The
growing wealth disparity has become a raging issue in the upcoming Presidential
elections. Both sides are promising to tackle this issue from their own idiosyncratic
viewpoints. While the democrats want to tax the rich in order to reduce this
income gap; the republicans think that a slowing economy due to excessive regulations
is a result of this widening disparity. The Federal Reserve has also time and
again expressed its empathy and concern over this phenomenon. What is however unmistakably
clear is the fact that this process that started to gain traction since 1970
i.e. since the onset of the monopolised fiat monetary system has been
responsible for stealing the vitality from the millions of American households.
While it’s
true that our current monetary setup has broken the shackles of the past
wherein the supply of credit was restricted by the amount of gold and thus
enabling various parts of the world including US to witness unforeseen growth and
so it would be naïve to return back to the previous system, however a fatal
flaw of this setup has meant that steadily fewer people would end up
controlling large chunk of the economic resources and thus not just widening
the income gap but also paving the way for a plunge in future growth rates.
Under the
previous commodity based monetary system, the depositors used to deposit their
savings in form of gold or gold backed dollar bills in their banks and this
used to form the basis of the credit that the bank used to lend forward so in
other words the savings would lead to credit. In the prevailing system the banks
create credit out of thin air and lend it to the borrower which is
simultaneously deposited in the bank account. Thus under the current monetary
setup it is the credit that leads to savings and deposits.
The
problem with the current setup is that unlike previously wherein the price for
the malinvestments was paid by savers, today the bill for the malinvestments
fall on the doorsteps of the workers themselves. Infact any loss from
the malinvestments in a sector would impact that particular sector first
followed by the banks which would then transmit the losses to various other
sectors of the economy like a nerve centre of the brain. So the current fiat
monopolised monetary setup converts the unwinding of malinvestments in a
particular sector into a full blown downturn for the entire economy.
This phenomenon
of wealth transfer taking place today can be explained more clearly by the
following scenario.
An entrepreneur planning
to setup a business hires some workers. These workers can be compensated in two
ways; a share of the profits (equity) or a fixed compensation.
The entrepreneur
would now approach the bank to get a loan which he would use to pay off his
workers atleast till his business start to generate cashflows. The workers would in turn deposit these wages
into their bank accounts which would now constitute the liabilities of the
bank.
In the first
scenario the risk for the success of the project is shared between the entrepreneur
and the workers and so the compensation of the workers is higher. In the second
scenario the risk is shared between the entrepreneur and "the bank"
and "not the Workers" and so they are given lesser
compensation. However as we are going to see the workers still share the risk
and are not even compensated for it anymore, all because of the monetary
system.
Now let's say
that the project has failed and hence has not generated any cashflows, the bank
would have to right-off that loan (an asset on the books of the bank),
following the rules of accounting it has to wipe-off an equal amount in
liabilities which would mean that the salaries of the workers would now be
obliterated. So as in scenario one because the project has failed the entrepreneur
and the bank gets nothing but more importantly even the workers would have
nothing; which is unfair as they took to the option of lesser compensation
because they wanted to have their pay irrespective of the state of the project.
However if the
project succeeds the entrepreneur makes millions, bank is going to have an
interest income but the workers would have no upside but only the pay which was
unfairly computed as it was assumed that the workers are taking no risk.
So the irony of the
current monetary system is that the people working at fixed pay have no upside
to the success of any business but downside to its failure, banks have no
downside but upside (interest income if project succeeds & no real losses
as they anyways printed money to lend which would be written off) and people
working for equity have both upside and downside. Under the earlier setup the risk
of the failure of the project was passed on to the savers and not the workers.
Ofcourse in
practical parlance to avoid such a possibility in which the banks would
have to right-off the savings of the workers, the Central Banks constantly aim
at boosting the credit growth in the economy and inflating the money supply
which only creates an illusion wherein the people working on fixed pay appear
not to lose money but this scenario changes nothing as they are still losing
out in the same "real terms" to the banks and people
working for equity.
As a result of
these actions not just the wealth disparity in US and across the world has
exploded but the malinvestments have been prevented from getting unwound. As a
result the financial sector which is supposed to play a tertiary role has
grabbed the bulk of economy (see graph) and the wealth is moving in the hands
of a few people at an increasing rate.
Even though US
has registered decent GDP growth over the last 3-4 decades but thanks to the
grotesque monetary tools the living standards of a majority of the population
has not changed by much and now with even the growth slowing down, the monetary
authorities have to choose between the devil and the deep blue sea because
pursuing the old policies would mean a slow bleed in the living standards of
the people while failing to do anything
would end up with a catastrophic unwinding of the massive malinvestments which
threatens to take down the savings of the masses. The only way out of this mess
is to move away from the monetary setup that is akin to “cocktail socialism”
and give way to a system wherein the quantity of credit and its price (interest
rate) is determined by the forces of free market rather than a politburo of the
Central Bankers.