Does the free market cause wealth inequality?

The wealth gap is a serious problem. The richest 20 percent of Americans now own 80 percent of the country’s wealth. Over the past three decades, the average American has seen his income either fall or remain flat. Over the same period, the top 20 percent of income-earners have enjoyed a modest rise in income while the top one percent have seen their income skyrocket.

While the left blames the free market for America’s wealth and income disparities, the real culprit is the government itself — specifically, the quasi-government Federal Reserve System.

The left’s solutions consist of the same tired nostrums: higher taxes on the wealthy, more wealth redistribution, and more government interventions in the market. Liberals want more big government, believing the market has failed and that the state must clean up the mess.

Their argument is a straw man. America does not really have a free market economy. We have central planners who control interest rates — the worst form of price fixing. At best, we have a mixed economy, containing elements of a free market but also elements of a centrally planned economy. Unfortunately, the American economy is becoming incrementally less free, a trend that has accelerated due to the financial crisis of 2007-2008.

In fact, since the financial crisis, we have witnessed unprecedented government interventions in the market — and the wealth gap has widened dramatically.

According to the Keynesian economic paradigm, in order to spur economic growth, the central bank should pursue an easy-money policy. Pushing more money into the economy spurs bank lending and consumer spending, causing the economy to pick up steam. We generally view this policy as neutral in its effects — i.e., the benefits are equal for everyone within the economy at large. The analogy generally offered is that this is like a “helicopter drop” that blankets the economy with new money. Fed Chairman Ben Bernanke has even been dubbed “Helicopter Ben” by his critics.

But the mechanism by which money actually enters the economy is far more destructive than the benign helicopter-drop analogy implies. Money does not enter the economy evenly. When the Fed creates a few billion dollars of new money, it does not write a check to every household in America. The money is injected into the economy through specific entities. Then, these newly printed dollars — or their digital counterparts — filter down to the rest of the economy.

Common sense tells us that the people who first receive the newly created dollars benefit the most. These folks are able to run out and buy stuff with their windfall before anyone else can. The folks who receive money from the Fed first are primarily the commercial banks, the so-called “primary dealers” — i.e., those banks which, according to the Fed’s website, “serve as trading counterparties of the New York Fed in its implementation of monetary policy.”

So it should come as no surprise that the financial sector has exploded since the crisis of 2007-2008. Since then, the Fed has engaged in a policy of massive on-again-off-again money printing, dubbed quantitative easing (QE). Much of this money has found its way into the financial markets. Thus, it’s no wonder that the Dow is once again at all-time highs.