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2017-10-11 — scmp.com

Central banks continue to focus on consumption inflation, not asset inflation, in their decisions. Their attitude has supported one bubble after another. These bubbles have led to rising ­inequality and made mass consumer inflation less likely.

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Despite low unemployment and widespread labour shortages, wage increases and inflation in Japan have been around zero for a quarter of a century. Western central bankers assumed that the same wouldn't happen to them without understanding the underlying reasons.

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The mistaken stimulus has the unintended consequences of dissipating real wealth and increasing inequality. American household net worth is at an all-time high of five times GDP, significantly higher than the bubble peaks of 4.1 times in 2000 and 4.7 in 2007, and far higher than the historical norm of three times GDP. On the ­other hand, US capital formation has stagnated for decades. The outlandish paper wealth is just the same asset at ever higher prices.

The inflation of paper wealth has a serious impact on inequality. The top 1 per cent in the US owns one-third of the wealth and the top 10 per cent owns three-quarters . Half of the people don't even own stocks. Asset inflation will increase inequality by definition. Moreover, 90 per cent of the income growth since 2008 has gone to the top 1 per cent, partly due to their ability to cash out in the ­inflated asset market. An economy that depends on asset inflation always disproportionately benefits the asset-rich top 1 per cent.

There have been so many theories on why inequality has risen. The misguided monetary policy may be the culprit. Germany and Japan do not have significant asset bubbles. Their inequality is far less than in the Anglo-Saxon economies that have succumbed to the allure of financial speculation.

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How is this all going to end?... In 2007, structured mortgage products exposed cash-short borrowers. The defaults snowballed. But, in China, leverage is always rolled over. Default is usually considered a political act. And it never snowballs: the government makes sure of it. In the US, the leverage is mostly in the government. It won't default, because it can print money.

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The most likely cause for the bubble to burst would be the rising political tension in the West. The bubble economy keeps squeezing the middle class, with more debt and less wages. The festering political tension could boil over. Radical politicians aiming for class struggle may rise to the top. The US midterm elections in 2018 and presidential election in 2020 are the events that could upend the applecart.

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