The Dow Jones Industrial Average and the S&P 500 have had a rocky couple of weeks, including the largest drop of the year on Tuesday. Their rollercoaster highs and lows haven't really meant much when it comes to economic growth in America though. And they are certainly not supporting a financial recovery for middle class America. Why? Because the Federal Reserve is playing a game that is twisting up the free market - it's a game of picking winners and losers and it's affecting everyone's portfolios.
There are few who would deny that the rates of return for stocks, real estate, and business equity depend primarily on the strength of the economy and how fast the economy is growing. Board members at the Federal Reserve, however, believe the converse: that the strength and pace of the economy is primarily dependent on the rates of stock, real estate, and business returns.
As such, their accommodative monetary policies target and inflate these very assets before the underlying economy justifies their returns. All Americans benefit from a healthy economy that provides higher wages, more purchasing power, and gains in productivity and innovation. Few benefit from higher asset prices when targeted and juiced by loose money.
Speaking about the effects of monetary policy on savers last Thursday, Fed Governor Sarah Bloom Raskin argued that "according to the Federal Reserve's Survey of Consumer Finances, less than 7 percent of total household assets are directly held in transaction accounts, certificates of deposit, savings bonds, and bonds. Instead, the bulk of household wealth is held in stocks, retirement accounts, business equity, and real estate." She concludes from this that the steady climb in stock indices over the past few years are generating wealth for everyone in America and helping the economy at large. For this reason, she claims "these returns should be supported, over time, by the accommodative monetary policy that we have in place."
Ms. Raskin's logic would be sound if that "bulk" of household wealth were distributed evenly. As it turns out though, the distribution is anything but even.
Eighty-three percent of all financial wealth in America is held by the top 10 percent, and nearly half is held by the top 1 percent according to NYU economist Edward Wolff's analysis of the Fed survey cited by Governor Raskin. This echelon of individuals at least in the very near term welcomes and greatly benefits from the Federal Reserve's money printing and zero-percent-interest-rate-policy as their stocks and business equity provide them growing wealth and growing income.
For the wealthiest 10 percent of American families, 47 percent of their income comes from interest and dividends, business profits, and capital gains compared to just 6 percent for the bottom 90 percent of U.S. families who depend on roughly 80 percent of their income from wages. And this data comes from the same report Fed Board Governor Raskin used to defend the Fed's policy against savers. Only a negligible amount of total income for these individuals is derived from the "bulk" of household wealth that Raskin and the rest of the Fed board is so fixed on inflating.
The point here is not to demean the wealthiest Americans. There is nothing inherently problematic about a diverse distribution of wealth. There is something wrong, though, when wealth becomes deeply concentrated as the result of accommodative monetary policy. That is not the free market at work.
The Dow's recent rise above 13,000 arguably owes much of its appreciation to the accommodative monetary policy of the Federal Reserve. This should not, however, be a reflection of an improving economy as Fed chairman Ben Bernanke is so quick to reference and take credit for. Much of the profits and investments of Dow Jones and S&P 500 companies take place and stay in other countries and do not benefit Americans who are themselves not invested.
And invested they are not. According to the same Fed report from Raskin's speech, the average value of stocks held by the bottom 90 percent of American families is $16,785. This pales in comparison to the wealthiest 10 percent of American families whose average value of stock holdings is $683,500.
But so what? So the rich are getting richer as the bulk of household wealth is being targeted and inflated by the Fed's free money. Doesn't that ultimately benefit those at the bottom as well?
Under today's fiscal and monetary policies, absolutely not.
A growing economy only benefits the economy as a whole, and thus those at the bottom, if growth comes in the form of operational innovation and gains in productive efficiencies. This means the ability to do more with less, to grow by leaps and bounds while driving down the cost of inputs. This was the case in the ‘80s and ‘90s, where for two decades technological and industrial innovation and efficiency gains allowed America to grow tremendously while having little to no effect at all on the price of commodities and the relative cost of labor. Real mean incomes grew nearly every year between 1981 and 2000 and 38 percent over the entire period according to the U.S. Census Bureau. Real wealth was created. The economy grew as a whole.
Then loose fiscal and monetary policies entered the story, and over the past decade the exact opposite has occurred. Commodity prices are skyrocketing, real mean incomes are at 1997 levels; having fallen nearly every year since 2000 according to the Census, and yet the relative cost of labor in America is still high. Real wealth is not being created.
Supporting stocks, business equity, and real estate through accommodative monetary policy merely accumulates wealth at the top and starves the remainder of the population from innovation and efficiency gains so needed for benefits to be felt by all members of the economy. That can only occur when capital is lured toward productive business investments and savings through higher interest rates, and discouraged from simply following the Fed's quantitative easing into asset markets fueled by an artificial rise in financial wealth.
This article first appeared at RealClearMarkets on March 8, 2012