1. 22 November 2011
Global Strategy
Alternative view
www.sgresearch.socgen.com
Global Strategy Weekly
Theft! Were the US & UK central banks complicit in robbing the middle classes?
Albert Edwards Mr Bernanke’s in-house Fed economists have found that the Fed wasn’t responsible for the
(44) 20 7762 5890
albert.edwards@sgcib.com boom which subsequently turned into the biggest bust since the 1930s. Are those the same
Fed staffers whose research led Mr Bernanke to assert in Oct. 2005 that “there was no
housing bubble to go bust”? The reasons for the US and the UK central banks inflating the
bubble range from incompetence and negligence to just plain spinelessness. Let me propose
an alternative thesis. Did the US and UK central banks collude with the politicians to ‘steal’
their nations’ income growth from the middle classes and hand it to the very rich?
 Ben Bernanke’s recent speech at the American Economic Association made me feel sick.
Like Alan Greenspan, he is still in denial. The pigmies that populate the political and
monetary elites prefer to genuflect to the court of public opinion in a pathetic attempt to
deflect blame from their own gross and unforgivable incompetence.
 The US and UK have seen a huge rise in inequality over the last two decades, as growth
Global asset allocation
Index SG in national income has been diverted almost exclusively to the top income earners (see
% Index
neutral Weight chart below). The middle classes have seen median real incomes stagnate over that period
Equities 30-80 60 35
and, as a consequence, corporate margins and profits have boomed.
Bonds 20-50 35 50
Cash 0-30 5 15  Some recent reading has got me thinking as to whether the US and UK central banks
Source: SG Cross Asset Research
were actively complicit in an aggressive re-distributive policy benefiting the very rich.
Indeed, it has been amazing how little political backlash there has been against the
stagnation of ordinary people’s earnings in the US and UK. Did central banks, in creating
housing bubbles, help distract middle class attention from this re-distributive policy by
allowing them to keep consuming via equity extraction? The emergence of extreme
inequality might never otherwise have been tolerated by the electorate (see chart below).
And now the bubbles have burst, along with central banks’ credibility, what now?
Top 0.1% income earners’ share of total income by country: did the US and UK central banks
allow/encourage housing booms to hide mounting inequality from the middle classes?
12%
Global Strategy Team 11% United States
Albert Edwards 10% United Kingdom
(44) 20 7762 5890
9%
albert.edwards@sgcib.com France
8%
Dylan Grice
share (in %)
7%
(44) 20 7762 5872
6%
dylan.grice@sgcib.com
5%
4%
3%
Please see important disclaimer and 2%
disclosures at the end of the document
1%
This article was first published on 21 January
0%
1913
1918
1923
1928
1933
1938
1943
1948
1953
1958
1963
1968
1973
1978
1983
1988
1993
1998
2003
2010. Only the internet links have been
updated
Source: Profs Emmanuel Saez and Thomas Piketty
Macro Commodities Forex Rates Equity Credit Derivatives
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2. Global Strategy Weekly
After reading Ben Bernanke’s speech, once again denying culpability for the bubble, I really
didn’t know whether to laugh or cry (remember that Ben Bernanke, like Tim Geithner, was a
key member of the Greenspan Fed). I feel like Peter Finch in the film Network, sticking my
head out of the window and shouting "I'm as mad as hell and I'm not going to take it
anymore!" Although criticism of the Fed (and the Bank of England) has now become louder
and more widespread, I feel my longstanding derision for their actions during the so-called
‘good years’ puts me in a stronger position than some to offer further comment.
Opening my 2002-2005 file of old weeklies I did not have to go any further than the first
paragraph of the top copy (end of December 2005). “As far as Alan Greenspan’s tenure at the
Fed is concerned, we have spared few words of derision. We have made plain our views that
the supposed US prosperity that has accompanied his tenure has been based on a grotesque
mountain of debt. We have likened the economy to a Ponzi scheme which will ultimately
collapse. He has allowed the funding of strong economic activity by mortgaging the US’s
future against one bubble (equity) and then another (housing), which is now beginning to
implode”. These are almost consensus thoughts now, but not then.
The pigmies that populate the political and monetary elites prefer to genuflect to the court of
public opinion. Blaming the banks is simply a pathetic attempt to deflect the public fury from
their own gross and unforgivable incompetence. We have stated before that banks are not the
primary cause of the bust. Just as in Japan, a decade earlier, bank problems are a symptom
of the bust. It is the monetary and regulatory authorities that are responsible for this mess.
And it is not just obvious in retrospect. It was perfectly obvious from the beginning.
I was shocked by a recent survey of Wall Street and business economists, published in the
Wall Street Journal (see Bernanke View Doubted 14 Jan – link). Asked whether they agreed or
disagreed with the proposition ‘excessively easy Fed policy in the first half of the decade
helped cause a bubble in house prices’, some 42, or 74% agreed with the proposition. So
unbelievably there are still 12 economists surveyed who did not agree! Even more incredible, a
majority of academic economists did not agree with the proposition. Maybe they have
sympathy for a fellow academic or maybe they actually believe the preposterous proposition
that the western central banks were not in control of the bubbles which were primarily due to
tidal waves of surplus savings washing across from Asia.
John Taylor shows this to be nonsense. There was no global savings glut (see chart below)
What savings glut?
Source John Taylor, The Financial Crisis and Policy Responses: An Empirical Analysis of What Went Wrong, November 2008
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3. Global Strategy Weekly
John Taylor is well known for his famous “Taylor Rule” for the appropriate level of interest
rates and he has been very vocal in his criticism of Fed laxity in the aftermath of the Nasdaq
crash in his paper ‘The Financial Crisis and Policy Responses: An Empirical Analysis of What
Went Wrong’, Nov. 2008 and elsewhere - link. His thesis is simple. Lax monetary policy
caused the boom in housing upon which euphoric credit excesses were built. The subsequent
bust was an inevitable mirror image of the boom. This simply would not have occurred had the
Fed (and the Bank of England) acted earlier to tighten policy as shown in the Taylor’s
counterfactual profiles (see charts below).
Source: John Taylor Nov 2008
More recently, the San Francisco Fed published a paper this month showing that those
countries which saw the steepest run-up in house prices over the last decade also saw the
largest rise in household sector leverage (see charts below and link). Of course the causality
runs both ways. Loose monetary policy generates higher borrowing which pushes up house
prices. Subsequently this prompts other households to borrow against the rising value of their
houses to finance consumption via net equity extraction.
Close relationship: household leverage and house prices
Source: Federal Reserve Bank of San Francisco
Generally most commentators have fallen for the populist line that the banks are to blame.
Very rarely does a leading commentator pin the blame where it deserves to be – on the central
22 November 2011 3
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4. Global Strategy Weekly
banks. Hence, I was very interested to read the Financial Times Insight column on Tuesday
from the deep-thinking columnist, John Plender (interestingly his title in the print edition was
“Blame the central bankers more than the private bankers” was changed to “Remove the
punchbowl before the party gets rowdy” in the web edition - link).
Plender’s point is classic Minsky. An unusually long period of economic stability, also known
as The Great Moderation, engineered by Central Bank laxity inevitably created the conditions
for the subsequent bust. “Central banks clearly bear much responsibility for past excessive
credit expansion. The Fed’s gradualist and transparent approach to raising rates in mid-
decade also ensured that bankers were never shocked into a recognition that unprecedented
shrinkage of bank equity was phenomenally dangerous. Despite the popular perception that
financial innovation caused so much of the damage in the crisis, the rise in bank leverage was
a far more important factor”. His point that it takes guts to remove the punch-bowl when the
party is in full swing is spot on. The Fed and the Bank of England were both gutless and
spineless. Their love affair with The Great Moderation meant they simply were not prepared to
tolerate a little more pain now to avoid a Minsky credit bust and massive unemployment later.
But what is the relationship, if any, between this extreme central bank laxity in the US and UK
and these countries being at the forefront for the extraordinary rise in inequality over the last
few decades (see cover chart)? And does it matter?
I was reading some typically thought-provoking comments from Marc Faber in his Gloom,
Boom and Doom report about current extremes of inequality. It reminded me that our own
excellent US economists Steven Gallagher and Aneta Markowska had also written on this. To
be sure, the rise in inequality has been staggering in the US in recent years (see charts below).
Income distribution in the US 35 million (1 in 8) Americans are now on food stamps!
50
Share of income accruing to each group
45
40
35
30
Top 10% (incomes above $109,630)
25
Top 1% (incomes above $398,909)
20
15
10
5
0
1917
1922
1927
1932
1937
1942
1947
1952
1957
1962
1967
1972
1977
1982
1987
1992
1997
2002
2007
Source: Emmanuel Saez, University of California Source: Sudden Debt, USDA
It is well worth visiting the website of Emmanuel Saez of the University of California who has
written extensively on this subject and now has updated his charts up until the end of 2008
(data available in Excel Format – link). The New York Times reported on the recently released
Census Bureau data and showed not only that median income had declined over the last
10 years in real terms, but that this is the first full decade that real median household
income has failed to rise in the US - link. What is also so interesting from Professor Saez’s
cross-sectional research is how inequality has clearly risen fastest in the Anglosaxon, free-
market economies of the US and the UK (also note that France, with much higher levels of
equality – see chart on front cover - saw much more subdued growth in household leverage).
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5. Global Strategy Weekly
Our US economists make the very interesting point (similar to Marc Faber) that peaks of
income skewness – 1929 and 2007 – tell us there is something fundamentally unsustainable
about excessively uneven income distribution. With a relatively low marginal propensity to
consume among the rich, when they receive the vast bulk of income growth, as they have,
then the country will face an under-consumption problem (see 9 September The Economic
News –link. Marc Faber also cites John Hobson’s work on this same topic from the 1930s).
Hence, while governments preside over economic policies which make the very rich
even richer, national consumption needs to be boosted in some way to avoid under-
consumption ending in outright deflation. In addition, the middle classes also need to be
thrown a sop to disguise the fact they are not benefiting at all from economic growth. This is
where central banks have played their pernicious part.
I recalled seeing another article from John Plender on this topic back in April 2008. His
explanation for why there had been so little backlash from the stagnation of ordinary people’s
income at a time when the rich did so well was simple: “Rising asset prices, especially in the
housing market, created a sense of increasing wealth regardless of income. Remortgaging
homes over a long period of declining interest rates provided a convenient source of funds via
equity withdrawal to finance increased consumption” – link.
Now you might argue central banks had no alternative in the face of under-consumption. Or
you might conclude there was a deliberate, 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 it is clear in my mind that ordinary working people would not have tolerated these extreme
redistributive policies had not the UK and US central banks played their supporting role. Going
forward, in the absence of a sustained housing boom, labour will fight back to take its proper
(normal) share of the national cake, squeezing profits on a secular basis. For as Bill Gross
pointed out back in PIMCO’s investment outlook ‘Enough is Enough’ of August 1997, “When
the fruits of society’s labor become maldistributed, when the rich get richer and the middle
and lower classes struggle to keep their heads above water as is clearly the case today, then
the system ultimately breaks down.”-link. In Japan, low levels of inequality and inherent social
cohesion prevented a social breakdown in this post-bubble debacle. With social inequality
currently so very high in the US and the UK, it doesn’t take much to conclude that extreme
inequality could strain the fabric of society far closer to breaking point.
The Japanese didn’t riot during their lost decade. Let’s see what happens in the US and UK.
Source: Datastream, SG Cross Asset Research
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6. Global Strategy Weekly
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