Ignoring the Correlation

Paul Krugman waxes about income inequality:

Apologists for rising inequality often argue that since most Americans’ income has risen despite rising inequality, there’s no reason to complain about inequality other than envy.

You see the contrast: a doubling of family incomes in the post war generation compared with maybe 20 percent since, and family incomes growing in line with GDP before, lagging far behind since, with the difference basically being the rising share of the 1 percent.

This is real stuff, not some trivial envy-driven concern. But we must be very, very quiet about it, right?

Krugman is very quiet about one thing: the fundamental change in the monetary system that took place in 1971, the year that Richard Nixon made the dollar a completely fiat currency by removing its peg to gold. After that event, income inequality has really raced ahead.

Now I know full well correlation does not imply causation. But I also know that giving central bankers free rein to print as much money to hand out like candy to their friends in big finance does imply that they will do it. How do I know that? Because they do:

From the Levy Institute:

The bottom line of crisis of 2007-9: a Federal Reserve bailout commitment in excess of $29 trillion.

My hypothesis is that leaving the gold standard was a free lunch: headline GDP growth could be achieved without any real gains in productivity, or efficiency, or in infrastructure, but instead by pumping money into the system and assuming that this would have a positive effect on the economy as a whole. After all — say the Keynesians — “aggregate demand (i.e. money circulation) is the state of the economy”.

But in reality “higher GDP” and “higher aggregate demand” just mean more money circulating. It’s perfectly possible for more money to circulate while the real economy (productivity, labour, technology, infrastructure, etc) deteriorates. In fact, in many respects this is exactly what happened during the Bush administration, where trillions of dollars of productive capital was burnt up on military adventurism.

Now maybe I have a thick skull. If so, could someone explain to me what I’m missing? The Federal Reserve was set free to print as much money as it wanted and give it to its friends with little oversight, and in the following years income inequality soared.

Seems like simple cause and effect.

62 thoughts on “Ignoring the Correlation

  1. Your hypothesis would seem very plausible. Especially since are primary export is “money” and not goods and services. Has there been much scrutiny of the FED over the years, since its modern inception, or is the current demand for more transparency the only real challenge it has faced?

  2. I don’t accept greed and envy explanations. I’m certain there are those in the 1% who are driven by greed as much as anything else, but I also convinced the majority are motivated by achievement and advancement of the human condition. And much of the envy seems to come from the ‘conscience of the liberal’.

    Not knowing how the demographic defining family is defined and tracked, it strikes me that the changing composition of the family relative to the distribution of ‘capita’ might have some effect. But I think that your issue related to the gold standard and fiat currency might be most of the explanation.

    I was there when the Nixon Administration carried out that change. America was in the middle of a serious recession, I had three young children and a job with a small technology company at high risk of going under, so I made changes to compensate that turned out well for me and my family. But, in the long run of history (my lifetime), I question, as you do, the macroeconomic propriety and efficacy of the dropping of the gold standard altogether. This was not the only strange economic policy action taken by Nixon, so I’m certain he is not the source (having understanding of what he is doing and why) of these moves.

    I’m interested in how these moves originated and who in the U.S. were the drivers and I will be doing some research for that explanation. Anyone here who already knows the details, chime in.

  3. As the Keynesians (and Paul Krugman) have been so prone and eager to mistake correlation for causation, it seems weird that they are so dismissive of even considering this obvious correlation (and whether it may imply anything). And it’s not just income inequality: you could take other statistics like unemployment, work force participation, income adjusted for inflation etc. etc. and you’ll see an obvious trend emerging at the beginning of the 1970s.

    As for Bob Thompson’s comment: when a system is complex enough you shouldn’t even bother to look for causes, because the system will just choose that path of least resistance.

    • Your last is intriguing, to say the least, but if we are seeking solutions, don’t we need to understand what problems we are trying to solve and use what we know to solve them? That is, if we have such knowledge, and, if not, don’t we have to learn how regardless of the complexities involved? Are you saying that we have reached the limit of our ability to exercise control over the society we have built and now the society controls us?

      • I’m just saying that the idea of dropping the gold-link likely appeared as the best course to follow from many, many angles. Of course, there were back then people that were against this move for the right reasons and these people have now been likely proven correct. I’m just saying that trying to pinpoint the decision to drop the gold standard on a single individual or group of individuals that *were certain* of what they were doing and of the *ultimate implications* of what they were doing, would be incorrect.

        • I’m really not very interested in who but the arguments for why the gold standard was dropped so any new knowledge acquired over four decades can be used to debunk those arguments (if, in fact, they do). I appreciate your points.

        • The French were to turn in some $280 mil USD in exchange for gold and Nixon wanted to stiff them. He then turned around and propped the now fiat USD by agreeing with the Saudis to overturn US law which limited US imports of crude to 25% in exchange for Saudis agreeing to make all oil transactions in USD. Now this petrodollar wall is crumbling and one day we will no longer be able to export our inflation.

  4. PS: “And it’s not just income inequality” -> Actually you should check these (not sure I mentioned the correct statistics, but I did see many others that match this pattern – also, you should check what ShadowStats are saying as well).

  5. It may be a circular argument in the sense that GDP growth is a good measure of the success of Modern Monetary Theory but it only applies if the economy obeys all the assumptions set out. The reality is that growth in GDP is not the same as growth in prosperity and certainly not equality.

    Central bankers of the last 25 years have indeed had a free lunch too, they have been able to pump liquidity into the economy with little recourse as a result of 3 massive tectonic global influences which started in the late 1980’s and exerted huge disinflationary forces: Perestroika and end of cold war, rise of Emerging Asia Mercantilism, birth of the Internet.

    • I realised a while back that those disinflationary influences you are talking about, coupled with mandates of “price stability” may have made for a more bubble-friendly world.

      The more externalities cause disinflation, the more inflation central bankers need to create for CPI to remain at close to zero. This also means that inflation will be concentrated predominantly in certain sectors that do not benefit so much from externalities — specifically housing, but also IPOs, energy, etc.

      The biggest problem, though, has surely been the securitisation of these bubbles. This has meant that when the bubbles burst it dragged down the entire economy as many institutions, banks and funds owned these securities.

  6. You correlate it to a worng things. Income dsparity has nothing to do with gold standard. Rather it’s mostly affected by taxes. Remember that marginal tax was 90-93% during 1994-1963. You take more from the rich and distribute it to the poor. This how it works. This distribution system started to fail with globalization: cheap labor abroad moved taxable production out of the country, making it impossible to control taxable income.

    • Assuming that income inequality is a function of government not redistributing enough seems quite one-dimensional. Net income results from a variety of factors, of which tax rate is secondary.

      The key factor is that you’re not explaining why there is a correlation between income inequality and fiat credit creation.

      Here’s the US money supply from 1960:

      The money supply starts exploding as soon as income inequality does. The more money is created, the more unequal the distribution seems to be. That makes sense; all that credit creation is not going to wage labour, it’s being pumped out by the Fed and then lent by the PDs and going into Wall Street. And very little seems to trickle down.

    • John was not inferring anything, he was merely presenting a correlation. To address your comment: how would globalization have played out under a gold-linked currency? Perhaps we should ponder whether the day of reckoning would have come much sooner than under the fiat-dollar standard.

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