The Fed takes middle-class to the cleaners

Despite all the talk about the progress made over the last four years, the jobless recovery is eating away at the American economy like a swarm of termites invisibly consuming a house from the inside out, widening income inequality and undermining Americans’ belief in upward mobility.

The economic growth rate has fallen to less than 2 percent and the only reason the headline unemployment rate has declined to 7.3 percent is because so many people – especially middle and lower class Americans- have stopped looking for work or are working part-time. Job creation can’t even keep up with population-related growth in the labor force.

It is anticipated that under Janet Yellen, the likely successor to Federal Reserve Chair Ben Bernanke, current monetary policy will remain in place and the government will continue to pump trillions into the financial system, keeping interests rates near zero to offset the drag of current fiscal policy. When considering the feasibility of any future quantitative easing, government speak for printing money, the Fed would be wise to consider the policy’s adverse effects on savers and retirees and their interest income.

According to economics textbooks, reducing interest rates and the cost of credit is supposed to spur lending; encourage spending on big ticket items like cars and houses; and boost business investment in inventories, plant, equipment and hiring.

Sure, credit is the most important and most direct channel through which the Fed’s polices affect the economy, but the transmission lines through which cheap money flows are clogged. Despite sitting on an astonishing $2.3 trillion in capital available for lending, banks remain reluctant to extend credit to all but households with the highest credit scores. If you don’t need money, you can get all you want. And by dropping its short-term lending rate to near zero, the Fed allows banks to borrow, for example at 0.10 percent and invest the proceeds in Treasury bonds. Nobody in their right minds wants to own the 10- year Treasury bond at a 2.5 percent interest rate, but banks are doing it because they can borrow at nearly interest-free and earn a spread of 2.40 percent.

The good news is that the Fed’s policies have boosted the stock market. Chairman Bemanke has said that “higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”

But while a rising stock market has helped market participants like financial institutions and large firms, it has done little to improve economic growth and reduce unemployment. The median amount of wealth middle-income families have is about $20,000. By contrast, the family that earns $90-$100,000 annually has about $424,000 in financial wealth.

The spoils of the recovery have not been equally shared. The boost in asset prices is likely to disproportionately benefit the wealthy and increase income inequality. Unemployment is still high by historical standards, economic growth is anemic, and real wages adjusted for inflation have not improved.

One of the overlooked consequences of the Fed’s rounds of monetary stimulus and reducing interest rates is to rob hardworking, average American savers and retirees of income and spending power, because the interest they earn on their savings isn’t enough to keep up with inflation. This dramatically reduces their spending, which hurts businesses, leaving them unable to hire. Consumer spending is critically important because it accounts for more than 60 percent of the nation’s gross domestic product.

But then who said the Fed was responsible for the equitable distribution of wealth, income or credit? After all, they have their hands full minimizing unemployment and inflation. Nowadays the average American doesn’t have much carry with a Fed whose policies are taking the middle class to the cleaners.

originally published: October 19, 2013

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