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Old 18-01-2006, 07:32 AM
mangitbay mangitbay is offline
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Ripping off the poor

As I was wrapping up last week’s column I couldn’t help but think about the wealth-gap, and the fact that it’s increasing: by Paul van Eeden

From the most recent US Census data I found that the median household net worth in America is $55,000, most of which is home-equity. Without home-equity, the median household net worth is only $13,473. The average household net worth, on the other hand, is over $180,000 (including home-equity).

It indicates that most of the wealth is concentrated in the hands of a few, and that those few are extremely wealthy compared to the majority. But we already knew that from last week, since only one percent of taxpayers pay roughly one third of all the taxes.

Why do the rich get richer and the poor poorer?

I can think of two reasons: inflation and deficit spending.

Deficit spending is a politician’s favorite ways to buy votes. They promise this, and they promise that, and they have no way to pay for it other than raising taxes or issuing debt (borrowing).

It makes sense to raise taxes to buy votes. If only one percent of taxpayers pay roughly a third of the tax, and only five percent pay more than half of the tax, then you can make ninety-five percent of the population happy by raising taxes on the five percent. And if you can promise ninety-five percent of the population something they want, but don’t have, you might just get elected. Who cares about the five percent “rich” anyway? After all, they must have ripped off the less fortunate, the poor, and the working class to get rich in the first place -- so it only makes sense to tax them, and make them give some back.

I have heard this idiotic rhetoric more times than I care for, and I suspect that I’ve not heard it for the last time either. It is not the “rich” that is ripping off the poor, it’s the government itself.

Taxes have a way of working themselves through the economy until there is an offsetting increase in the cost of goods and services, which means that in the end, the ninety-five percent of the population who are supposed to benefit from this redistribution of wealth, end up footing the bill. Except they never realize it.

The eventual increase in the cost of goods and services hurts the lower-income segment of the population far more than the higher-income segment. And that is one reason why the wealth gap increases, and will continue to increase.

The other way the government finances its deficit spending is by borrowing money, typically by issuing Treasury securities. Government debt, even though many believe it will never have to be repaid, does have consequences. The interest on the debt has to be paid and it can be done by raising taxes or by taking on more debt. We have discussed taxes already.

Increasing the amount of outstanding government debt will eventually (in addition to the increased tax burden) lead to an increase in interest rates and possibly a devaluation of the currency.

Higher interest rates again increase the cost of doing business, and therefore lead to an increase in the cost of goods and services. Once again, the poor suffer disproportionately.

A devaluation of the currency increases the cost of imports, and you already know who feels the brunt of that cost increase.

But the damage doesn’t stop there. The money the government allocates to its ill-conceived social programs has unintended consequences.

Making money available to high credit-risk groups leads to asset price bubbles since buyers that would otherwise not be in the market are in the market. A good example of that is the current housing bubble that is being driven by interest only mortgages, adjustable rate mortgages and organizations such as Fannie Mae that buy lower quality, securitized mortgages from the banks.

The second consequence is that those people who have a little bit of cash saved up are often the ones who fall for the easy money, buy assets at over-priced levels, and end up losing not only their life’s savings when prices decline again, but become saddled with debts that are impossible to repay, resulting in an increase in bankruptcies.

But of everything the government does, the most insidious is inflation. Inflation is the increase in money supply, and it has dire consequences.

When the supply of money increases it causes the prices of goods and services to increase since the more money there is, the less each unit of it is worth. As can be expected, increases in prices of goods and services do not all occur at once, or even at the same time, and one of the laggards is wages.

People in the lower income quintiles often have little, if any savings. They live from hand to mouth and it takes careful budgeting to make sure there is food on the table at the end of the month. If the cost of gasoline rises, it hurts. If rents increase, it hurts. If food prices increase, it hurts. In almost all these examples an increase in prices will force lower income families to change their spending patterns and in many cases, their diets, since food is often a family’s second largest monthly expense after housing.

Assuming they are able to stow away a little bit of cash, then inflation strikes again. Unless invested, inflation rapidly erodes the purchasing power of cash.

Compounding is beautiful to behold when it works for you, but an ugly monster when it works against you. Consider that if you had $15,000 ten years ago, and that’s more than the median household has to spare, then inflation at five percent per year would erode that into only $9,208 in equivalent buying power today. Then consider that M3, the broadest measure of money supply, increased by an average of 7.7% in the ten years to 2003.

Okay, so let’s say they save some money AND they manage to invest it. But invest it in what? Where is the “average” person going to find the time to educate himself sufficiently so that he doesn’t lose it all? Investing can often be more dangerous than inflation because the majority of investors have no clue what they invest in. For most part they don’t know nearly enough about the companies they buy, or the industries they invest in, or the macro-economic risks to their investments. Most investors are in fact worse off than those who left their money in cash. At least the latter will have something left at the end of the day.

Of course, higher taxes, higher interest rates, an increase in asset prices… all these things do affect the rich as well as the poor.

Taxes hurt the rich much more than the poor and in the short term it may appear as if an increase in taxes is a way to redistribute some of the wealth. But let’s see what really happens.

In addition to the fact that most of the taxes are ultimately passed on to the consumer, an onerous tax regime forces capital out of the economy. Those with capital will always try to increase the return on their investments while minimizing the risk of losing the capital. Taxes reduce the income on investments, which means that investors will attempt to find places to allocate their capital where taxes are lower.

The removal of capital from the economy again hurts the poor far more than the wealthy. First of all it is the “wealthy’s” capital that has been removed, so they were able to avoid some of the taxes and get a higher return on their capital elsewhere. Not much harm done there. But the resultant reduction in available capital in the economy eliminates jobs, reduces economic growth and increases interest rates, all of which hurt the poor far more than the rich.

Higher interest rates most certainly have a disproportionate affect on the poor. Typically they increase the cost of almost everything the poor have to buy and since they don’t have any capital, they get none of the benefits. But the rich, on the other hand, have capital to invest and so they can get a higher return on their invested capital by virtue of the higher interest rates. So while higher interest rates hurt the poor in every possible way, the rich can insulate themselves from it, and even profit from it.

Higher mortgage rates affect the majority of homeowners, except the very wealthy, who can buy their homes for cash. Remember, all that money the government spends has to come from somewhere, and government deficits cause interest rates to rise, including mortgage rates.

What about inflation, and an increase in asset prices? Once again, the poor suffer because their wages and capital never seem to appreciate fast enough for them to be able to get ahead while the wealthy, who own the assets, are protected from the ravages of inflation.

Inflation assures that lower to middle income families never accumulate enough wealth to buy sufficient assets to overcome the effects of inflation. This is the main reason why the wealth-gap, across the world, in almost every country, is increasing. And the higher the rate of inflation the larger the wealth-gap: more wealth concentrated in the hands of less people with a higher percentage of the population living in abject poverty.

Governments aren’t going to stop meddling with free markets, eliminate taxes, or give up on fiat currency any time soon and I am not going to bore you with my philosophical solutions to the problem.

Buying physical gold and silver may not have worked during the Eighties and Nineties, but we now know why. But buying gold and silver now may be the safest, and surest way to insulate your savings from inflation, regardless of how much capital you have.
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