Mother Jones featured a piece in their most recent issue titled "It's the Inequality, Stupid: Eleven charts that explain everything that's wrong with America." I thought it was interesting and did a good job of starkly illustrating the various forms of inequality in the American economy: unequal distribution of wealth, an increasingly regressive tax system, and the tacit acceptance of our entire plutocratic political establishment.
One thing it did not do, however, was "explain everything that's wrong with America," as the subtitle led me to believe. Certainly, these charts were interesting. Shocking, even. But how exactly does income inequality hurt our economy--not just the poor or the middle class, but all of us? This is something everyone who sees a problem with income inquality should know. Let's explore the economics below the fold.
We all know a thing or two about the Great Depression. The excess and expansion of the Roaring Twenties was simply unsustainable, and it all started coming apart on September 3, 1929, when the Dow hit its then-peak of 381. Though it had its ups and downs from that point, the slide didn't stop until July 8, 1932. The Dow was at 41.22. It had lost nearly ninety percent of its value in less than three years.
Our economy as a whole mirrored this slump. Industrial production slipped 46%, foreign trade 70%. GDP dropped 29 percent from 1929 to 1933, and unemployment skyrocketed to 25%. You know how the story goes.
So what happened?
The answer is twofold. First, as was written by Keynes to have caused the Depression, the slump in demand took our economy down the pipes. Second, though, and unmentioned by Keynes, was the fact that we had a monetary disaster on our hands--and the Fed only exacerbated it.
As you know, what happens when people stop buying is not pretty. Commerce is a good thing, and when consumption and investment drop--which together amount to 85% of our GDP--our GDP slumps, as you can see on the horizontal axis of the graph at the right. This is what happened in the 1930s and this is what has happened over the past couple years. But that's not all. See the vertical axis, the one labelled "P"? That would be price levels. When price levels rise, that's inflation; when they drop, that's deflation, and deflation is precisely what happens when aggregate demand drops.
Before I continue, let me interject a word about price levels and interest rates, one I'm sure many Kossacks already understand to some extent but that bears explaining anyways. Inflation isn't always bad. There are times, yes, when inflation can rise fast enough to hinder commerce; we saw that in the seventies, and many other countries see it quite often. But in the United States, inflation is historically low and steady. It's for reasons like that that we had 30-year fixed-rate mortgages, something absolutely unheard of in other countries like the UK.
As you can probably guess, then, inflation and interest rates are related. When you lock into a loan on some interest rate, that interest rate reflects not only what the bank is charging you for borrowing money, but they're also adding in what they think inflation will be. Thus, if inflation is expected to be 4% and the bank wants to get 5% interest from you, the interest rate on your loan will be around 9%.
Here's the kicker, though. When inflation is higher than expected--not unusual, seeing as people generally expect inflation to be tomorrow what it is today--working-class and middle-class borrowers, like you and me, win. That is, if inflation is 4.2% in the example from the last paragraph, the bank ends up collecting a real interest rate of 4.8%. Historically, this wasn't entirely a rarity. It wasn't a bad thing, either: banks, clearly, continue to do pretty well.
And that is where things changed during the Depression.
Price levels, which are generally rising in what we call inflation, dropped. Steeply. Like, more than 25% from 1929 to 1933. Part of this wasn't just from the drop in aggregate demand and from lines of credit collapsing across the country, but from the inexperienced Fed tightening the money supply when they should have done precisely the opposite. Either way, what ensued caused our economy to plummet even deeper into crisis.
In short, what happened was that the poorer working-class and middle-class borrowers lost--big time. Contracts and mortgages were written in the late 1920s with inflation written in, but the inflation didn't materialize. Instead, the deflation caused banks to collect even more; if, in that loan example above, inflation turned out to be -4%, that borrower would have been stuck with a 13% interest rate. Across the country, borrowers--the working and middle class, those who got the short end of the income inequality stick--were stuck with loans with skyrocketing interest rates that many couldn't pay. Some lost their homes. Others lost their livelihoods. All of them had to cut back.
And cut back they did. As more money went from the hands of the poorer borrowers--who normally spend the vast majority of their money on consumption, which is itself 70% of our economy--to the hands of wealthy lenders, who simply put the money into their vaults--a massive and even greater shock to demand than Keynes could explain took place. That is why our economy hit depths then that it didn't hit in this past recession; this time, we didn't get pulled into a spiral of deflation.
What if income inequality hadn't been so astronomically high? Well, things might not have been as bad. In the 1920s, 80% of Americans had no savings, so when they had to pay more on mortgages and contracts, that money came directly out of their consumption and into the pockets of the rich lending class, which just saved even more. If things had not been so unequal--if the working and middle class had savings they could have cut back on, and if the wealthy spent a higher fraction of their income on consumption--consumption wouldn't have taken that double hit.
What's different this time around? A few things. For one, the Fed knows better. Yes, I know this might garner some skepticism, but looking back on their policies during the Great Depression puts things in perspective; this time, they lowered short-term interest rates and put quantitative easing measures into place to prevent the collapse of credit and rampant deflation that plagued the thirties from occurring. For another, our government learned a lesson; the legacy of FDR is embodied in unemployment insurance and the FDIC to protect the poorer, borrower class, and a progressive taxation system is in place (though under attack) that is estimated to reduce our Gini coefficient (a measure of income inequality) from 0.51 to 0.43, according to the Congressional Research Service.
But our position is far from secure.
Fiscally, the GOP is all about keeping our economy unequal. Unlike during and after the Great Depression, there has been no leveling out, no high-taxes-on-the-rich and stimulative policy that brought us the best growth we had ever seen. No; on the contrary, not only did the rich get bailed out, but they got to keep their tax cuts, too. Inequality is as high as it ever was before the recession.
Monetarily, inflation is currently a mere 2.7%--higher than it's been, but still low by historical standards. Last year, we saw numbers drop from above 2% around this time to 1% during the summer, but that didn't stop a group of Republican economists from signing a letter discouraging the Fed from keeping our economy scraping by.
Republicans have made maintaining the inequality and idiotic monetary policy that brought us the Great Depression their number one priority. I've had enough of the lies of Reaganomics and the "the-wealthy-are-job-creators" bullcrap. We can't just let the conservative mantra of small government and low taxes rule the day. We know where it leads us; it's time we shout it from the rooftops.