You observe an aquarium filled with an assortment of small trees. The trees on the right seem larger, healthier, and more robust compared to those on the left. In fact, the further you look to the left, the less healthy the vegetation appears. You notice a water spigot located in one corner of the aquarium on the right, dripping water and providing ample hydration to the trees on that side.
Water steadily finds an equilibrium and distributes throughout, but not until the trees on the right have had their healthy share. The vegetation on the left receives what remains after the trees on the right have had plenty to drink.
Located near the base of the aquarium, you’ll find a second spigot that serves as a drain. It functions as an overflow outlet, ensuring the water level remains within a healthy range. The excess water appears to be filling a large reservoir situated beneath the main aquarium.
Suddenly, you notice that the trees on the right have long, healthy roots reaching the water stored in the reservoir, while the trees on the left do not. Some of them are barely able to touch the flow of water that eventually fills the reservoir tank
This is a simple metaphor for the economic system. Water represents liquidity or money. The water spigot on the right represents government fiscal spending and Central Bank monetary policy. The large trees on the right symbolize institutions and agents that have first access to new money, government spending, and government-endorsed industrial policies.
The trees further away from the right symbolize the average small- and medium-sized businesses, as well as the middle-class and lower middle-class working people.
The water level in the tank is analogous to the general money supply, the velocity of money, and/or the inflation rate as measured by the CPI. The overflow spigot serves as a deflationary force, keeping inflation low and filling the reservoir tank. The reservoir tank represents the financial and real asset markets, such as the stock market, real estate markets, arts, collectibles, and cryptocurrency market.
Governments, Central Banks, and commercial banks have the ability to add liquidity to the economy. Those with close access to money have a first-mover advantage, known as the Cantillon effect. This includes large banks, major corporations, the military-industrial complex, and government institutions. Agents who work for the government, such as government employees and social benefit recipients, also have first access to new money.
As new money circulates and permeates the economy, it incrementally drives inflation with each transaction. Over time, this process erodes the value of fiat money. Those positioned furthest from the money source experience the greatest inflationary impact.
Liquidity gravitates towards capital markets, filling the reservoir of assets such as residential real estate, commercial properties, cryptocurrencies, and collectibles. Surplus fiat money tends to be invested in assets that are both scarce and in high demand. Those with deep roots and with access to these capital markets are better positioned to benefit from the inflation-driven appreciation of these markets.
Inflation is not often reflected in the Consumer Price Index (CPI) due to numerous counteracting variables, such as global trade and technological advancements. These deflationary forces help to suppress inflation. It’s important to note that the CPI only measures a basket of goods, excluding financial, capital, and real assets.
Consequently, when governments and central banks generate trillions in fiat money, liquidity is channeled into capital markets. This leads to an inflation of speculative assets such as cryptocurrencies, collectibles, equity markets, and real estate. However, none of these are included in the official government Consumer Price Index (CPI).
When the value of stocks, real estate, and crypto rises, it’s often viewed positively. Conversely, increases in the cost of fuel, food, and shelter are seen negatively. However, these phenomena are related. Easy monetary policies from central banks and governments can devalue the currency. Money first flows into consumer goods, reflected in the Consumer Price Index (CPI), and the remainder flows into assets not measured by the CPI. These assets continue to appreciate because governments persist in printing money. While homeowners may be thrilled when their home value doubles in five years, it poses a significant challenge for first-time buyers. Moreover, this represents a market distortion and imbalance caused by government and central banks.
Individuals with deep roots to the asset and financial markets are protected from the detrimental effects of asset inflation. Those without such ties manage to maintain a standard of living just above the minimum. Without these deep ties, prosperity is illusive.
The paradox is that life for the lower and middle classes continues to improve in absolute terms, yet the wealth gap between them and the top 1% has never been wider. Why is this? Despite the bottom 99% having less access to asset markets, life continues to improve. Technology and free markets have created prosperity for all, including the bottom half. However, the wealth disparity between them and the top 1% continues to grow. Access to capital markets enable the rich to become richer and ride the wave of asset inflation created by governments and central banks. The lower 99% may have ascended the economic ladder, but they remain trapped in the gilded cage of golden handcuffs.
Only the top 1% can truly liberate themselves from labor. Their stake in the capital markets secures them a slice of the expanding pie, a product of government and central bank policies. Wealth initiates a cycle of escalating prosperity: inflationary assets appreciate, and wealth generates more wealth. Those distanced from the influence of government and central banks, however, face a more challenging climb towards financial independence. They must first establish deep roots in the reservoir of financial and real assets.
A byproduct of wealth generation through asset inflation is that affluent individuals often exit the workforce. They sustain their lifestyles through their investment assets, ceasing to contribute to production. This transition exerts upward pressure on inflation. As the consumer population grows and the number of producers shrinks, economic stability is compromised. If this trend intensifies, the economy could collapse under its own weight as inflationary pressure escalates in tandem with asset prices, fostering an unsustainable and unstable environment.
Another consequence of wealth from asset inflation and the significant wealth gap in society is the concentration of social, political, and financial power in the hands of the top 1%. This concentration of power can have varying impacts, from benign to highly positive or even disastrous, depending on their competence. It could accelerate growth and overall national wealth, or it could lead to an erosion of free market capitalism, liberty, and freedom. As the rich get richer, their power expands, and the wealth gap widens. The stakes are high. Can we trust the super-rich and powerful to act in the best interests of society?
Modern capitalism is driving capital markets to the moon, while inflation remains subdued. The overflow hole drains excess liquidity into the reservoir, inflating markets further. Rising home prices and higher S&P 500 numbers are seen as indicators of a robust economy. However, these are largely the result of distorted government spending and lenient central bank policies. No one complains about their 401K value increasing rapidly. Modern capitalism and free trade have suppressed consumer prices and continue to elevate the living standards of the average Mr. and Mrs. Smith. Yet, they remain oblivious to the underlying distortion and instability accumulating in the economic system.
Is a large and growing wealth gap in society truly problematic? Life is improving. We have more leisure time and an abundance of food, entertainment, and luxuries. Certainly, the top 1% have even more, but why should that impact us as long as our lives continue to improve? Modern capitalism appears to be a miracle (so far). However, we’re gradually witnessing a dangerous concentration of power and financial influence within the top 1%
This pyramid scheme must collapse at some point, right? How can wealth continue to accumulate at the top, with more people leaving the workforce to live off assets, expecting the rest of us to serve them? If government and central bank policies foster extreme wealth gaps through asset inflation, a tipping point will inevitably arrive. As more people ‘retire’ into the wealthy asset class, riding the wave of asset inflation, and leaving the rest of us to work our 9-6 shifts, a culmination will occur when there are simply not enough producers versus consumers. No matter how much money central banks and governments print, asset prices won’t keep up with wage inflation, and hyperinflation could destabilize society as the imbalance and loss of equilibrium bring the system down. The drainage hole fails when new money is pumped in faster than it can drain. The reservoir of assets cannot inflate indefinitely. There is a hard wall, and a reckoning will come.
A rebalancing will inevitably occur. As the top 1% sell their assets to exchange for goods and services, they’ll come to realize that it’s becoming increasingly expensive. Asset prices will eventually deflate to reflect the actual cost of living in society. This will lead to a new equilibrium or a reset
Could Artificial Intelligence and robotics offset inflationary pressure? These technologies could increase production, creating disinflationary and/or deflationary effects. Indeed, it’s very possible that advancements in AI and robotics could prolong the ‘Ponzi scheme’ for a considerable period.
As the government increases spending, it crowds out the private sector, which weakens the central bank’s ability to control inflation. Government fiscal spending pumps liquidity into the economy and expands the size of the government, while central bank tightening weakens the private sector and reduces the size of the private market. This will lead to higher rates, adding to inflationary pressures, and we’ll be locked in a death spiral of inflation. If the government or central banks implement yield curve control, then the question arises: who will buy our debts? The central bank will become the buyer of last resort, which will cause the US dollar to plunge and confidence to be lost. What foreign nation will want to hold US Dollars or Treasuries knowing that they’re being manipulated? This could fast-track the removal of the US Dollar as the world reserve currency.
Conclusion:
The global economy can be likened to a simple aquarium. One faucet symbolizes government spending and central bank money printing, while the bottom overflow faucet serves as an outlet for inflationary pressure that spills into the financial and asset markets (reservoir).
Liquidity primarily enriches those closest to the water source, enabling them to establish a cycle of wealth accumulation and deepen their roots into asset markets. This, in turn, allows them to further increase their wealth as future liquidity drains into the financial and real assets.
However, this uneven distribution has consequences. While liquidity does circulate throughout the economy, each transaction dilutes the potency and value of money. As a result, all members of society experience an increase in wealth, but the distribution is uneven.
The standard of living continues to rise due to the positive impacts of capitalism, global trade, and the free market. However, the issue of wealth disparity persists as the Cantillon effect favors those closest to new money. Inflation remains under control until a tipping point is reached, and excess liquidity hyperinflates asset markets, giving owners a false sense of wealth created by easy monetary policy and government spending.
As we approach the tipping point, this imbalance will need to be reset. A clash is imminent between wealthy asset holders who profit from inflationary forces and the 99% who have endured a prolonged, marginalized standing in society. Market and social equilibrium will disintegrate, currencies could collapse, and governments will no longer be able to print their way to prosperity.
The End
