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Corporate Oct 3, 2013

Once more! Fed is blowing bubbles to cover up growing inequality

By Vivek Kaul

The Western central banks primarily the Federal Reserve of United States and the Bank of England, have been printing money (or quantitative easing as they like to call it) at a very rapid rate since the start of the financial crisis in late 2008. The idea is to print and pump money into the financial system and thus ensure that there is a lot of money going around, leading to low interest rates.

At low interest rates people were expected to borrow and spend more. When they did that businesses would benefit and the economic growth would improve. But this theory hasn't really worked as well as it was expected to.

The money that was and continues to be printed, has found its way into various financial markets around the world, leading to bubbles and at the same time benefiting those it wasn't intended to. As Albert Grice of Societe Generale writes in a report titled Is the Fed blowing bubbles to cover up growing inequality...again?- dated September 27, 2013 - "Quantitative Easing(QE) has mainly helped the rich. The Bank of England admitted as much a year ago. Specifically it said that its QE programme had boosted the value of stocks and bonds by 25%, or about $970 billion. It then calculated that about 40 percent of those gains went to the richest 5 percent of British households."

AFP

The money that was printed, has found its way into various financial markets around the world, leading to bubbles and at the same time benefiting those it wasn't intended to. AFP

The situation is similar in the United States as well, where the Federal Reserve prints $85 billion every month to keep interest rates low. As Gary Dorsch Editor, Global Money Trends newsletter, writes in his later newsletter dated October 3, 2013, "The Fed has always kept its foot pressed firmly on the monetary accelerator, and thus, keeping the speculative juices flowing. Over the past 1-½ years, the Fed has increased the...money supply by +10% to an all-time high of $12-trillion. In turn, traders have bid-up the combined value of NYSE and Nasdaq listed stocks to a record $22-trillion. That's great news for the Richest-10% of Americans that own 80% of the shares on the stock exchanges."

Hence, it is safe to say that bubbles across various financial markets have helped the rich get richer, which wasn't the idea in the first place. Numbers confirm this story. As Emmanuel Saez, of University of California at Berkeley, points out in a note titled Striking it Richer: The Evolution of Top Incomes in the United States and dated September 3, 2013 "From 2009 to 2012, average real income per family grew modestly by 6.0%...However, the gains were very uneven. Top 1% incomes grew by 31.4% while bottom 99% incomes grew only by 0.4% from 2009 to 2012. Hence, the top 1% captured 95% of the income gains in the first three years."

This rise in income inequality might be one reason why the Federal Reserve of United States continues to print money. As Edwards writes "while governments preside over economic policies that make the very rich even richer... the middle classes also need to be thrown a sop to disguise the fact they are not benefiting at all from economic growth."

So how is the middle class offered a sop in disguise? This is done through an easy money policy of maintaining low interest rates by printing money. In the process, the home prices continue to go up and this ensures that the home owning middle class which forms a significant portion of both the American and the British population) feels richer.

The S&P/Case-Shiller 20 City Home Index which measures the value of residential real estate in 20 metropolitan areas of the US, shows precisely that. Overall home price rose by 12.4% in July 2013, in comparison to July 2012. Home prices were up by 27.5% in Las Vegas. They were up 24.8%, 20.8% and 20.4%, in San Francisco, Los Angeles and San Diego, respectively.

A similar scenario seems to be playing out in Great Britain as well. As Edwards wrote in a report titled Fools dated September 19, 2013 "Evidence is mounting that easy money ...in the UK housing market is leading to another explosion of prices, with London, as always, leading the way with double-digit house price inflation."

Edwards further points out in another report titled If UK Chancellor George Osborne is a moron, Fitch's Charlene Chu is a heroine dated June 4, 2013, that people have been unable to buy homes despite interest rates being at very low levels because the prices continue to remain very high. As he wrote "Young people today haven't got a chance of buying a house at a reasonable price, even with rock bottom interest rates. The Nationwide Building Society data shows that the average first time buyer in London is paying over 50% of their take home pay in mortgage payments - and that is when interest rates are close to zero!"

Of course people who already own homes and form a major portion of the population are feeling richer. And thus income inequality is being addressed.

This mistake of propping up housing prices to make the middle class feel rich was one of the major reasons for the real estate bubble in the United States, which burst, before the start of the current financial crisis.

The top 1% of the households accounted for only 7.9% of total American wealth in 1976. This grew to 23.5% of the income by 2007. This was because the incomes of those in the top echelons was growing at a much faster rate.

The rate of growth of income for the period for those in the top 1% was at 4.4% per year. The remaining 99% grew at 0.6% per year. What is even more interesting is the fact that the difference was even more pronounced since the 1990s.

Between 1993 and 2000, the income of the top 1% grew at the rate of 10.3% per year, and the income of the remaining 99% grew at 2.7% per year. Between 2002 and 2007, the income for the top 1% grew at the rate of 10.1% per year. For the remaining it grew at a minuscule 1.3% per year. In fact the wealthiest 0.1% of the population accounted for 2.6% of American wealth in 1976. This had gone up to 12.3% in 2007.

But it was not only the super rich who were getting richer. Even those below them were doing quite well for themselves. In 1976, the top 10% of households earned around 33% of the national income, by 2007 this had reached 50% of the national income.

American politicians addressed this inequality in their own way by making sure that money was available at low interest rates. As Raghuram Rajan writes in Fault Lines: How Hidden Fractures Still Threaten the World Economy "Politicians have therefore looked for other ways to improve the lives of their voters. Since the early 1980s, the most seductive answer has been easier credit. In some ways, it is the path of least resistance...Politicians love to have banks expand housing credit, for all credit achieves many goals at the same time. It pushes up house prices, making households feel wealthier, and allows them to finance more consumption. It creates more profits and jobs in the financial sector as well as in real estate brokerage and housing construction. And everything is safe - as safe as houses - at least for a while."

While Rajan holds politicians responsible for running easy money policies to keep the real estate bubble going, the likes of Alan Greenspan and Ben Bernanke, successive Chairmen of the Federal Reserve, are also equally responsible.

Of course, this is really not a solution to the problem of addressing income inequality. It only makes people feel richer for a short period of time till the home prices keep rising and the bubble becomes bigger. But eventually the bubble bursts.

The irony is that people refuse to learn from their mistakes. The same mistake of propping up home prices is being made all over again.

(Vivek Kaul is a writer. He tweets @kaul_vivek)

by Vivek Kaul

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