Editors' Pick: Originally published Feb. 24.

There has been an undeniable increase in income inequality in the U.S., especially over the past 45 years.

But, the increase in wealth inequality has been even more pronounced. This can help to explain the income inequality and give us a better hint as to what has caused the increased inequality.

The Pew Research Center divides American households into three wealth groups in a recent study: 21% of households are in the "upper" group; 46% are "middle"; and 33% are "lower."

As Robert Gordon explains in his challenging new book The Rise and Fall of American Growth, the change in the real inflation-adjusted value of wealth from 1983 to 2013 shows that the middle group experienced a modest rise to $96,500 from $94,300; the bottom group fell to $9,300 from $11,400; and the upper group saw its real wealth double over this time period to $639,400 from $318,100.

One thing that is important to realize when talking about wealth is that the wealth figure is a "stock" figure and includes the increase that takes place in the value of assets from one time period to another, whereas the income figures is a "flow" measure and examines, well, the flow of income received over a given period of time.

This is particularly important because in the early 1970s, the inflation in the value of assets became a real important factor in the United States. Consumer price inflation began rising in the 1960s and had become high enough that the United States had to go off the gold standard and float the value of the U.S. dollar in 1971.

People began to seriously invest in assets by the end of the 1960s and in the 1970s this became an important part of wealth management. Gold, of course, was one of the favorite choices as an inflation hedge, but paintings and other valuable assets also came into favor.

Credit inflation became such an important part of the U.S. financial system that the financial system and financial innovation became major components of the economy during the latter half of the century and the number of people taking advantage of the rise in asset prices became larger and more sophisticated.

Credit inflation is the intentional rise in public and private debt that is driven by the fiscal and monetary policies of the federal government. Credit inflation is not only spurred on by fiscal deficits and expansionary monetary policies aimed at achieving high levels of employment, or, low levels of unemployment, but also to put more and more people into homes.

In the 1960s, the commercial banking system in the United States was completely changed as unit banking states and limited branching states moved to become, first, statewide systems and then to systems that allowed branching between states. Also, American banks became more global during this time.

In the 1970s, the inflation and higher interest rates completely changed the thrift industry in the United States starting it on its downward slide leading to collapse in the early 1990s.

Some financial innovation was begun in the federal government itself. I worked for government agencies in the late 1960s and early 1970s and saw the efforts put into inventing the mortgage-backed securities. The idea was to get home mortgages off the balance sheets of commercial banks and thrift institutions by creating a financial instrument that insurance companies and pension funds would find acceptable.

Then the commercial banks and thrift institutions could create more credit for more people that wanted to own their own home. The driving force here were politicians that believed that if more people owned their own home, more people would vote for the people that created the MBS. This was just the start, as Michael Lewis shows in his famous book Liar's Poker describing Wall Street in the 1980s.

And, as they say, the rest is history. 

The federal government set out to do good things. It set out to insure that unemployment was kept at very low levels. It set out to see that more American families could own their own homes.

But there were unintended consequences. The federal government produced economic policies that led to the inflation of asset prices and led to the creation of credit bubbles.

This continued into the 2000s and into the period of economic recovery following the Great Recession. One of the most popular posts that I have ever written is called "Bernanke is Underwriting the Wealthy," published in February 2013. It described how the wealthy were taking advantage of the low interest rates produced by the Federal Reserve System to make lots and lots of money.

The point of this is that income inequality was enhanced by exorbitant executive salaries and stagnant middle income salary increases. As Gordon points out in his book, the middle classes have suffered in the corporate world being supplemented by improving information technology, which put them into greater competition with blue collar workers around the world creating an over-supply in many markets. The changing nature of those in jobs or seeking employment has created a bifurcation in the workforce which benefits the individuals that are more highly educated at the expense of the less educated.

But, these changes did not produce the massive re-allocation of wealth in the United States that the asset price inflation of the last fifty-five years has produced. The policy leanings of the United States government need to be changed, not because they don't have good intentions behind the current ones, but because of the unintended consequences that result from the constant credit inflation due to existing policies.



This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.