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Monday, November 22, 2010

QE2 polarizing Haves and Have-nots

The policy of supporting asset prices at artificially high levels through easy money policy is popularly referred to as QE2. This policy is widening the difference between Haves and Have-nots. 

Preventing new net Asset ownership
Asset Price support helps those who owns assets, while denying those who do not own assets an opportunity to ever own any asset. If you own some asset, you can convert it into others. If you do it skillfully by selling your asset at its peak price and buying other assets at their lowest prices, then you get richer. In other words, we are all asset managers.

What happens if we do not own any asset to start with? Well, earlier, your hard work, your labour value was an asset. But today that won't get you far. You need to start with an asset if you want to get close to median income. And that is where credits or loans come in. At a very basic level, you can get a students loan and improve your labour value and convert it into a labour category that markets value. This is the central utility of credit to our economy.

The Income-asset price connection
Usually asset price - income cycle works other way around. Higher median incomes drive asset prices up. The converse is not always true. In other words, higher asset prices need not drive median incomes. Note the use of word "median"income.

Here it is important to explain that at a gross level the asset price-income cycle is reversible. It means if we use total national income and asset prices across all assets in our cycle then we get a reversible cycle.

However, the moment we consider median incomes the reversibility breaks down. With each iteration, the income of the rich increases while those of the poor reduces. The median income reduces as we push through with these cycle.

Ben Bernanke is operating at a gross level but real economy will recover only when median incomes start stabilizing. Thus the Fed's policies of QE-X won't achieve anything unless Fed starts looking at median income levels. I hope they get it sooner than later.