Easy Money Is Punishing the Middle Class

With the Republican Party committed to a gold commission and the Federal Reserve committed to easy money, a substantive debate about the principles underpinning our monetary system is finally in the offing. For sound money to carry the day, Republicans will need to do more than point out the still-hypothetical risks of easy money. The GOP will have to detail the harm that the middle class has already suffered as a result of a policy of low but persistent levels of inflation.

A little inflation appears to be a free lunch, lubricating the economy and gradually erasing past financial mistakes. But the nature of the free lunch is that its costs aren’t absent—they’re just distributed broadly. And in the case of low but steady inflation, the broadly distributed costs are borne by the middle class. Over time, rising prices have eroded American workers’ standard of living. And, over time, the Federal Reserve’s persistent easy money hurts the very person it is presumably intended to help, the American worker.

The notion that modest inflation is helpful to labor dates to John Maynard Keynes’s “General Theory of Employment, Interest and Money.” Keynes pointed out that the supply of labor is not a function of real wages alone. Rather, the instance in which the supply of labor is determined solely by real wages is a special case that fits into his broader “General Theory,” which showed the strong influence that observed wages have over the supply of labor.

He noted workers’ strong preference for a 2% wage increase in a 4% inflation environment to a 2% decrease in wages during a period of constant prices. But he also drew from this preference the obvious policy conclusion: A constantly rising price level can be used to make actual declines in wages more palatable, thereby reducing conflict with labor and leading to higher short-run employment.

The Federal Reserve doesn’t just understand workers’ tendency to use observed prices as a proxy for real prices; under Chairman Ben Bernanke’s leadership, the Fed has become increasingly bold in the exploitation of this tendency. With inflationary expectations not yet unsettled by the Federal Reserve’s $2 trillion balance-sheet expansion, Mr. Bernanke has committed the Fed to an open-ended round of quantitative easing in hopes of trading a little extra inflation for a little short-term employment.

The problem with Keynes’s theory and the Federal Reserve’s action—a problem that both Keynes and Mr. Bernanke long ago recognized—is that easy money only boosts employment in the short run. And, as Mr. Bernanke must now recognize, contrary to Keynes’s assertion, we’re not all dead in the long run.

The problem not fully recognized by either Keynes or Mr. Bernanke is that the low level of inflation necessary to anesthetize the American worker to declining real wages also has the long-run side-effect of anesthetizing the American worker to price signals needed to compete in the global marketplace. Inflation’s subtle corruption of these price signals at the heart of the market’s purpose underlies the unhappy situation in which both real wages and employment ratios have been in decline for decades.

The more than five-fold increase in the median income of the American household since 1971, to $50,000 from $9,000, certainly provides the clear appearance of progress. But after the dollar’s 82% loss of purchasing power over the same period is factored in, the median household income rose just 12%. This much more modest increase is largely the result of the growing prevalence of two-income households.

The median real income for working men over the same 40-year period rose just 8%. And that improvement only accrued to the ever-shrinking percentage of men fortunate enough to still have full-time jobs—just 67%, according to the latest data from the Bureau of Labor Statistics, within a percentage point of the lowest level on record since the figure was first recorded in 1948.

In the past four years alone, since the Federal Reserve started aggressively expanding its balance sheet, the declines in the middle class’s real income have been particularly severe. With American median household income unchanged at roughly $50,000 since 2008, inflation has been steadily chipping away at middle-class earnings. Adjusted for inflation, the real income of the average American household has fallen each of the past four years, resulting in a cumulative real decline of 7% since the Federal Reserve embarked on its experiment in money printing.

Having successfully protected the American worker from the sharp message of the market, the Federal Reserve is powerless to protect the American worker from the forces of technology and globalization reshaping the world economy. Recognizing the failure of so many American workers to adjust to the demands of the global market place, Mr. Bernanke has spoken passionately about the importance of education. But, the chairman’s speeches aside, the only real support the Federal Reserve is offering the middle class is help in financing ever-growing levels of public assistance.

The alternative to this unhealthy status quo is clear. The Federal Reserve needs to stop infantilizing American workers and start providing them with the clear message that only long-run stable prices can provide. To retrain, to adjust, to compete, the American worker needs the market’s unvarnished truth. This truth will in turn break the cycle in which American workers mistake the appearance of price stability for actual price stability, a mistake for which they receive the appearance of progress without its substance.

The recognition that persistent, low-level inflation leads to lower, not higher, long-term employment will also clarify the organizing principle of our monetary system. The Federal Reserve was not created to address an employment problem. The Fed was set up to ensure bank solvency, a prime directive from which it has not wavered.

With the Federal Reserve’s underlying mandate clear, we can weigh sound money that benefits the American worker against easy money that benefits the banks and leveraged financial institutions. Framed properly, gold money that holds its value over time will be clearly recognized as the best system for the American worker—if not the overleveraged banker.

By Sean Fieler

Mr. Fieler, president of Equinox Partners, L.P., a New York-based hedge fund, is chairman of the American Principles Project, a Washington advocacy group.

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