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
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.
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.
Once again, changing the inflation measurement problem is easier said than done. In the U.S., Japan, the U.K and the eurozone, debt levels are a huge issue. Lower inflation rates keep interest rates low, allow new borrowing (budget deficits) at low rates and keep the interest cost of the debt manageable (at least temporarily).
Also, a low official rate keeps the cost-of-living adjustments for social programs -- Social Security, Medicare and government pensions -- low. As a result, Social Security, Medicare and pension payments are significantly lower than they otherwise would be. Returning to the older, more accurate inflation measures would truly be budget busting.
Constraints on Small Business Lending
One of the reasons that the economic recovery has been so sluggish is the inability for small business to expand. Since the financial crisis, much of the money creation by the Fed has ended up as excess reserves in the banking system (now more than $2.3 trillion).
Small businesses employ more than 75% of the workforce. So, why aren't banks lending to small businesses?
In prior periods of economic growth, especially in the 1990s and the first few years of the current century, it was the small and intermediate-sized banks that made loans to small businesses in their communities.
Today, for many of the banks that survived the last five years, there are so many newly imposed reporting and lending constraints (Dodd-Frank) and such a fear of regulatory criticism, fines or other disciplinary action that these institutions won't take any risk at all. In earlier times, the annual number of new community bank charters was always in the high double digits.
But, since 2011, the FDIC has approved only one new bank charter that wasn't for the purpose of saving an existing troubled bank. Only one!
In effect, the federal regulators now run the community banking system from seats of power in their far away offices.
Small businesses cannot grow due to the unavailability of funding caused by overregulation and government imposed constraints. This holds down the income growth of much of the entrepreneurial class and is a significant contributor to income inequality. Of the policies discussed in this post, this would be the easiest to change.
There is definitely a growing income gap, but, much of it is the result of public policy. New elections or new legislation won't fix these policies. The first step is recognition. But, as I've pointed out, many of these policies are rooted in the fabric of government.
There is little desire on the part of those comfortably in power to recognize them, much less to initiate any changes.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.