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While most everyone agrees that the so called mortgage crisis is what has lead the economy into recession, there is disagreement as to its causes and where to place blame. Looking below the surface for what induced the present situation, some point to unscrupulous lenders (and the lack of oversight that enabled them) while others blame irresponsible borrowers for the meltdown. In actuality, what these two viewpoints are referring to are not causes at all, but rather consequences of underlying disparity. The true root of the present economic downturn is an inequitable distribution of wealth and the blame belongs to those that promote policies that exacerbate the imparity. Since Adam Smith ushered in the modern age of economics by publishing The Wealth of Nations in 1776, there have been various philosophies or theories that were considered bona fide socio-economic principles. Some of these accepted beliefs resulted in no more than a shrug when their flaws were exposed while others produced disastrous results. The stagflation of the 1970’s, where the American economy saw a rise in inflation along with unemployment, contradicted the commonly held belief that inflation and unemployment had an inverse relationship. This was merely a lesson learned. In the late eighteenth century Thomas Malthus, in his publication An Essay on the Principle of Population, contended that a society will expand till it can no longer feed itself, resulting in a continual subsistence boom/bust cycle. The effect of this widely accepted dogma was the belief that catastrophes such as war and famine were “natural” means to limit population growth and promoted the notion that aiding the poor and starving was detrimental to society. The harsh response (or more accurately the lack of response) on the part of the British government to the Irish potato famine of 1848 is a stark example of how unsound convention can have disastrous impact on populations and the economies that support them. Malthus wrote his work at a time when the industrial revolution was just beginning in England. It would be another 40-50 years before the so called “second industrial revolution” heralded the advances in industry and agriculture that are still in place today. The changes that Malthus could not have foreseen – mechanization and automation, for example, produced crop yields that far outpaced population growth proving his contention (a foreshadowing of an aggregate “Peter Principle” – society rises to it’s own level of incompetence) to be precariously flawed. Today we are in a period of societal transition as well. The communication age is still in its infancy; it’s ramifications in regard to conventional wisdom are still unfolding. Not only are technological advancements changing the way we live, but so is the impact of the melding of autonomous markets into a world economy. And regardless of political dogma, the driving force behind the movement toward a common market is man’s inherent propensity for capitalism. No where is this more evident than China, where the planned economy of communism is rapidly giving way to demand based markets. Other previously secluded economies of so called “third world” countries are now emerging and impacting the global economy with ramifications being felt throughout the world -including the shining star of capitalism - the United States. Accordingly, it is imperative to scrutinize and evaluate long held beliefs about how capitalism functions with particular scrutiny toward societal reaction to economic policy. Franz Kafka said “Capitalism is a condition of the world and of the soul”. The science of that condition - macroeconomics - is really the study of aggregate psychology. One long held belief of modern economists is the notion that the wider the disparity in the distribution of wealth the more efficiently a capitalist economy functions. From a cursory glance this makes sense in that capitalism works best when incentives are strongest. The rich retaining their riches is a strong incentive as is the need to survive for the poor. But just as Arthur Laffer pointed out by graphing tax rates, the extremes –zero percent and one hundred percent - produce the same result – no revenue. The real point that Mr. Laffer made was that there is a point of diminishing returns in regard to increasing tax rates and revenue. Could this same cumulative rationale be applicable to disparity in the distribution of wealth? Consider the dynamics of inflation and the current mortgage crisis. While there are various types and degrees of inflation, the underlying root cause is too many dollars chasing too few goods. Too many dollars! That is exactly what prompted the hyper-appreciation in housing prices. The wealthy were willing to pay exorbitant prices for real estate because they could. This pushed housing prices up to the point that conventional financing for home ownership was not applicable to the working class which constitutes the vast majority of society. Thus non-traditional financing was born. And while the abuses of both lender and borrower of high-risk creative financing are what prompted the present recession, the root cause was that homes were not affordable by conventional means to the masses in the first place. Likewise, just as that impact can be seen in housing, other markets such as the auto or garment industries are affected in the same way. Traditional two and three year car loans have been replaced by five and six year loans and bridal shops now offer financing, so that the mass middle class can afford to buy cars and wedding dresses. Put succinctly, rich people, with their abundance of discretionary dollars, have an inflationary effect on prices that impact the middle class by lessening their buying power while they, the wealthy, are immune to the limitations of higher prices. They are also immune to the Keynesian reaction by the Federal Reserve of tightening the money supply (by raising the prime rate) as their needs for credit are negligible compared to the middle class that must rely on higher priced credit in order to maintain a moderate standard of living. It also negatively impacts small businesses resulting in higher unemployment, which, of course, prompts a different reaction by the Fed. And the cycle continues. But is it inherent to capitalism or just the recurrent result of a grossly disproportionate distribution of wealth? Winston Churchill once stated “The inherent vice of capitalism is the unequal sharing of blessings”. But like any vice, moderation is tolerable and excess is calamitous. We live in a country where one percent of the population possesses over forty percent of the wealth and executives at corporations that lose vast amounts of money earn eight and even nine figure incomes while the hard working middle class is forced to accept wage and health benefit cuts. At some point, that middle class will decide to not work as hard or just not work at all if their standard of living and quality of life is continually eroding. That in turn, will profoundly impact the lives of the select one percent. That is truly the point of diminishing returns and self interest on the part of the wealthy dictates that the repercussions of reaching that point remain unknown.
