Despite a steady increase in aggregate output/ GDP over the past several decades income inequality has risen exponentially. From the 1970’s to present, earnings of the top 5% of citizens have risen steeply while earnings of the bottom 95% have stagnated (adjusted minimum wages is lowest in history). As it stands a small fraction of citizens own the vast majority of capital assets, liquid or illiquid, while the other 80% of the US population owns 7% of the wealth. Compounding multiple decades of real wage stagnation has been a continual rise in the adjusted consumer price index. Due to stagnating wages and rising prices, the savings rate for citizens– specifically the low and middle class– has seen a chronic decline and historical lows. As a result of these financial pressures the US population has accrued massive consumer debt to maintain consumption, of which 33% is revolving credit (such as credit cards) and 67% is comprised of loans (such as mortgage, car, student, etc).
Due to the dollar’s position as the worlds reserve currency, the past several decades have seen rising global account imbalance as foreign investment in the US steadily increases. Most of this foreign investment wealth originated from gains in the emerging Asian markets and increases in commodity, energy, and oil prices. With the US leading the world in developed financial markets, foreign investors are attracted to the financial liquidity of US markets. In addition, they perceive US assets as safe investing due to its reliable historical growth and stable government.
In the years following the tech bubble collapse, many believed that the low interest rates post 2001 would cause a run on the dollar. Instead foreigner investors looked for other American safe-assets. This high demand, combined with competitive greed and lack of regulation, led to the development of debt markets and their financial instruments and securities such as CDO’s and CDS’s. (Financial institutions placed additional pressure on mortgage lenders to find borrowers to meet demand. With rising real estate prices, this wasn’t difficult. These debt markets had exceptional yields and were thought to be reliable and safe assets.)
Due to bargaining power imbalances and habit persistence over income, lower class wage inequality has risen with increases in aggregate output. The rise in income inequality has been much greater than the rise in consumption inequality due to borrowing and taking on debt; that is, despite low and middle class income income/ wage stagnation, borrowing has allowed their consumption to increase, fueling domestic demand. However, because the lower class does not have access to international financial markets, they must borrow from wealthy domestic lenders. (From 1998-2008 private credit from other financial institutions, i.e. credit cards, loans, etc., rose from 37% to 150% of GDP, whereas private credit from deposit money banks rose marginally from 55% to 65%.) The sustained increase in consumption from borrowing has kept domestic demand high and increased aggregate output. It also created a deficit as domestic lenders acted as intermediaries for foreign investors who sought financial safety in the dollar in the form of liquid financial assets. Over the years this system has exacerbated inequality as lower class consumption and income decreased to the benefit of the wealthy as their consumption and investment assets increased.