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Inequality vs. Debt: Which is Worse?

By James H. Nolt

Tuesday night’s first Democratic Party presidential candidate debate had a unique tenor compared to all previous debates I have heard. I am pretty sure it is the first ever televised presidential debate during which the phrases “democratic socialism” and “political revolution” were uttered with a positive connotation. It also emphasized growing inequality to an extent never before heard.

These developments were largely because of the game-changing tone of Sen. Bernie Sanders’ populist campaign for president. Sanders even seemed to push the dialogue of the other candidates leftward, including the most conservative of them, former Sen. Jim Webb of Virginia, who barely registers in the polls. Furthermore, while the candidates did argue over some detail of policy, they seemed not to argue with Sanders’ “big issues,” namely, the corrupting influence of money in politics and the tendency of income and wealth to concentrate at the very top of the American social pyramid.

One of Sanders’ constant refrains during the debate and his stump speeches is that the richest one percent of Americans gained nearly all the increase in national income during the recent economic recovery since the Great Recession of 2007-2009. While the exact figures depend on the methods used, this point is substantially correct. Some of the supporting data are included in a recent paper by UC Berkeley economist Emmanuel Saez. He says, “The top 1 percent captured 91 percent of the income gains in the first three years of the recovery.”

French political economist Thomas Piketty’s widely reviewed book Capital in the Twenty-First Century includes similar findings worldwide over a much longer time span. Piketty finds that, over the centuries, capitalism tends to concentrate income and especially wealth. Piketty’s book is based on 15 years of extensive research into the data of all the major capitalist countries. His arguments also have the virtue of being clear and fairly easy to understand even for non-specialists.

Interestingly, Piketty finds that the only long period in recent centuries when wealth did not tend to concentrate increasingly at the top was during the two world wars and the years surrounding them. This accords with my own historical investigations as well.

The concentration of wealth fell during the world wars and the Great Depression because enormous quantities of capital were destroyed. Most of the loss of capital was not because of actual physical destruction of capital resources from bombing, ships sunk, etc., though this was a significantly minority of the total capital loss in countries including Germany, Japan and France. Rather it was because of the falling value of financial assets, including huge losses on bonds because of inflation and default, and, during the Great Depression especially, stocks. Moreover, the loss of capital had to do with the depreciation of physical productive capital that was worn out and not replaced as production was diverted from capital goods to weapons in all the combatant countries. Many countries suffered severe losses in productive capacity as a result.

Other than this one period, capitalism has proven very effective in concentrating wealth and income at the top. Piketty shows that the share of national income going to capital tends to increase over time. The recent results of income distribution in the U.S. that Sanders highlights are therefore not atypical of the long history of capitalism. Perhaps that is why he calls himself a democratic socialist.

The growth in capital’s share of national income also appears to be correlated with the growth of debt, especially private debt. This is not surprising, since debts are a form of financial capital. If debts grow relative to the real economy (which has a strong trend in recent decades) the total quantity of capital is growing relative to the economy as a whole and the quantity of debt capital is growing relative to the amount of productive capital, e.g., machinery and other physical means of production. As debt capital is added to accumulated physical capital, total corporate profits grow. This trend is starkly illustrated by several graphs in an article by The Atlantic editor Derek Thompson. The rapid growth of private debt is also why within total corporate profits, the profits of financial firms like banks and insurance companies have grown the fastest.

Debt is like a drug addiction. As it accumulates, more and more of society’s wealth is diverted from productive to unproductive uses, just as an addict may be unable to work productively, and live parasitically off the income of others.

Mainstream economists dispute this by arguing that private debts merely transfer income among people without increasing or decreasing the total amount of income. New debts do create new claims on income in the form of interest payments, but they also add to the buying power to the borrower, stimulating demand.

Such debt-induced demand, however, seldom stimulates all parts of the economy equally. Depending on who borrows the funds, this injection of new spending power may have various impacts. During the decade prior to the Great Depression, popularly known as the Roaring Twenties, private debt soared in many countries, and especially in the U.S., but the debt that grew fastest was the debt of non-financial corporations, which were spending heavily on new means of production, increasing capacity to produce more in the future.

During the contemporary debt boom, the private debt is growing fastest among financial corporations and the very rich, who are borrowing not mainly to expand real productive output, but to gamble using leveraged positions, as bears or bulls. Borrowing for financial investments does not necessarily create jobs or stimulate the real economy. Instead it may simply stimulate price bubbles in the value of assets like real estate, stocks, or, as I noted last week, T-bills. Sanders emphasizes that inequality is a moral problem, but that is not all. It also increases economic instability.

Borrowing to bid up the price of assets is a bullish move, but as I have often mentioned in this blog, it increases potential vulnerability to bears, who may leverage short positions using their own borrowing. The resulting rise in the relative value of financial assets and real estate increases capital’s claim on an ever rising share of society’s real output, leading to greater inequality in income distribution, as the data show.

However this debt bubble, because of its growing vulnerability to bearish assault, is inherently unstable. Crashes, large and small, are inevitable. Like an earthquake fault, several small crashes may scare bulls enough to induce deleveraging and avoid a huge crash. But in any markets where prices rise rapidly with few “corrections” and large increases in leveraged bulls are fueling the bubble, larger crashes are most likely.

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James H. Nolt is a senior fellow at World Policy Institute and an adjunct associate professor at New York University.

[Photo courtesy of Phil Roeder]

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