Inequality, Austerity and Central Banks

By Alexander Chrisostomou

We’ve all heard this before: ‘’the rich get richer and the poor get poorer’’. Thomas Piketty has been dubbed the man who ‘exposed capitalism’s fatal flaw’, the ‘flaw’ being that the rich get steadily richer in relation to everybody else. I’d like to note firstly that inequality is not necessarily a bad thing. In fact, inequality is unavoidable, as people all have different ends with different means to the ends they desire, with different constraints. People aren’t homogenous robots, and therefore the argument that egalitarianism is a revolt against nature is a sound one.

Whilst inequality may be a normal outcome, an explanation must be given for consistently increasing inequality. Due to competition and increased productivity through cooperation, capitalism is associated with the maximum reduction in prices. Consumer freedom to spend as you wish also means resources are allocated to the most desired goods. Capitalism can be seen to maximise choice and efficiency, inequality merely the cost of this. But do people actually get richer as the Penn World Tables would suggest? Well, data suggests so. But more importantly, is the burgeoning inequality a result of the free market?

The graph of historic data offered by Piketty in his book “Capital in the Twenty-First Century” focuses on the US. The amount of income in the US owned by the top 10 percent of earners begins at around 40 percent in 1910. It’s hard to deny that this is a fairly high percentage, but it did rise to about 50 percent before the Great Depression although as a result of that crash that percentage unsurprisingly fell considerably lower. Then it returned to about 40 percent 20 years ago before rising once more steadily to about 50 percent before falling again after the more recent 2008 financial crisis. Why is it then that the relative income of ‘the rich’ rose during economic bubbles yet fell in reaction to the subsequent busts?

Blame the central bank’s (the Federal Reserve’s) belief that credit expansion, increasing the supply of money and debt are actually healthy. This is a perversion of markets, often called ‘crony capitalism’. At the expense of the wage earners and the poor, it is the state and the banks that first receive the money. Here, a change in prices causes a change in resource allocation, but before the market has adjusted to the increase in money supply.

A result of creating money is that interest rates are artificially lowered, real market conditions are no longer on show, obscuring your ability to understand the market. This causes the misdirection of capital and the initiation of unsustainable investments. The natural rate of interest sees interests rates fall because saving increases; there is coordination and true economic growth is made possible as savings are invested wisely, something governments can’t do and shouldn’t involve themselves with. What actually happens when central banks get involved is that resources that would have satisfied consumer demand are diverted into projects that only make sense in response to the artificial conditions they created. This leads to feelings of false prosperity until businesses fail and investment projects are abandoned, which can be devastating for people involved in these businesses.

What makes things worse is that businesses are blamed, and the government that allows central banks to act in the ways they do claim to cure the problems. Those businesses that have ‘friends in government’, as well as the reckless bankers who participate in fractional-reserve banking (knowing well that they wouldn’t be the one’s paying the costs for their own mistakes) get bailouts, and that money comes from the ‘ordinary people’. This includes owners of the businesses that just lost a lot of money due to the deceptive market conditions. Essentially, wealth is taken from the more rational individuals and given to the reckless rich. Then the ‘legitimately rich’ (those that respond well to consumer demand for goods and services) get painted as evil and people ‘beg’ that more money is extorted from them.

Voters have a habit of ‘begging’ for the wrong response to problems; the public response to ‘austerity measures’ is an interesting one. Strangely however, the word ‘austerity’ is used to describe two opposites: reducing government spending and increasing taxes. They’re opposites as lowering spending means fewer resources are used by the government, whereas higher taxes will mean more are. It ultimately comes down to whether you want government to handle more or fewer resources.

Therefore, austerity isn’t about ‘cutting’ anything that is worthy. It’s about transferring control over productive resources from bureaucrats to companies and individuals; in other words, ‘power to the people’ or power to the ruling class? Politicians appease voters to get into power and then people get angry when they don’t fulfil promises that they were never going to be able to fulfil, whereas people voluntarily trade in ways that always benefit them.

Those advocating spending increases may claim that government spending creates a ‘multiplier’ which sounds great but is nothing short of fantasy. The ‘multiplier’ that is said to exist is always cancelled by the ‘negative multiplier’. All resources come from somewhere, so if you give a pound to the state then that’s a pound less that you are able to spend at the shops; there was a ‘multiplier’ in both directions so they cancelled out.

Governments are poor stewards of resources, so why people beg the government to stay in control is beyond me. It’s people that have the power when resource allocation is decided by them. In a freed market, resources are channelled from those who serve consumers inefficiently and engage with business plans inconsistent with the preferences of the consumers they wish to provide for, to market actors with the potential to do a better job. Poorly run companies collapse with their assets transferred to others as a result of many individual decisions. You’re essentially voting with your money, so people always come out better.

When more money is in the hands of people, people have more resources to trade; due to the law of comparative advantage, you’re actually more likely to get a type of ‘multiplier’ effect as more is able to be produced. People also end up happier when government isn’t involved in trade. As you cannot coerce others to further your plans, like government coerces you to further theirs, you must induce others to voluntarily cooperate with you. In doing so, you’re furthering the plans of another, making them better off, as they valued whatever good or service you exchanged to them more than the good or service they exchanged to you. Therefore, voluntary trade is always a positive-sum game. So let’s have more of it, let’s initiate social change with it. If you’re not fed up with sluggish political systems, you should be.