When Bubbles Fail: Albert Edwards Explains What Happens When The Fed Can No Longer Contain The Fury Of The "99%"

The premise in Albert Edwards’ latest letter “Is the Fed blowing bubbles to cover up growing inequality… again” is simple: the unprecedented social inequality in the US (and the rest of the world – as pointed out here), and what it will ultimately lead to. Regarding what it will lead to, Edwards believes, is that “growing inequality drains the swimming pool dry. The crunch, when it comes, will be ugly.” Simple enough.

Digging a little deeper.

It is ironic that nearly five years ago, we first posited that the only result QE would achieve as a result of reflating asset prices to astronomical levels, while transferring (in)finite wealth from the middle class to the 0.1%, would be an inevitable tear in the social fabric resulting, eventually, in outright conflict and/or war (and, ultimately, hyperinflation because the Fed will stop at nothing to reflate the debt, especially in a rising rate environment – even paradropping money from helicopters, something even Deutsche Bank agrees with now). Back then everyone called this (as so often happens) a naive conspiracy theory. Now, even respected strategists are starting to see things our way. From Edwards:

Some argue that central banks had no choice in the face of under-consumption, while conspiracy theorists might even conclude there has been some sort of unspoken collusion among policymakers to “rob” the middle classes of their rightful share of income growth by throwing them illusionary spending power based on asset price inflation. We will never know. But now it all makes more sense!

Naturally, economists being the last to voice concerns about the status quo (and their sanctity of their tenures of course), are even more muted. But even they are starting to admit the underlying threat.

Set aside any moral or political concerns you may have about rising income inequality – worries about poverty, justice, undue political influence or even social mobility. According to Mr. Dervis, co-author of the book, the research collected in “Inequality in America,” shows that a growing number of economists suspect that once inequality passes a certain point it may jeopardize economic stability and economic growth. As the book argues, “rebalancing of the distribution of income may play a role in unlocking the U.S. economy’s growth potential in a sustainable way.”

 

That is exactly the point Warren Buffet, Bill Gross and Stanley Druckenmiller make. You don’t have to be a communist to conclude that high levels of inequality not only adversely affects long-term growth, but also increases the economy’s vulnerability to recession.

Edwards then goes on to observe if in a world of record income inequality, all that matters is one’s “starting point”, i.e., being born with a silver spoon in the mouth. His conclusion: why certainly.

Joseph Stiglitz makes the most simple point in a NY Times op-ed “Our skyrocketing inequality – so contrary to our meritocratic ideal of America as a place where anyone with hard work and talent can make it – means that those who are born to parents of limited means are likely never to live up to their potential. Children in other rich countries like Canada, France, Germany and Sweden have a better chance of doing better than their parents did than American kids have.” He is right. There is growing body of evidence that the largest determinant of your income is increasingly your starting point.

 

When I was studying economics I think this was part of the lecture on the Edgeworth box: how well you do depends on your initial endowments and how far you move along the contract curve. Or to put it another way, it is economically inefficient for Tim (nice but-dim)’s parents to buy education at his private school while the highly intelligent Tracy sinks like a stone at a local sink school (no disrespect to any Tim’s or Tracy’s out there). It’s not about equality of outcomes, it’s about equality of opportunity. I think all of us, especially economists, can identify with that…until it comes to our own children, that is.

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