Ripping off the poor
August 13, 2004
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.
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 (see “The
Gold Price -- April 2003” in the Library section of my website
at www.paulvaneeden.com). 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.
Paul van Eeden
PS I’ll be in Las Vegas speaking at the Las
Vegas Precious Metals Investment Conference on September 8th and
9th. Please visit www.iiconf.com for more information (look for
the Las Vegas conference), and check the conference schedule on
the left sidebar for details about this, and other upcoming conferences.
Registration for the Las Vegas conference is $99 but
if you mention that you heard about it from me (Paul van Eeden)
you’ll get in for free. There is a drop-down box on the registration
page where you can check my name.
Also, I hold a workshop at each of these conferences
and several times in the past the workshops have been over-crowded.
You can now pre-register for my workshop to make sure you get in.
There is a separate registration box on the website to register
for my workshop (it’s right above the “Submit”
button). Hope to see you there.
Paul van Eeden works primarily to find investments for his
own portfolio and shares his investment ideas with subscribers to his weekly
investment publication. For more information please visit his website (www.paulvaneeden.com)
or contact his publisher at (800) 528-0559 or (602) 252-4477.
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