How the Fed creates wealth inequality mathematically. I have often spoke in my Blogs about how the Fed and other central banks, are at the root cause of our wealth inequality. Often said to be the issue of our time. I would go on to say, that they are also the most destabilizing organizations we have on earth today. Wealth inequality often drives the politics of business, even to the point of war. So I though I would write a simple mock economic scenario to demonstrate how these mathematics works.
First let’s set up the scenario of our economy. We have Tom, Tim and Ted. Each starts out with zero assets, and work to trade amongst each other, where Tom earns $100 per month, Tim earns $200 a month and Ted earns $400 per month. Each must pay $100 to live each month. So after 10 months what does the balance sheet of each member in our economy look like?
[ul]
[li]Tom (0%): $0
[/li][li]Tim (25%): $1,000
[/li][li]Ted (75%): $3,000
[/li][/ul]
Median wealth: $1,333
Now let’s assume for a moment that all stop working (perhaps an economic down-turn or retirement) and now they will all need to live on the income of their accumulated assets. I take the issue of income away, so we can see more clearly the effects of how the system works. In our example we will work with a return of 10% on their assets per month. So what does the situation look like after another 10 months?
[ul]
[li]Tom (0%): $0 (Tom had no assets, so no income – out on the street.)
[/li][li]Tim (17%): $1,000 (Tim has his original assets and can just break even living.)
[/li][li]Ted (83%): $5,000 (Ted has his original assets plus the excess after living expenses.)
[/li][/ul]
Median wealth: $2,000
Notice that the wealth inequality is building. This may all seem reasonably fair, as after all Ted worked harder and smarter and should earn more than the others, though remember everyone has stopped working. So Ted has done nothing new to enhance his position – its just the system that allows him to get richer. But, it gets even far worse. What happens when the magic of a fractional reserve system comes into play? Also, let’s assume for the moment no inflation worries and all else being a constant.
Since the economy has stalled, our government whizz-kids come up with a great idea, of using the fractional reserve system to expand the money supply to boost growth – via leverage. In our example, let’s assume everyone qualifies and the central bank doubles the money supply for everyone. So what does the balance sheet look like now?
[ul]
[li]Tom (0%): $0 (Tom had zero, so 2 * 0 is … still zero.)
[/li][li]Tim (17%): $2,000
[/li][li]Ted (83%): $10,000
[/li][/ul]
Median wealth: $4,000
Hmmm … the wealth inequality is expanding even further for Tom, as those with no assets can not participate. Unfair or just too bad? Again no one has started working again and everyone is still living on past work efforts of their interest on capital. You earned perhaps on work efforts of your past, but does this entitle you to future benefits, over and above others? Let’s advance time another 10 months. So what does the balance sheet look like now?
[ul]
[li]Tom (0%): $0 (Tom still zero, and still on the street.)
[/li][li]Tim (7%): $3,000 (Tim earns $200 – $100 living expenses per month)
[/li][li]Ted (93%): $19,000 (Ted earns $1,000 – $100 living expense per month)
[/li][/ul]
Median wealth: $7,333
Voila Ted went from having 75% of the wealth in our economy to 93% of the wealth with out even lifting a finger, through the magic of our fractional reserve system. Also keep in mind for poor Tom, as well as Tim, they keep falling further behind in terms of median wealth. Now do this process a 100 times over and your head would explode.
This scenario gets even be worse, if you factor in actual wages, credit qualification and inflation losses against the median wealth factor. The other thing to remember is, that this also assumes that Ted will not use his financial strength to monopolize markets, push down wages and buy government to even further enhance his position.
The summary point? A fractional reserve system creates wealth inequality mathematically. The way the current rules that most central banks operate under means: more leverage = more wealth inequality. Yes and more poverty. It outweighs any other issue on wealth inequality, by many factors (click here for a pdf presentation on this and click here for a video).
Blue Point Trading, William Thompson