Income Disparity in America

In the late 19th century, from 1870 to 1900, the United States rose to be the leading industrialized nation in the world, taking over this position from Great Britain. This was the culmination of the industrial revolution that had been going on for over a century. The economy rose at the fastest rate in history, and real wages, capital formation, GDP, and real wealth all increased rapidly. No period of time since has matched this growth, even with the recent tremendous increases in technology. By 1900, the U.S. per capita income was at least 50% higher than any major country in Europe. While the average American was experiencing a much better life, certain high profile industrialists were obtaining huge fortunes, such as John Rockefeller, J.P. Morgan, Cornelius Vanderbilt, and others. But the middle class was growing at an unprecedented rate.

The growth of the middle class had been going on since the beginning of the industrial age. In England, it began as the feudal system faded and free tradesmen with skills in demand were able to lift themselves out of squalor. Just as the feudal lords had established their own stature by forcing the king to accept the Magna Carta in 1215, so the tradesmen began to establish their own freedom and demands. This was the origin of the middle class. Before that, there had been wealthy landowners and serfs, and not much in between. Industrialization slowly grew the middle class and raised the plight of huge segments of the population. Nobel Prize winner Robert Lucas has stated, "For the first time in history, the living standards of the masses of ordinary people have begun to undergo sustained growth “ ... Nothing remotely like this economic behavior is mentioned by the classical economists, even as a theoretical possibility.” This was not because of a redistribution of the wealth that already existed, but because of the rapid increase of new wealth that never existed before, the production of durable goods in an ever more efficient manner.

So by the 1870s and 1880s in America, industry was pushing the standard of living to new heights. The highly successful were envied, but they were also quite philanthropic. For example, Andrew Carnegie gave 90% of his wealth to charity, and private money endowed thousands of hospitals, colleges, museums, schools, libraries, etc. That is not to say that there were no problems. Working conditions in factories gave rise to unions which enabled the working class to have more leverage. This led to other problems, such as violence during strikes and corporations attempting (often successfully) to use the courts to intervene in strikes. But generally speaking, the middle class grew rapidly and the average American quality of life became immensely better.

The setting for this advance in prosperity, including the enlargement of the middle class, was the individual liberty that existed in America, more so than in any other nation, and the presence of a sound currency. Industrialization creates products that enhance our wealth, but they still must be traded to have an effect on the lives of the people. Barter provides a reliable method to ensure that you receive something of comparable worth for that which you give. But barter is very inefficient, you must find someone who has what you want and who wants what you have in order to conduct a trade. Currency eliminates this inefficiency, but it is only reliable if it can maintain its worth. The founders of the U.S. understood this, and that is the reason that they insisted that the states could only make gold or silver a proper payment of debts. It was under this setting from 1870-1900, with the industrial revolution in full swing, that economic growth and real wages increased at the fastest pace in history.

Private banks of the day did issue notes not fully backed by precious metals which were circulated as currency, and this did cause panics and recessions from time to time, but because they were generally localized, they normally did not cause extreme hardships nor did they last long. It had been a longtime goal of many advocates of such notes to have a national bank provide the same function, and they had their followers in government. Alexander Hamilton was one such proponent and had successfully established the First Bank of the United States in the early 1800s, and a bit later the Second Bank of the United States. Thomas Jefferson had vehemently fought against any such bank, and it was finally terminated in 1836 by Andrew Jackson. Jefferson thought such a bank was not authorized by the Constitution and that it lent itself to corruption. Some of the issues we have seen in the last five years are all too familiar when we read the quote from Jackson about the bank; when he said “Gentlemen! I too have been a close observer of the doings of the Bank of the United States. I have had men watching you for a long time, and am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country. When you won, you divided the profits amongst you, and when you lost, you charged it to the bank. You tell me that if I take the deposits from the bank and annul its charter I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin! Should I let you go on, you will ruin fifty thousand families, and that would be my sin! You are a den of vipers and thieves. I have determined to rout you out, and by the Eternal, I will rout you out!”

So while there were brief periods of inflation and recession, overall the economy of the U.S. was the envy of the world, and this was due to liberty combined with a soundly backed currency. In fact, from 1810 until 1910, there was actually deflation in the U.S. The purchasing power of the dollar became significantly stronger. The same amount of goods that required $100 to purchase in 1810 only required $77 in 1910, and this was largely because of improved industrial efficiency combined with the stability of the currency. The middle class was surging.

Americans at this time were a hale and hardy people. Certainly, there were difficulties that existed that are much less commonplace today. Infant mortality rates were relatively high, and communicable diseases were more lethal then because of the lack of sanitation, but degenerative diseases were much less common than today by comparison. For example, cancer rates were 1 in 50, and diabetes was a rare disease.

But unfortunately, this environment was not to last. Banking interests wanted a way to expand their profit, and politicians wanted a way to be less constrained by the dictates of the Constitution. The people became more interested in what government could do for them, rather than how it could benefit everyone in the same manner. This resulted in the creation of the Federal Reserve System and the passage of the 16th Amendment in 1913. The former provided government with a way to borrow money at will, thus bypassing the need to raise taxes in order to fund pet projects. The latter provided a way to tax without depending upon consumer behavior. They need not depend on the people to spend money in order to collect it. Of course, this passed with the help of the promotion of the idea that the income tax would only apply to the rich, and would never surpass 1% of income. Obviously, that was not true.

The first major effect of the transformations of 1913 was the dismantlement of sound money on a national scale. This resulted in the United States being able to fund involvement in WWI, which led to the deaths of hundreds of thousands of Americans and the enlargement of the military industrial complex. It also had a much more devastating effect on the entire world. Without U.S. involvement in WWI, the war would likely have resulted in a stalemate, with much of Europe returning to pre-war boundaries and conditions. Instead, the Treaty of Versailles imposed harsh penalties on Germany, led to the hyperinflation of the German currency and provided the environment that was ripe for the rise of Hitler a decade later. It also provided the environment for the Bolshevik Revolution in Russia which resulted in the eventual slaying of millions of Russians, and thereby gave rise to the cause of fascism in Italy and other parts of Europe as a counter reaction to communism. Thus, without U.S. involvement in WWI, there likely would never have been a WWII, and without WWII some of the reasons for the unrest in the middle east today likely would never have existed.

The ability to create money almost at will resulted in the second major disaster from the 1913 changes. Wall Street became highly leveraged as even middle-class Americans bought stocks on the margin and were becoming wealthy on paper, but there was not a corresponding rise in actual productivity. This bubble was known as the Roaring ‘20s and the American economy sped forward as if there was no end in sight, but there was an end. The bubble burst and resulted in the longest and deepest depression ever experienced. The Gloomy ‘30s was not limited to America. Most of the western world suffered to some extent as well. Huge government expenditures were put in place but to no avail, and the depression really did not come to an end until after the end of WWII. Post war government spending cuts and the international agreement known as Bretton Woods, which pegged the U.S. Dollar to $35 per ounce of gold finally brought the economy back to life and prosperity resumed. The 1950s were enjoyed with even greater benefit to the middle class, as by this time technology had made huge advancements over the last half century and all the people benefitted.

But the American government just could not resist the temptation to print money. In the 1960s huge social programs were enacted and the Vietnam War was raging. Both of these were huge drains on productivity. I remember my college economics professor in 1969 stating that the Vietnam War had the same effect as taking hundreds of American factories and dumping them in the jungle and setting them on fire. When productive capital is used for things that blow themselves up, there is a loss of true wealth. On Main Street, however, the effect seemed minimal at the time. Business kept going at a seemingly steady pace, but the losses were still occurring, like a unknown cancer. The loss was in the form of a gold drain from the country. By 1970 gold coverage by the U.S. of the dollar had dropped from 55% to 22% and gold was being depleted from the country to cover the dollars being spent internationally. Private banks of the Federal Reserve System also got into the act, as the personal credit card became common in American life and a new way to create money sprouted.

By 1971, the ability of the U.S. to cover expenditures in gold was all but exhausted, and President Nixon chose to remove the U.S. from the Bretton Woods agreement and allowed the price of gold to float. This had the effect of high inflation and shortages, especially of imported oil, as Americans stood in line at the pump hoping to buy gas before the station ran out. But while this relieved the immediate problem of the gold drain, it was the beginning of a new disaster, as the backing of currency shifted in essence from gold to something not as stable, but more abundant: real estate. The gold had run out, but instead of tightening their belts and becoming fiscally responsible, the American government began spending the real assets of the American people. More and more social programs were enacted, and more and more military involvement around the world began to occur. Like gold, real estate values began to surge, and homeowners mistakenly thought this was a wonderful thing. Some, of course, who sold their homes before the inevitable crash in 2008, made windfall profits, but the vast majority have lost or are in danger of losing the entire savings of their life.

The problem of income disparity in American life today is not really about the vast amount of difference between the top CEOs and the average worker. That is really not a problem as long as your purchasing power is intact. But the real wages--adjusted for inflation--of the average American has not changed since 1971, when Nixon removed the U.S. from the gold standard. In other words, the average American has had zero gain from the incredible amount of productivity and efficiency gained by the technological advancements of the last 40 years! The reason for this is, without a doubt, the lack of a sound currency with which he/she can trade reliably. As mentioned before, from 1810 until 1910, the value of the dollar increased by 23%. A hundred dollar purchase in 1810 would only have required $77 in 1910. But today, a purchase that required $100 in 1910 would have cost $2,330 in 2010! The dollar had lost over 95% of its value, and that was immediately after a huge correction in 2008. Every time the government or the banks create money without a corresponding increase in production of goods and services, the value of your money decreases, so if you agree to sell your labor at a certain price today, you probably will not receive the same value next month, as the Fed has introduced more dollars into the economy. Currently, they are doing so at the rate of $85 billion per month, known as quantitative easing, or QE.

This is a fundamental problem. No amount of tax adjustment or monetary manipulation can solve the problem of the shrinking middle class. Only a return to a sound currency, where people can trade efficiently, yet reliably, can solve the problem.