplus currency was then presented to the deficit country. The accounts were settled by transferring gold — the monetary system's reserve at the time — from the deficit country to the surplus country.
As the gold left, it had a chilling effect on the deficit nation's economy — either because investors caused interest rates to rise or because the central bank pushed them up. This resulted in slower economic growth and less spending, thereby correcting the outflow of funds to the neighbor.
It was precisely this self-correcting mechanism that the feds were determined to stop when the Nixon Administration “closed the gold window” at the Treasury department in August of 1971. The US had spent too much on the Vietnam War. French banks, which were still very active in Vietnam, tended to be the recipients of the money...which flowed to the Bank of France. The French, anticipating a problem with the dollar, wanted to exchange dollars for gold. This was the proximate cause of the Nixon Administration's reaction — an actual default on its financial obligations. It was also the cause of the subsequent run up of the price of gold...which was followed by a bust in gold...and thereafter, a huge boom, in which ordinary Americans were lured into debt and coaxed towards poverty.
Isn't that something. Nixon took us off the gold standard in 1971 so we wouldn't have to pay France the gold they wanted for the dollars they owned. Why? Because we were already bankrupt as a nation! In 1971!

But I digress. By closing the gold window, Nixon opened the door to the wealth disparity between the rich and middle class (and the poor as well), and the eventual loss of manufacturing from America to China and elsewhere.
One other problem the middle class face due to a fiat currency: building their own personal wealth. The middle class typically builds their wealth from producing more than they consume and saving the difference. With a deflating dollar, they can never keep ahead of inflation...and when they retire, their savings do not last long.

We need to get back to sound money somehow. Most likely massive defaults will happen; a write down of unpayable liabilities (social programs, U.S. Treasuries and other bonds), and a re balancing of assets and liabilities. Then some kind of sound money system. What is sound money? I'll explain in another blog.

For the full article written by Bill Bonner, click below.

Appetite for Wealth Destruction