Principles of Inequality

The Daily Reckoning PRESENTS: “The rich are getting richer,” we often say in these pages. The problem with that, of course, is that the average American is not rich – and his wages are not budging…or are on the decline. Dr. Hans Sennholz reports…


Many Americans are unhappy about the growing inequality in individual income and wealth. Corporate profits are rising, executive salaries are soaring, but the wages of most workers are barely moving. Even employees with technical skills are feeling squeezed and college graduates are finding it difficult to make a fitting beginning. It is not surprising that politicians, in search of a popular issue, are adding their interpretations and recommendations. On the left, they are criticizing corporations for unpatriotic behavior, exporting American jobs in search for ever higher profits. On the right, they are condemning corporations for hiring illegal aliens who come to the United States and labor in the underground economy. Both sides are waving the American flag and filling the air with political malice and strife.

Men are made by nature unequal. Surely, to assure social peace, all men must be equal before the law and have an equal right to the protection of the law. But they do not have equal ability and productivity and, therefore, do not have equal incomes. A political order that endeavors to create economic equality by force is unnatural; it is destined to self-destruct in destitution, discord, and strife.

Individual incomes always depend on a person’s productivity in rendering services to others. Most individuals merely earn compensation for services rendered, commonly called wages, salaries, fees, or honoraria. Thrifty individuals may enjoy also interest income on their savings. And enterprising individuals may even reap pure profits, which flow from correct anticipation of future needs and supplies, future costs and prices, in short, future states of the market. In a welfare state many people also enjoy transfer benefits forcibly taken from taxpayers. More than fifty million Americans presently draw such payments from their fellow countrymen.

In a free market economy individual differences in income may be very visible although rather limited in numbers. There are few corporate executives, artists, and authors with million-dollar salaries and honoraria every year. There are not many investors enjoying million-dollar interest payments on their holdings. But there always are some young entrepreneurs who manage to foresee important market changes and therefore reap million-dollar profits. But all such differences pale in significance when compared with those caused by man’s choice of social and economic organization. Depending on his perception of the nature of man and on his understanding of social and economic cooperation, he may choose to live in a great variety of economic orders. Some are highly productive yielding high standards of living for all; others are barren and poor condemning members to short and wretched lives. According to The Economist’s World in Figures, 2006 edition, the people in Luxembourg, for instance, are enjoying an annual gross domestic product (GDP) of $55,500 per year, in Norway they are producing $37,910, and in the United States $37,750. In contrast, the people of Somalia subsist on $440 a year, in Sierra Leone on $530, and in Malawi on $590. The life expectance in the latter is about one-half of that in the former.

Such country differences began to develop some 300 years ago when in Western Europe a new social and economic philosophy began to remove institutional barriers to economic development. The laissez-faire philosophy of Adam Smith, David Ricardo, and many other authors in England, France, Germany, and the United States replaced old doctrines that branded economic freedom and acquisitiveness as immoral and advocated legal barriers to economic inequality. The new philosophy set the people free to remove these barriers and pursue their economic interests. Economic production immediately accelerated and standards of living increased visibly. Unfortunately, occasional relapses to old thoughts and policies interrupted the economic progress, and many countries that have never been exposed to the light of economic freedom continue to linger in dismal poverty.

At the present, the light is spreading slowly throughout many parts of the world, even where the political structures continue to be authoritarian. China, Vietnam, and India seem to be leading the way. But economic stagnation is holding many other countries in its grip as new production barriers are being erected to reinforce the old. Business taxes may be raised and business capital may be consumed not only by the poor and needy but also an ever-hungry bureaucracy. There is economic stagnation in France, Germany, Italy, Japan, and Switzerland. In many countries some economic pursuits do prosper while others stagnate or even decline.

Economic progress builds on the formation and investment of business capital, which raises output and income. It may do so with new methods of production and new inventions or without altering the mode of production. Market pressures then divide the new income between the entrepreneurs who lead the way and the suppliers of the factors of production. In the short run, the entrepreneurs may be the beneficiaries but, in the long run, production adjustments always eliminate the entrepreneurial profits and make workers the primary recipients. In the United States and all other capitalistic countries they have been the main beneficiaries ever since obstacles were first removed and new investments were made.

Short-run syndromes of change now are permeating the American economy. Some executive incomes are counted in the millions of dollars, but the wages of many workers are barely keeping up with the rate of inflation. And once again, old explanations are making their appearance, finding grievous fault with such profits and the profit motive. These critics favor a more progressive tax system that would reduce the gap between the rich and the poor. They would reform and expand social welfare, in particular the health care system and the public pension system. And above all, they would restructure the education system in which only three percent of students at top colleges come from the poorest quarter of the population. Unfortunately, such reforms not only would boost the powers of the political reformers but also raise the costs of labor and weaken the labor market. They may even increase the rate of unemployment, especially of unskilled workers. There would be more beneficiaries of Social Security, Medicare, Medicaid, and generous scholarships, but social mobility would suffer another blow. In a heavily taxed and regulated economy it is much more difficult for a poor worker to advance in income, wealth, and position than for a wealthy person to remain wealthy.

Globalization is outsourcing some white-collar jobs, which is more grist for the mill of the reformers. Their eyes are glued on executive incomes; they are blind to policies that have undesirable consequences, policies that may even give rise to the very effects, which they deplore. There cannot be any doubt that the monetary policies of the Federal Reserve System greatly affect not only the purchasing power of the U.S. dollar but also individual income and wealth. When economic activity slowed down in 2002 the Fed immediately slashed its discount rate to 1¼% and then 1%, the lowest in 45 years. Resting on the Fed rate, all other interest rates promptly plummeted to levels far below true market rates, which induced some investors to search for higher rates and higher incomes abroad. With the discount rate at 1% and all other rates not much higher, and with foreign rates at double and triple levels, it is only natural that many investors seek higher returns abroad. They may even have to leave the country in order to meet the competition that is now abroad. Surely, the driving force is the investor’s profit motive, but it is the Federal Reserve policy that creates the foreign opportunities.

In a free and unhampered economy the short run is a period of readjustment to a changing market condition. Entrepreneurs and investors react quickly in order to maximize their profits. When legislators and regulators, for any reason, erect their barriers, they obviously delay the readjustment; labor productivity and wage rates may stagnate or even decline. Legislation and regulation may turn a free market economy into a command economy with rigid income and class structures. Massive deficit spending may pave the way. At the present, the federal government is suffering budget deficits amounting to hundreds of billions of dollars, which are readily financed by the Federal Reserve System. Surely, the Fed does not directly purchase new Treasury I.O.U.s; it merely enables American and foreign financial institutions to buy them.

Extraordinary expansion of money and credit gave rise to phenomenal trade deficits, $618 billion in 2004, some $700 billion in 2005, and probably higher yet in 2006. Suffered by any other country, such deficits would soon cause the national currency to flounder and thus call an early halt to the deficits. But the U.S. dollar is the primary reserve currency of the world, which persuades many foreign creditors to cling to their dollars or invest them in dollar claims. According to some estimates, foreign banks and investors are holding some $9 trillion of U.S. paper assets. They are owning some 43% of U.S. Treasuries, 25% of U.S. corporate bonds, and 12 % of U.S. corporate equities. Dollar cash holdings as well as U.S. Treasury obligations obviously are no investments in business facilities, such as corporate stocks, bills, notes, or bonds, which would raise labor productivity and wage rates.

Many Americans undoubtedly are unhappy about the growing inequality in individual income and wealth. They are guided by simple motives and beliefs in the equality of man, which theologians, philosophers, and statesmen have featured since the beginning of time. Thomas Jefferson affirmed it in the Declaration of Independence: “We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of happiness.” No matter how we may read this declaration, it does not dwell on any equality of income and wealth. On the contrary, it speaks of “unalienable rights” in “the pursuit of happiness,” which undoubtedly comprises also the right to pursue income and wealth.

When Thomas Jefferson wrote the Declaration Continental Congress had little money and poor means of obtaining more. The financial situation was rather precarious. Congress then authorized many issues of paper dollars and the states followed suit, issuing their own. By the end of the war, they were “not worth a Continental.” Surely, the current situation differs significantly from that of the American Revolution, but it also resembles it in several important aspects. Then and now the political authorities eagerly issued paper dollars that lost some of their value every day. The economic maladjustments, which the issues brought about created countless opportunities for knowledgeable entrepreneurs to make the needed readjustments. While labor productivity and income stagnated or even declined, business opportunities and profits actually soared.

The old order always changes, yielding to the new; but many economic changes merely reflect variations in monetary policy and their inescapable consequences.


Dr. Hans Sennholz
for The Daily Reckoning
July 26, 2006

Editor’s Note: Dr. Hans Sennholz is president emeritus of The Foundation for Economic Education (FEE) in Irvington, NY. His essays and articles have appeared in over thirty- six major German journals and newspapers, and 500 more that reach American audiences. Dr. Sennholz is also the author of 17 books covering the Great Depression, Gold, Central Banking and Monetary Policy.

You can write to him at this address:

We pick up today’s missive where we left off – looking at the Big E’s…

Our second Big E is the Experimental monetary system. Funny money bears on the price of energy and on everything else. It is quite possible, for example, for the price of gasoline to go up even with no change in the supply or demand for energy itself. That’s because we are working with an elastic tape measure. As demand rises for energy resources, producers begin to see their oil and gas as precious assets and begin to ask what they are getting in return…and how they can get more.

Oil is calibrated everywhere in dollars, they notice. But what is the dollar calibrated in? The answer is that it floats in the air like a willow leaf. If the winds are favorable, it stays up. If it gets caught in a downdraft, it falls.

Thus, we have an “experimental” financial system; nothing like it has ever existed before.  We do not mean this is the first experiment with money lighter than air. No, the U.S. Treasury did not invent pure-paper money. It has been tried many times – only, never with happy results. And never, ever on such a grand scale. Now, practically every currency in the world is backed by dollars, while the dollar itself is backed by nothing. In fact, the whole world’s financial system rests on the shoulders of a single currency, which everyone knows to be a shirker.

Until now, paper currencies were backed by gold or sometimes by both gold and silver. Occasionally, they were by land or something else that is presumed to have real value.  The reason is obvious: If you open up a central banker, he has the same internal organs as everyone else. And just like everyone else, he is susceptible to influence and temptation. If people are reluctant to use a currency that does not have sufficient precious metal backing, it is because they figure that the bankers in charge can succumb to temptation as well as anyone else; they can print up so much money that each bill sheds a part of its value. They can create as many pieces of paper as they want and default on their promises. Lie. Cheat. Steal. Central bankers can do all of those. But people also know that bankers can’t create gold. And gold doesn’t lie. It doesn’t sneak out of town. It doesn’t cook the books. It doesn’t go up in smoke. It is what it is.

Indeed, the dollar was backed by gold, albeit imperfectly, until just 35 years ago. Then, on the 15th of August 1971, the Nixon administration cut the umbilical cord between the dollar and gold. We recall it nostalgically. We were driving cross-country and we drove into Albuquerque, NM, in the middle of a gasoline price war. Every gas station we passed quoted a lower price until we arrived almost in the middle of town to find regular gasoline for 25 cents a gallon. We cannot remember ever seeing it so cheap – before or after. Now, it is 1,200% higher. And we don’t believe that that’s solely because consumers want more or oil producers have less. In fact, output is higher than ever. It’s more expensive for one reason only – because it’s measured in dollars, and the dollar has been stretched out by inflation. Each bill now represents a tinier piece of the world’s wealth.

Thus have producers caught on to the science of modern central banking, which is nothing more than surreptitiously inflating the currency. Now that people know, the magic no longer works. Instead of increasing production in response to greater demand (more dollars), businessmen merely increase prices. Stagflation, it is called. We won’t dwell on it here, but yesterday, we gave an interview to a documentary filmmaker who asked us what we thought of it. “What do you most fear – inflation, deflation or stagflation,” he asked.

“We fear none of them,” we replied. “What’s more, we expect them all. The Fed is ‘flating up the money supply, which means we will have stagflation – with rising prices and little or no real economic growth. Soon, expect general deflation, as consumers are forced to cut back. Then, the Fed will panic. They don’t call the Fed chairman ‘Helicopter Ben’ for nothing. He has already told us what he will do if deflation menaces the economy: he will drop dollars from helicopters. This will cause hyperinflation and the destruction of the dollar.”

We only bring up out little chat to show that the Big E – our experimental monetary system – is unlikely to turn into a Big P – a permanent money system. In the first place, no money system is ever permanent. And a system not firmly attached to things of real value – such as gold – can be expected to last even less. Thirty-five years is already a record.  Our guess is that the dollar has a few years left, but not many. And when the end comes, it will be the same as in all such experiments. The world’s monetary system – with the dollar floating on nothing but air – will collapse and be replaced with something else.  When, how…at what cost? We don’t know, but judging from the way in which the quantity of dollars, debt, and derivatives has increased over the last 10 years, we guess that the change will come with crisis…within 10 years…and with much pain.

Which brings us to our next Big E: Economic Cycles – the normal ebb and flow of prices, as well as the big epochs in economic history. Temperature changes from day to night and from winter to summer, for example, but there are also extraordinary periods that last decades or thousands of years – ice ages followed by global warming. Indeed, Nicholai Kondratief described economic patterns as waves of growth and decline that last about as long as a human life. We suspect his work was mostly bogus, but there is nothing bogus about patterns.

For instance, we know that from boom to bust in the stock market is usually a period of about 18 years. The bull market began in 1982 – or 1975, depending on how you look at it. It ended in 2000, a quarter of a century later. The bear market that began in 2000 was held off, but not reversed, by the biggest flood of liquidity in human history. But that bear market is still waiting around the corner. And it will probably carry the Dow down to about 5,000 or lower before it is over. And, it probably won’t be over until 2015 or so.

We know that the bond market has similar patterns of boom and bust that last a very long time. Bonds fell from after World Ware II until Paul Volcker took charge at the Fed and managed to bring inflation under control 30 years later. Then, began a long bull market in bonds – with falling yields and rising bond prices – that either came to an end in June of 2003…or is still going. Looking at the chart, we think that bull market in bonds is over after lasting almost a quarter of a century. If we’re right, we could be looking at falling bond prices for the next two decades.

But can’t the Fed do something about either bear or bull market, you ask. That is one of the great illusions that begs correction. The Fed cannot control market cycles – or much of anything else. It can influence them, but then, only in a bad way. For example, after the boom/bubble of the 1990s, U.S. markets badly needed a rest; consumers needed to catch their breath and pay down their debt a little. But with 9/11 and visions of Japan’s 10-year slump haunting their sleep, the Fed panicked and pumped out so much new liquidity that it stopped the correction in its tracks. Instead of paying down debt, consumers contracted more. And instead of allowing the markets to take a rest, the Fed set them off on a five-year wind sprint that has left consumers doubled up in exhaustion.  Now, they have their tongues hanging out and their pockets turned inside out. And so now, the United States faces not only a bear market in stocks and an economic slump, but the worst fate a country can face: the destitution of the masses.

No one cares, particularly when speculators, punters, players, and gamblers take losses.  But it is another thing entirely when the middle and lower classes are wiped out. That is what happened in Germany in the 1920s. It is what happened in Argentina just a couple years ago. It is also what happened in France prior to the French revolution. You remember, a crowd of hungry peasants appeared at the palace gates. Marie Antoinette wanted to know what they were complaining about.  “They have no bread,” explained an attendant.

“Well, let them eat cake,” she said carelessly. After all, how could she know it wasn’t a matter of preference? In due course, of course, the mob leaped at her throat and she got her education. We wonder at whose throat the lumpen will leap this time, when they finally realize that the joke is on them?

The future is predictable, but who knows when it will happen.

More news from our friends at EverBank…

Chris Gaffney, reporting from St. Louis:

“Just as they did last year, the U.S. consumers seem to be looking past all of the negatives and continue to support the economy.”

Be sure to read the rest of today’s issue of The Daily Pfennig.


And more thoughts from Vancouver…

*** “Here’s the only trade you have to make in the next 25 years,” says our friend Steve Sjuggerud. “Buy commodities now. Sell them in 2016.”

Steve went on to point out that commodities and stocks go in opposite directions. When one zigs, the other zags. Bull markets in commodities typically last about 16 years. This one began about six years ago. So, it has about 10 more years left to run. By contrast, the bear market in stocks began in 2000. It, too, has about another 10 years to go. The investment game is easy, says Steve, buy into the bull market after it has gotten underway, but before it has gotten very far. Stick with it until it reaches an end. And then, sell the thing that is most popular at its peak and buy what is least popular.

In particular, Steve recommends St. Gaudens gold coins. The premium you will pay for the coin, over the price of the metal itself, is at an all-time low, he says.

*** And a note from Short Fuse, also reporting from Vancouver:

“Yesterday, history was made…after speeches from Addison and Bill – the Mighty Mogambo emerged from his bunker to regal the crowd at the Wealth Symposium with his speech: ‘We’re All Freaking Doomed!’

“As you know, dear reader, one of the Mogambo’s favorite subjects is Alan Greenspan and how the Federal Reserve, under his command, led the United States to financial ruin. Yesterday was no exception. At one point, he called the Maestro ‘a stinkin’ pile of dog crap.’ At least no one could ever accuse the Mogambo of mincing words…

“After riling up the audience, the Mogambo stepped down and Dan Denning emerged to bridge the yawning chasm between global analysis and specific stock plays. Dan mixed his respected macro views with seven stock recommendations specifically geared to ride on the global trends of the next three decades.

“Of course, we can’t give you the specific recommendations in these pages, but keep your eyes peeled for the full report from the conference, which should be arriving in your inbox shortly.”

More from the Fuse tomorrow…

*** “It really is amazing,” began a friend from New York. “When I was little no one in the Hudson River valley had any money. They all just got by – except the rich families with the big estates. But I remember that mansions were cheap, too. As late as the 1970s, you could have bought one of them – a huge place built in the 1840s, with big white columns and about 200 acres of ground – for less than $100,000. Now, the price would be in the millions. And all those little cottages in Rhinecliff, for example, people are paying a million dollars and more for them.

“Where’s all the money coming from? Well, from Wall Street, as near as I can tell.  People earn a lot of money on Wall Street and they decide they need another house for the weekends. And so, they come up the Hudson, and then they need other things, too – like restaurants and cafes – and the character of the whole area changes. All the old homeowners are rich.”

A few areas have done spectacularly well out of the latest period of financial exuberance.  Some will probably hold their gains. Others will revert back to their long-term mean prices.

*** Henry turned 16 on Monday.

“What do you think you might want to do in life?” we asked him. “Maybe you’d like to join the family business?”

“No, I don’t think so,” said Henry, “I’d rather do something where I get to travel a lot.”

“But we do travel a lot already,” we replied.

“No, I mean travel for fun. We’re always working when we travel. You always take us to places where there’s an old house to fix up. We’ve been working on this place for 10 years, and now you want us to work on that place you bought in Argentina,” Henry declared.

“That’s not work,” we protested, “that’s fun. And by the way, we need to change our clothes because we have a lot of stone to move for that stone wall.”

“Some people have pretty strange ideas about what is work and what is play,” said Henry. “That’s why I don’t want to work for you, Dad.”