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Existing Public Policy Fosters a Growing Income Gap

NEW YORK (TheStreet) -- In his State of the Union address, President Obama referred to the widening income gap as "the defining issue of our time."

There is no doubt that the gap between the rich and the middle class and poor has widened in recent years. And the most recent studies confirm a continuation of that trend with capital gains playing a major role.

What is ironic is that public policies -- some long practiced, some new, -- contribute significantly to the problem. Recognizing and fixing such policy issues, however, is easier said than done.

In this post, I will discuss three such policies: 1) The asset inflation policies of the Fed; 2) The policy that significantly understates inflation; and 3) The policies that strangle lending to small business. There are many other public policies, such as work disincentives, that also have an impact, but I'll discuss them another time

Fed Policy

Since the financial crisis, the Fed, through its "quantitative-easing" policies, has relied upon the "wealth effect" via equity asset price inflation to combat the so-called deflationary forces that had built up in the economy.

Each time a QE policy ended, there was a big decline in equity prices. Those declines prompted another round of QE.

As indicated above, capital gains have played a major role in the recent growth of the income gap. Those gains also played a major role in the dot.com and subprime bubbles of the recent past.

Inflation

In his Jan. 29 missive to clients, David Rosenberg of Gluskin Sheff, a wealth-management firm, said that "if we were to replace the imputed rent measure of CPI (consumer price index) with the actual transaction price measure of the CS-20 [Case Shiller home price index], core inflation would be 5.3% today, not 1.7% as per the 'official' government number..."

John Williams (www.shadowstats.com) indicates that, using the 1990 CPI computation, inflation in the U.S. was 4.9% in 2013; using the 1980 computation method, it was 9.1%.

Those of you old enough may remember that in 1980 the then new Fed Chairman, Paul Volker, began to raise interest rates to double-digit levels to combat an inflation that was not much higher than the 9.1% of today (if the 1980 methodology is used).

Over the years the Bureau of Labor Statistics has changed the computation method for CPI, in effect, significantly biasing it to produce a much lower inflation rate.

In a post I wrote last September ("Hidden Inflation Slows Growth, Holds Down Wages," TheStreet.com, 9/13/13), I showed how the growth of wages earned by middle-class employees has hugged the "official" inflation trend.

If that "official" inflation trend understates real inflation by 3% per year (the difference between Williams' computation using the 1990 methodology and 2013's "official" rate is 3.1%), over a 20-year period, the real purchasing power of that wage would fall by more than 80%.

That helps to explain why both husbands and wives must work today, why the birth rate is falling and why the income gap is widening.


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