Saturday, August 13, 2016

How Inflation Creates Inequality Through Capital Gains

By George Reisman

In recent years, critics of capitalism have spent much of their time self-righteously
denouncing growing income inequality, which is now supposedly at a level not seen
since the 1920s.

It is no accident that the present period is compared with the 1920s. Both are
characterized by rapidly rising stock and real estate prices, whose rise serves to create
corresponding capital gains. Not surprisingly, these capital gains accrue overwhelmingly
to the wealthy, who are by far the largest owners of stock and real estate. The inclusion
of these capital gains in the calculation of income is responsible for much or most of the
perceived growth in income inequality.

In both the 1920s and the years since the mid-1990s, the underlying cause of the rise in
stock and real estate prices was inflation, in the form of a rapid increase in the quantity
of money manufactured by the Federal Reserve and the banking system. In both cases,
this additional money entered the economic system in the stock and real estate
markets, thereby driving up stock and real estate prices and creating capital gains.

Two essential facts to grasp about these capital gains and the income inequality that
follows from them are that they are transitory and ultimately illusory.

As soon as the new money entering the stock and real estate markets stops flowing, the
foundations of stock and real estate prices are pulled away and markets plunge, as in
1929, 2002, and 2008.

If inequality of income were recalculated in such years and the immediately following
years, it would be dramatically less, because substantial capital gains were replaced by
substantial capital losses.

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