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How the Rich Rule

Libertarians know the financial system is rigged.
How the Rich Rule

ERNEST HEMINGWAY: I am getting to know the rich.

MARY COLUM: I think you’ll find the only difference between the rich and other people is that the rich have more money.

Irish literary critic Mary Colum was mistaken. Greater net worth is not the only way the rich differ from the rest of us—at least not in a corporatist economy. More important is influence and access to power, the ability to subordinate regular people to larger-than-human-scale organizations, political and corporate, beyond their control.

To be sure, money can buy that access, but only in certain institutional settings. In a society where state and economy were separate (assuming that’s even conceptually possible), or better yet in a stateless society, wealth would not pose the sort of threat it poses in our corporatist (as opposed to a decentralized free-market) system.

Adam Smith famously wrote in The Wealth of Nations that “[p]eople of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” Much less famously, he continued: “It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty or justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary.”

The fact is, in the corporate state government indeed facilitates “conspiracies” against the public that could not otherwise take place. What’s more, because of this facilitation, it is reasonable to think the disparity in incomes that naturally arises by virtue of differences among human beings is dramatically exaggerated. We can identify several sources of this unnatural wealth accumulation.

A primary source is America’s financial system, which since 1914 has revolved around the government-sponsored central banking cartel, the Federal Reserve. To understand this, it must first be noted that in an advanced market economy with a well-developed division of labor, the capital market becomes the “locus for entrepreneurial decision-making,” as Walter E. Grinder and John Hagel III, writing within the perspective of the Austrian school of economics, put it in their 1977 paper, “Toward a Theory of State Capitalism: Ultimate Decision-Making and Class Structure.”

Grinder and Hagel, emphasizing the crucial role of entrepreneurship in discovering and disseminating knowledge and coordinating diverse production and consumption plans, write: “The evolution of market economies … suggests that entrepreneurial activity may become increasingly concentrated within the capital market as the functional specialization of the economy becomes more pronounced.”

That sounds ominous, but as long as the market is free of government interference, this “concentration” poses no threat. “None of this analysis should be construed as postulating an insidious process of monopolization of decision-making within the non-state market system,” they write.

Market factors [that is, free and open competition] preclude the possibility that entrepreneurial decision-making could ever be monopolized by financial institutions. … The decision-making within the capital market operates within the severe constraints imposed by the competitive market process and these constraints ensure that the decision-making process contributes to the optimum allocation of economic resources within the system.

All bets are off, however, when government intervenes. Then the central role of the banking system in an advanced economy is not only magnified but transformed through its “insulation … from the countervailing competitive pressures inherent in a free market.” Only government can erect barriers to competitive entry and provide other advantages to special interests that are unattainable in the marketplace.

The original theory of class formulated by early 19th-century French classical liberal economists is relevant here. It was these laissez faire radicals who pointed out that two more or less rigid classes arise as soon at the state starts distributing the fruits of labor through taxation: taxpayers and tax-consumers. Rent-seeking is born.

It takes little imagination to see that wealthier individuals—many of whom, in Anglo-American history, first got that way through the enclosure of commons, land grants, and mercantilist subsidies—will have an advantage over others in maintaining control of the state apparatus. (Economic theorist Kevin A. Carson calls the continuing benefit of this initial advantage “the subsidy of history.”) And indeed they have.

“It seems reasonable to assume that individuals [in the tax consuming class] sharing objective interests will tend toward an emerging and at least hazy common ‘class consciousness,’” Grinder and Hagel write. (Karl Marx acknowledged his debt to the French economists for his own, crucially different, class analysis.)

Unsurprisingly, in a money-based market economy the financial industry, with the central role already mentioned, will be of special interest to rulers and their associates in the “private” sector. “Historically, state intervention in the banking system has been one of the earliest forms of intervention in the market system,” Grinder and Hagel write. They emphasize how this intervention plays a key role in changing a population’s tacit ideology:

In the U.S., this intervention initially involved sporadic measures, both at the federal and state level, which generated inflationary distortion in the money supply and cyclical disruptions of economic activity. The disruptions which accompanied the business cycle were a major factor in the transformation of the dominant ideology in the U.S. from a general adherence to laissez-faire doctrines to an ideology of political capitalism which viewed the state as a necessary instrument for the rationalization and stabilization of an inherently unstable economic order.

In short, financial intervention on behalf of well-heeled, well-connected groups begets recessions, depressions, and long-term unemployment, which in turn beget vulnerable working and middle classes who, ignorant of economics, are willing to accept more powerful government, which begets more intervention on behalf of the wealthy, and so on—a vicious circle indeed.

Fiat money, central banking, and deficit spending foster and reinforce plutocracy in a variety of ways. Government debt offers opportunities for speculation by insiders and gives rise to an industry founded on profitable trafficking in Treasury securities. That industry will have a profit interest in bigger government and chronic deficit spending.

Government debt makes inflation of the money supply an attractive policy for the state and its central bank—not to mention major parts of the financial system. In the United States, the Treasury borrows money by selling interest-bearing bonds. When the Federal Reserve System wants to expand the money supply to, say, juice the economy, it buys those bonds from banks and security dealers with money created out of thin air. Now the Fed is the bondholder, but by law it must remit most of the interest to the Treasury, thus giving the government a virtually interest-free loan. With its interest costs reduced in this way, the government is in a position to borrow and spend still more money—on militarism and war, for example—and the process can begin again. (These days the Fed has a new role as central allocator of credit to specific firms and industries, as well.)

Meanwhile the banking system has the newly created money, and therein lies another way in which the well-off gain advantage at the expense of the rest of us. Money inflation under the right conditions produces price inflation, as banks pyramid loans on top of fiat reserves. (This can be offset, as it largely is today, if the Fed pays banks to keep the new money in their interest-bearing Fed accounts rather than lending it out.)

But the Austrian school of economics has long stressed two overlooked aspects of inflation. First, the new money enters the economy at specific points, rather than being distributed evenly through the textbook “helicopter effect.” Second, money is non-neutral.

Since Fed-created money reaches particular privileged interests before it filters through the economy, early recipients—banks, securities dealers, government contractors—have the benefit of increased purchasing power before prices rise. Most wage earners and people on fixed incomes, on the other hand, see higher prices before they receive higher nominal incomes or Social Security benefits. Pensioners without cost-of-living adjustments are out of luck.

The non-neutrality of money means that price inflation does not evenly raise the “general price level,” leaving the real economy unchanged. Rather, inflation changes relative prices in response to the spending by the earlier recipients, skewing production toward those privileged beneficiaries. Considering how essential prices in a free market are to coordinating production and consumption, inflation clearly makes the economic system less efficient at serving of the mass of consumers. Thus inflation, economist Murray Rothbard wrote, “changes the distribution of income and wealth.”

Price inflation, of course, is notorious for favoring debtors over creditors because loans are repaid in money with less purchasing power. This at first benefits lower income people as well as other debtors, at least until credit card interest rates rise. But big businesses are also big borrowers—especially in this day of highly leveraged activities—so they too benefit in this way from inflation. Though banks as creditors lose out in this respect, big banks more than make up for it by selling government securities at a premium and by pyramiding loans on top of security dealers’ deposits.

When people realize their purchasing power is falling because of the implicit inflation tax, they will want to undertake strategies to preserve their wealth. Who’s in a better position to hire consultants to guide them through esoteric strategies, the wealthy or people of modest means?

The result is “financialization,” in which financial markets and bankers play an ever larger role in people’s lives. For example, the Fed’s inflationary low-interest-rate policy makes the traditional savings account useless for preserving and increasing one’s wealth. Where once a person of modest means could put his or her money into a liquid account at a local bank at about 5 percent interest compounded, today that account earns about 1 percent while the consumer price index rises at about 2 percent. Savers thus are forced into less liquid certificates of deposit or less familiar money market mutual funds (which arose because in the inflationary 1970s government capped interest on savings accounts). Fed policy thus increases business for the financial industry.

Inflation is also the culprit in the business cycle, which is not a natural feature of the market economy. Fed policy aimed at lowering interest rates, a policy especially favored by capital-intensive businesses remote from the consumer-goods level, distorts the time structure of production. In a free market, low interest rates signal an increase in savings, that is, a shift from present to future consumption, and high rates do the reverse. Behold the coordinative function of the price system: deferred consumption lowers interest rates, making interest-rate-sensitive early stages of production—such as research and development, and extractive industries—more economical. Resources and labor may appropriately shift from consumer goods to capital goods.

But what if interest rates fall not because consumers’ time preferences have changed but because the Fed created credit? Investors will be misled into thinking resources are newly available for early-stage and other interest-rate-sensitive production, so they will divert resources and labor to those sectors. But consumers still want to consume now. Since resources can’t be put to both purposes, the situation can’t last. Bust follows boom. Think of all those unemployed construction workers and “idle resources” that were drawn to the housing industry.

While some rich people may be hurt by the recession, they are far better positioned to hedge and recover than workers who are laid off from their jobs. Moreover, even after the recovery, the knowledge that the threat of recession looms can make the workforce more docile. The business cycle thus undermines workers’ bargaining power, enabling bosses to keep more of the fruits of increased productivity.

Bottom line: inflation and the business cycle channel wealth from poorer to richer.

The financial system isn’t the only way that the rich benefit at the expense everyone else. The corporate elite have better access to the regulatory agencies and rule writers than the rest of us. (University of Chicago economist George Stigler dubbed this “regulatory capture.”) Wealth also gives the elite a clearer path to politicians and candidates for office, who will be amenable to policies that make wealthy contributors happy, such as subsidies, bailouts, and other measures that socialize costs and privatize extra-market profits. Campaign finance “reform” doesn’t change this, and even tax-funded campaigns would only drive the quid-pro-quo process underground.

Finally, a significant source of upward wealth distribution is intellectual property. By treating ideas and information as though they were objects to be owned, IP law encloses the intellectual commons and deprives the public of benefits that a competitive market would naturally socialize.

The conventional understanding of rich and poor, capitalism and socialism, is profoundly misleading. A corporatist, mixed economy institutionalizes financial privilege in ways that are overlooked in everyday political discourse—in part because of the ideological deformations created by the system itself. As Austrian-school macroeconomist Steven Horwitz put it in a lecture this year, one need not be a Marxist to see that the state is indeed the executive committee of the ruling class.

Sheldon Richman is vice president and editor at The Future of Freedom Foundation and author of Tethered Citizens: Time to Repeal the Welfare State.