When Inequality Isn’t By John Mauldin | Mar 29, 2014

“An imbalance between rich and poor is the oldest and most fatal ailment of all republics.”

–Plutarch, Greek historian, first century AD

“In the economic sphere an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if weforesee them.

“There is only one difference between a bad economist and a good one: the bad economist confines himself to thevisible effect; the good economist takes into account both the effect that can be seen and those effects that must beforeseen.

“Yet this difference is tremendous; for it almost always happens that when the immediate consequence is favorable, the later consequences are disastrous, and vice versa. Whence it follows that the bad economist pursues a small present good that will be followed by a great evil to come, while the good economist pursues a great good to come, at the risk of a small present evil.”

–Frédéric Bastiat, “That Which Is Seen and That Which Is Unseen,” 1850

“Still one thing more, fellow-citizens – a wise and frugal Government, which shall restrain men from injuring one another, shall leave them otherwise free to regulate their own pursuits of industry and improvement, and shall not take from the mouth of labor the bread it has earned. This is the sum of good government, and this is necessary to close the circle of our felicities.”

–President Thomas Jefferson, first inaugural address

Plutarch argued over 1900 years ago that it was income inequality that lay at the heart of the failure of the Greek republics. Other writings of that period demonstrate that the leaders were worried about the distribution of wealth in society. The causes of unequal distribution have certainly changed over time, but it seems to be built into our DNA to obsess over what we have relative to what others have.

That we are living in the most splendid golden age in the history of humanity – if by golden age we mean that for the world at large there is less hunger, longer lives, less poverty, better healthcare, better and more universal education, and a host of other factors that are manifestly superior as compared to 2000, 1000, 200, 100, 50, and even 20 years ago – is patently evident. We are far from the world Thomas Hobbes described in 1651 in Leviathan when he said “[T]he life of man [is] solitary, poor, nasty, brutish, and short.” He would be amazed at the relative abundance achieved by mankind in the last 263 years.

And still, authority after authority the world over, in rich country and poor, from the President of the United States to the leaders of some of the most impoverished nations, describes income inequality as a fundamental injustice and the source of many problems .

We have spent three letters (so far) dealing with the topic of income inequality. The topic is everywhere in our daily conversation and in economic research. I’ve dealt with many of the facts of income inequality in these three issues and will try to conclude the topic this week. We’ve discovered so far that income inequality is a fact; however, income mobility has remained roughly the same over the last 40 years. That is, a person’s chances of rising from a lower stratum of wealth distribution to a higher stratum is approximately the same as it was in 1975.

We have liberals and progressives who use data to demonstrate the correlation between income inequality and recessions or slow growth and then erroneously equate correlation with causation. I think we have sufficiently shown the absurdity of their conclusions. This week we will look at some of the actual causes of income inequality, and in an argumentum ad absurdum I will offer “solutions” that I guarantee can absolutely reduce income inequality just as easily as taking money from the rich and giving it to the poor. In fact my solutions are far more direct, as they affect the causes rather than the effects of income inequality. I must warn you, however, that if you harbor a religious passion for pursuing higher taxes rates on the rich and rely on income inequality as your excuse, you may not be happy with my suggestions or with the rather inconvenient facts I present.

I would like to begin this week’s letter with a quote that might at first appear to have nothing to do with income inequality, but it strikes me that it is at the heart of the argument advanced by those who favor more progressive taxation. Charles Gave argues that there is a correlation (and he sees causation) between the financial repression perpetrated by central banks and the reduction of growth in the developed-world economies. And he links the low-interest-rate policies of central banks to an increasedGini coefficient and income inequality. Those of us who are of a more classical economic persuasion will find this correlation more attractive than we do the supposed one between income inequality and recessions. And we will see that the logic behind Charles’s argument is more compelling.

The simple fact is that there are many correlations to be found in the economic world, and politicians find economists useful in supplying justifications to support almost any policy. The fact that economists might not agree on the data that is used in this way is immaterial to politicians who are simply looking for an excuse to do what they want to do anyway. In this regard, economists perform the same function as shamans and witch doctors in tribal societies, who regard the entrails of sheep or some other unfortunate animal and predict the future, which generally corresponds to what the chief wants to hear. Economists are far more advanced than that, of course. We painstakingly gather data and develop complex computer models to show what our politicians want to hear.

I realize that I argue at the extreme and that most economists are actually well-intentioned and trying hard to figure out how the world works. But they cleave to economic theories in much the same way that people hold religious beliefs to try to explain how the world functions. These theories often predetermine the conclusions economists come to when they analyze data. Maybe someday we will have more precise models and better theories, but until then it is probably best to be somewhat humble in setting forth our conclusions.

Now, let’s devote a few moments of our attention to six paragraphs from Charles Gave’s latest note (gavekal.com – subscribers only) (emphasis mine):

I read everywhere that the US budget deficit is contracting because government consumption is falling as a percentage of GDP, now that the worst of the crisis has passed. This would be very good news indeed; however, I am not so sure that this decline is for real. In fact, I believe it is an accounting illusion.

Over a period of time long [interest] rates, if left to their own devices, always converge to the nominal GDP growth rate (this was

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