By Guest Author: Tom Henderson

Again the collectivist economists and followers are touting the increase of income and wealth inequality gap of the top 1% as a reason to raise taxes or to promote some wealth redistribution program.  In effect, the statists are using income inequality to attack free markets.  The standard rebuttal by those not familiar with free economic principles is to point out that the 1% pay 38% of the income taxes.  They go on to explain the top 5% pay 59% of income, and conclude with the top 10% pay almost 70% of income taxes paid.  From this standpoint, what is more interesting is the fact that the top 1% begins at $380,354; the top 5% begins at $159,619, while the top 10% begins at $113,799.

Wealth inequality is nothing to whine about.

Wealth inequality is nothing to whine about.

WOW!  These figures indicate that many federal employees are in the 5% to top 10% range.  There is something wrong with this scenario, but it is a topic for a different issue.  Also as a side note, one should never defend free markets by noting how much the top 1% is taxed.  This also, is another topic for discussion.  Rather than explaining how much in taxes the rich pay, wealth inequality, in and of itself, is the natural result of individual liberty, free market principles, and indeed of nature.  If all income were equal, there would be no division of labor, and therefore, no growth or innovations.  Think about this for a second.  If income were equal across the board, regardless of skills, talents or toil, why would anyone go through the expenses, hardships and risks to pursue a skill or investment, only to partake in the same rewards as everybody else?

Take becoming an M.D. for example.  Who would go through the expense and inconvenience to toil through four years of college, four years of medical school, at least three years of interning at long, strenuous hours with little pay, and come out hundreds of thousands of dollars in debt, only to be paid the same if you decided you wanted merely to stock shelves at Walmart.  (As a side note, there would be no shelves to stock, because who is going to risk capital to produce or bring products to a store.)

One has only to look at North Korea to understand the results of a system where there is income equality.  Income inequality is Nature’s way to introduce efficiency and progress into our way of life.

Even though wealth inequality is natural and good, I do want to address the issue of the recent enormous increase in the gap of income and wealth of the upper strata.  More and more we are hearing “Not since the Great Depression has the income gap been as wide as it is now.”  The implication is free markets have failed, and the need for more taxes and/or more wealth redistribution programs.  What is overlooked is the reason for the surge in the income gap; the massive and prolonged credit expansion by the Federal Reserve (FED).

Remember, when the FED expands credit and sets interest rates at below market rates, the results are borrowers will borrow and lenders will lend when it is not financially prudent.  The result causes bubbles to form and eventually burst.  Hence the boom/bust cycle.

In the boom phase of the cycle, especially prior to the bust, it is common for the upward income strata to increase the wealth gap, only to lose it during the bust phase.

Comparing the increasing wealth gap in the 1920s prior to the Great Depression to today is a good comparison; if the reasons for major increases of economic inequality during these time periods are also examined.  Let’s begin our analysis with the fact that when the FED artificially expands credit, this expansion shows up very early in the stock market.  Low interest and easy money tends to artificially drive up common stock prices, since corporations can borrow cheaply to purchase inventory and/or capital goods which increases profits.  Since investors in common stock tend to be the more affluent, the rise in stock prices will not only artificially increase the net balance sheet of the affluent investors, but also increase the income of these investors when they sell their stock for huge profits.

Because the lower strata does not invest in stocks, they do not get to take advantage of the rising stock prices.  Hence the wealth gap widened during this time.  “The rich are getting richer and the poor are getting poorer” was the catchphrase of the time.  However, when the bubble burst in 1929 the stock prices went down 40% in a month and “the rich” were jumping out of windows, there was no mention of the wealth gap.  Instead you heard, “See, free markets don’t work!”

The scenario in the 1920s is a snapshot of what is happening today.  In the early 2000s, credit was easy and cheap for several years.  The Dot Com era moved into fast forward where investors became rich overnight as easy money made it possible for even the lower income investors to join the band wagon.  People were borrowing money from their credit cards to purchase stocks and IPOs of companies that had not made a profit.  The collectivists again touted “the rich are getting richer and the poor are getting poorer.”  When the Dot Com era went bust, the cry from the statist was, “See, free markets do not work!”

Then came 2008 where years of artificially low interest rates initiated by the FED, along with government coercion to promote home ownership gave rise to subprime loans.  Fannie Mae, as well as foreign banks, hedge funds, and investment banks were purchasing these toxic loans in the form of mortgage backed securities.  They rationalized their mal-investments by purchasing credit swaps, which is insurance on the loans that were purchased.

“The rich are getting richer and the poor are getting poorer,” was again the cry of the collectivist pundits.  Alas, this boom was also built on a house of cards or artificial credit and crumbled.  Except this time when the bubble burst, there were entities like Bear Stearns, Lehman Brothers, and Goldman Sachs that were collapsing.  AIG, the insurance company that insured these loans was also going under.  The Bank of Germany, along with other central banks was heavily insured by AIG.  The end game was a massive government bailout of Goldman Sachs, Fannie Mae, and AIG.  Those who were not political favorites saw their wealth disappear.  “See, free markets don’t work” was again the slogan of the day.

Wealth inequality is a natural result of liberty and free market concepts.  It is the difference of income that promotes efficiency and progress.  However, there also is the phenomenon of the wealth inequality gap widening when the FED artificially expands credit, especially for long periods of time.  The Wealth Gap will widen with the chant, “The rich are getting richer and the poor are getting poorer” and the outcry will be “See, free markets don’t work.”

What “did not work” was the FED’s creating easy and below market credit.  History repeats itself.