The conundrum is this: Real incomes of 80% of American households, including the beleaguered middle class, have been declining since 1995; and income has been transferred to the top 5% who have a relatively low propensity to consume and a relatively high propensity to save. Those two factors should have caused the economy to stall.

But growth – with exception of some dry spells – has been more or less strong. How is this possible in a consumption-based economy when 80% of the consumers have less purchasing power than before?

Monetary stimulus, said a new report by Natixis, the asset management and investment banking division of Groupe BPCE, the second largest bank in France. Alas, that stimulus – the only thing that kept GDP growing over the period – is about to disappear.

The US Census reported late last year that in 2012, 46.5 million people were living in poverty, the largest number ever. The poverty rate has been rising from a low of 11.3% in 2000 to 15% in 2012. Many researchers claim that the official poverty rate understates the actual problem. For example, a study found that 38% of Americans lives from paycheck to paycheck – including parts of the maxed-out middle class.

Based on the Census data, the real incomes of the lowest 20% of households has edged down since 1980 to $11,490. The next quintile experienced a 4.3% increase spread over the 32 years – the definition of stagnation. The third quintile saw a gain of 8.5% over that 32-year period. The fourth quintile was up 18.8%. The top quintile was up 47%. But the top 5% – the happy campers in this economy – saw their incomes soar 72.5% to $318,052.

The scenario since 1997 has been even drearier: the purchasing power of the bottom 80% – a sign of our crazy times that these kinds of expressions are now common – declined or remained stuck. Only the top quintile saw an increase in purchasing power. And even within this group, the increase was concentrated at the top 5%. But these people have a high propensity to save, instead of blowing all their scarce money on bare essentials – which is what the vast majority of Americans have to do.

When 80% of the consumers lose purchasing power, overall economic growth over this period in an economy dependent on consumer spending should have been weak. But that wasn’t the case, the report pointed out. Instead, there has been “strong growth,” based on “a sharp increase in household consumption despite the stagnation in the purchasing power of the middle class. How is this possible?”

Turns out, income inequalities have been “corrected” by two effects of loose monetary policies:

One, expansionary monetary policy kept long-term interest rates lower than the growth rate from 1998 until the Financial Crisis in 2008. Cheap credit encouraged households to load up on debt to fill the widening holes in their incomes. Households became debt slaves, substituting “credit for income to consume and invest in housing.”

And two, starting with the Financial Crisis, the Fed unleashed QE and ZIRP on the economy, or rather on Wall Street, causing asset prices to skyrocket. These asset bubbles allowed people to feel richer and open their wallets and spend money. It stimulated household demand at the top where these assets were concentrated. The infamous wealth effect. And the household savings rate has been deteriorating again since the end of 2012.

So expansionary monetary policies have sustained growth by boosting household demand despite the devilishly declining purchasing power that most households suffered during that time.

Alas, now that the Fed is tapering QE out of existence and is thinking out loud about raising interest rates, both pillars of economic growth – ballooning household indebtedness and asset bubbles – are likely to buckle. And where would that leave the US economy? In trouble….

Now “the negative impact of income inequalities on US growth may appear clearly as a consequence of the stagnating purchasing power of the middle class,” the report argues. And so, “we fear” that “the weakness of the economy due to income inequalities may suddenly be revealed.”

It would of course come as another surprise to the Fed that its ingenious plan of enriching the top 5% via asset bubbles while pushing the vast majority of Americans ever deeper into the black hole of debt does not lead to stellar long-term economic growth – and might someday backfire.

So what happens when the huge and reckless buyers of stocks with their nearly endless resources start cutting back after a phenomenal peak? Well, we know what happened in 2008. Read….Last Time Corporate America Did This, The Stock Market Crashed

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