Editor’s note: In this groundbreaking analysis, Shah reveals how quantitative easing – a misguided multi-trillion dollar central bank policy and the greatest financial disruptor of our time – has distorted the global economy, made many traditional investments unprofitable, and stoked wealth and income inequality. But Shah says there are steps we can take to limit some of the damage – if we act now.
The growing income and wealth gap between the rich and poor, most of whom used to be called middle class, has many fathers. But behind the scenes one primary cause emerges. It’s the greatest financial disruptor of modern times: Quantitative Easing (QE).
While the jury’s out on whether QE will eventually be the step-ladder that lifts us out of the lingering Great Recession, as its proponents argue, the facts demand that the verdict on QE’s egregious enrichment of the rich and subjugation of everyone else is: “guilty.”
Here are the facts. Policymakers and struggling middle class and poor people must take a strong stand to fight this financial plague. Here’s how…
A Chicken and Egg Story
Quantitative easing is the term America’s central bank, the U.S. Federal Reserve, came up with for its experimental policy of buying trillions of dollars’ worth of U.S. government bills, notes and bonds (Treasurys), and mortgage-backed securities (MBS) from banks.
This was new. Typically, when financial or economic troubles befall the U.S., the Fed lowers interest rates in order to make more money available to financial institutions and the public, providing liquidity to banks and capital to consumers and producers.
The Fed lowers interest rates by offering banks cheap loans. The idea is that if banks have more money to lend, lower rates will work their way into the economy and stimulate consumption and production.
When the credit crisis hit in 2008, the Fed lowered its target rate to zero, essentially making loans between banks free. But banks still wouldn’t lend to each other – they were afraid borrowing banks could go toes up at any time. Big banks were virtually insolvent.
The Fed’s response to this emergency? It cooked up QE.
The Fed was able to pump money directly into ailing banks by buying bank loans, Treasurys, and mortgage-backed securities from them.
The banks eventually made out like bandits because in later rounds of QE they bought Treasurys and MBS in the open market, knowing they were just going to flip them to the Fed at inflated prices.
Fed purchases from big banks started in 2008 and continued throughout 2009. That wasn’t enough to save the banks. In 2010 the Fed stepped up its purchases under the banner QE2, buying $600 billion worth of assets that year. That still wasn’t enough.
Meanwhile, the economy, which had shown signs of perking up, slipped backwards. So in September 2012, the Fed began QE3, purchasing $85 billion a month of assets ($45 billion of Treasurys, $40 billion of MBS) for the next 24 months.
By the time it was done, the Fed’s balance sheet had ballooned from $750 billion in 2007 to more than $4.25 trillion dollars, and big banks were making record profits again.
The Greatest Wealth Redistribution Ever Conceived
The Fed’s ZIRP, or zero interest rate policy, restored banks’ balance sheets, grossly enriching them in the process. Low rates allowed corporations to borrow cheaply to buy back their shares and eventually raise dividends. Low rates allowed well-heeled speculators to margin and leverage their bets on rising financial asset prices.
Cheap money fed private equity companies and venture capital firms’ ambitions, backing start-ups like Uber, AirBnB, Snapchat, and others. Financial intermediaries, once again, reaped big fees from arranging loans, orchestrating mergers and acquisitions, and taking companies both public and private.
Pre-existing owners of financial assets and financial intermediaries have enjoyed a windfall at the expense of the middle class and the poor. And it was planned that way.
The Fed openly stated the purpose of QE was to create a “wealth effect” by lifting financial asset prices so people would feel wealthy and start consuming again.
Which works fine if you have a job, your wages are increasing, the value of your home is rising, your retirement assets are appreciating, and you are feeling well off.
But that’s not happening for the middle class and people who aren’t asset owners.
Savers and retirees are getting killed. Interest income on their hard-earned savings and on the fixed-income investments retirees need are close to zero. These people are being punished. The wealth they could be accumulating has been redistributed to everyone who has the means to borrow cheaply to acquire appreciating financial assets. That’s QE.
As a result of the credit crisis and Great Recession, the household sector, meaning the middle class, lost $11 trillion in wealth and 10 million jobs. The country lost an estimated $21 trillion worth of productivity. The Great Recession’s middle-class losers haven’t bounced back, but QE has made the rich even richer.
The Damage Might Be Permanent
French economist Thomas Piketty’s controversial 2013 bestseller, Capital in the Twenty-First Century, reduces the facts, figures, metrics, and statistics to a simple conclusion that explains why the wealth and income gap will keep widening: The rate of return on capital is greater than the rate of economic growth, globally.
That means the rate of return on capital and assets, especially financial assets, will grow faster than economic opportunities that help the poor and middle class.
So, what do policy-makers and the disadvantaged have to do? A lot.
The only way to upend this geopolitical and economic travesty is first to break up all the world’s big banks into much smaller players that will be more willing to serve all borrowers.
Breaking up big banks upends the argument that central banks are needed to bail them out when they implode, which is the only reason central banks really exist today.
Second, because they would no longer be needed, central banks should be shut down.
Third, policy-makers, meaning governments, should readdress their priorities to create more opportunities for more people to work and advance themselves.
I’m not talking about redistribution. I’m talking about simplifying the tax code to eliminate egregious shelters and to spread the tax burden appropriately among corporations, extraordinarily high earners, and the general population, eliminating provisions that discourage wasteful, unproductive financial intermediation and breaking down barriers to short- and long-term investment and entrepreneurship.
We will need fiscal policies designed to reduce government debt and automatically expand and contract the money supply and credit extension to levels appropriate to the rate of economic growth.
We need smaller, more effective regulatory regimes that don’t overburden businesses with inappropriate, over-the-top rules and regulations, but establish black-and-white rules along with fines and jail sentences for rule breakers, including corporate officers and managers.
That’s a lot to expect. I’m not holding my breath for any of it.
In the meantime, everyone who isn’t part of the entitled, fortunate, or criminal class of “haves” has to learn how to make what they can, save as much as possible, and learn how to play the markets, specifically the stock market.
The stock market is the have-nots’ only real way, other than by successful entrepreneurship, of creating enough wealth to live a decent to good life and be able to retire in comfort.