Some readers of this blog and my column argue that the ever-widening gap in income levels in the United States is not a big deal -- in fact, they say, raising it constitutes a kind of phony populism that only serves as a divisive argument at a time when the nation needs unity. They also say that the disparity is not the result of Republican administration tax cuts (Reagan and, 20 years later, again with Bush) but of other factors, including stagnant wages. They also say, essentially, that life for the middle class and lower is not so bad because families are smaller and all Americans have enjoyed periods of prosperity during the last 30 years, even as the income gap between the top and bottom widened significantly. 

"The increasing gap between rich and poor is a function of the dynamism of the US economy," wrote John Sandstrom of Phoenix, Maryland. "Low-skilled high-paying work is disappearing with jobs moving out of the country and those jobs remaining requiring training and education which translates into higher pay. Furthermore, the allegation that somehow the standard of living and income of the middle class has stagnated is likewise wholly incorrect and easily disproved with readily available statistics.  Family income is confused with individual income.  Largely because of prosperity, family size had gotten smaller and therefore family income has reduced or remained the same.  Consumption levels are the easiest way of determining increases in standard of living.  It has increased 74% from 1980 to 2004."  

Mr. Sandstrom cites the conservative columnist Thomas Sowell to support his take on this.

But, given the result of the last 30 years of tax policy and economic trends, and the disparity of the last decade alone -- a 9.1 percent growth in income for the top 20 percent, a 1.3 percent growth for the middle quintile and a loss of 2.5 percent for the bottom -- it's hard to agree that "prosperity" has been for all. Any such prosperity has been financed. Middle- and low-income families have gone into increasing levels of debt to get by.

People who know a lot more about this than Thomas Sowell or I do agree.
 John Campagna, of Benchmark Asset Managers in Baltimore, is convinced income disparity does make a difference and needs to be addressed.
"We have been tracking much of the [economic] crisis at a deeper level to understand what is needed in order to correct things and get us back on track investment-wise and as a country," he says. "If you are making over $250,000 you probably have not been borrowing as consistently as most Americans have who earn less, but it is not really even a debate about who is rich and who is not.  The debate should focus on what as a country should we do to give more income to the majority of people who have lack any income growth for 20 to 30 years, and in turn help our economy."

Campagna provided a good description of what the income gap has caused for the last 20 to 30 years, and how it directly contributes to the current crisis -- from the October newsletter of GMO. That's Grantham Mayo Van Otterloo, an investor whose chairman, Jeremy Grantham, is a widely respected investment manager with about $150 billion. He is an investor bear and was among those who predicted the collapse of financial institutions, hedge funds and some private equity firms. 

Here's an excerpt from his October newsletter that addresses household income and "illusory wealth" in the American mainstream:

 “The global economy is likely to show the scars of this crisis for several years. In particular, the illusion of wealth created by over-inflated asset prices has been dramatically reduced and, though most of this effect is behind us, a substantial part of the housing decline in some European countries and the U.S. is still to occur.

"We were all spending and, in the case of the U.S., importing as if we were much richer than is in fact the case. Particularly here in the U.S., increasing household debt temporarily masked some of the pain from little or no increase in real hourly wages for 20 to 30 years. Household debt since 1982 has added over 1% a year to consumer spending. Unfortunately, this net benefit does not go on forever.

"In the first year in which you borrow 1% of your income, the interest payment barely makes a dent and your spending is close to 101% of your disposable income. But each year you borrow an incremental 1%, your interest load grows. After 15 years or so in a world of an average 7% interest rate, the interest on the accumulating debt fully offsets the new borrowing when one looks at consumers collectively.
"Well, we in the U.S. are closer to a model of 30 years of borrowing an incremental 1%, meaning that we passed through break-even years ago and now pay much more in interest than we borrow incrementally.
"This is a situation favorable to an overfed financial structure as long as everyone can and will pay their interest, but it is no longer beneficial to aggregate consumption compared with the good old-fashioned way of waiting until you had actually saved up to buy a TV set. Indeed, a visitor from Mars examining two countries, one with accumulated consumer debt of 1.5 times GDP and the other with zero, would notice no difference except for the reduced number of consumer lending outlets.
"This generally unfavorable picture gets worse when you consider that we are likely to have, for the next 10 years or so, a modest annual reduction in personal debt of, say, 0.5% of gross income per year as well as a continued interest payment. So the debt accumulation effect reverses as does the illusion of the wealth effect from overpriced stocks and housing, especially the illusion of a decent accumulated pension. As we said two years ago (embroidering on Buffett), when the tide of overpriced assets goes out, it will be revealed not only who is not wearing swimming shorts, but also who has a small pension! Our silly joke has become a sick one in just two years.
"This reversal of the illusory wealth effect added to deleveraging will be felt worldwide, but especially in the so-called Anglo-Saxon countries, and will be a permanently depressing feature of the next decade or so compared with the last decade. It is indeed the end of an era.”