Inequality Is The Child Of Fiat Money

For a while there, it looked like the 2012 election was going to be a referendum on economic inequality. This would have been weird, in that economic growth and its twin, employment, are the clear issues of choice in these years of torpid economic recovery. Had President Obama succeeded in making the election about inequality, which it appears now he will not, it would have amounted to one of the great examples of changing the subject in recent political history (as I pointed out a few months ago in a talk at the Cato Institute).

But let it be clear that there are serious issues of economic inequality that deserve a hearing in our politics today. We are not likely to have them aired by an opportunistic presidential campaign, the Occupy Wall Street movement, or those academics who have made a career of dilating on the “top 1%.” Rather, we should turn our attention to that be-all and end-all of the contemporary economy—the fiat money system so beloved by the Federal Reserve.

One of the most shocking statistics of recent economic history is the change, since the 1960s, in the share of the economy taken up by the financial sector. That share has at least doubled, from 4% to probably about 10% today. People wonder what happened to manufacturing (and its generally high wages) in this country. One of the answers is alluded to in the subtitle of Judith Stein’s 2010 book, “How America traded factories for finance in the 1970s.”

The big switch to the foundation of the American financial structure at the advent of this period was the U.S. decision in 1971 to go off the gold standard. Before that time, it was basically clear that outside of wartime (when gold-standard conventions were often suspended), you could basically count on the dollar holding its value against major things like the consumer price level, foreign currencies, and commodities such as gold itself.

After 1971, in contrast, it became basically clear that you could count on no such thing. The CPI might go up 125% in one decade (as it did 1971-1981), the dollar could permanently lose 66% against major currencies (as it did against the yen in this period), and commodities could shoot up ten-to twenty-five fold (as was the case with oil and gold).

Therefore a new day in financial planning also arrived. Suddenly the importance of simply saving money diminished. Money that was saved also had to be hedged. If you simply saved money after 1971, you stood to get killed as the dollar lost value against things it was supposed to be able to procure in the future.

This is where the financial services industry began its long march upward in the share of U.S. economic output it gobbled up. People who had significant money—the rich—threw their money into the products offered by the financial sector, in that the worst thing to happen to a fortune diligently built up over the years would be to see it frittered away on account of currency depreciation.

But can the same be said for the working class and the poor? People of this station by definition have less experience, expertise, and access to financial services. Therefore, people of the lower classes are apt merely to save, as opposed to save and hedge, as has been necessary in the post-1971 world. The inevitable result is what we have seen: the stabilization and growth of the rich’s wealth stash, the diminution of that of the lower classes, and the aggrandizement of the financial sector. We can debate the statistics of the relative wealth of rich and poor—but the real zinger is the stubborn fact that finance’s share of GDP has gone up one and a half times since we went off gold.

What is to be done? Clearly, the income tax code is a highly inopportune place to start. At best, raising taxes on the rich would be to attack matters at the level of symptom rather than cause. At worst, and in all likelihood, higher taxes on the rich would cause a flight of capital out of this country or into inertness, the result being less investment and employment, and thus a worsening of the inequality problem.

As in medicine, the place to address things is at the cause, the root. In this case, the fiat money system. If the next presidency is to show true seriousness on reducing inequality as it has developed in recent generations in this country, a formal reform of the monetary system in the direction of permanent dollar stability will be required.

The article first appeared in Forbes.