OK, Daddy Warbucks, This IS A Problem

Here’s a report from Citicorp on income inequality and the likely long-term economic patterns that may result from it.

The latest Survey of Consumer Finances, for 2004, has been released by the Federal Reserve. It shows the rich continue to account for a disproportionately large share of income and wealth in the US economy: the richest 10% of Americans account for 43% of income, and 57% of net worth. The net worth to income ratio for the richest 10% of Americans increased from 7.4x in 2001, to 8.4x in the 2004 survey. The rich are in great shape, financially.


We think this income and wealth inequality (plutonomy) helps explain many of the conundrums that vex equity investors, such as why high oil prices haven’t seriously dented growth, or why “global imbalances” are growing along with the equity bull market. Implication1: Worry less about these conundrums.

We think the rich are likely to get even wealthier in the coming years. Implication2: we like companies that sell to or service the rich -luxury goods, private banks etc. Favored names include LVMH and Richemont.

I’m always suspicious of “it’s different now” analysis like this. But I also think that suspicious, or not, you have to take these views seriously.

There are, in our opinion, two issues for equity investors to consider. Firstly, if we are right, that plutonomy is to blame for many of the apparent conundrums that exist around the world, such as negative savings, current account deficits, no consumer recession despite high oil prices or weak consumer sentiment, then so long as the rich continue to get richer, the likelihood of these conundrums resolving themselves through traditionally disruptive means (currency collapses, consumer recessions etc) looks low. The first consequence for equity investors who worry about these issues, is that the risk premia they ascribe to equities to reflect these conundrums/worries, may be too high.

I’ve talked about this stuff a lot – and the fear at root has always been that we’ll wind up with a vastly wealthy transnational monied class, and a large group of interchangeable workers – which may be great for much of the world, but will put the US well into Neil Stevenson’s model where “once the Invisible Hand has taken all those historical inequities and smeared them out into a broad global layer of what a Pakistani brickmaker would call prosperity” America falls apart.
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9 thoughts on “OK, Daddy Warbucks, This IS A Problem”

  1. “The rich are in great shape, financially.”

    One of the great insights of our time. People actually get paid for this stuff?

    I’ve got a thesis for a study:
    _”Poor continue to lag in wealth behind wealthier classes.”_

  2. This is a report from 2006, discussing data from 2004. If you had taken their advice to buy LVMH the day the report came out, you’d be down 10% right now.

    The rich were in better shape 5 years ago.

  3. It would be really interesting to track the Plutonomy Index through the crash and reflation of the last year or so.

    One of the core questions for the economy as a whole right now is whether the plutonomy rise was really an unsustainable faux-wealth illusion, with the full price tag yet to come. Knowing more will require asking about:

    How hard did the financial shocks hit the groups (financial and corporate) Citi tracks here?

    Has the financial crisis part 1 passed, only to be followed by the Economic Crisis? If it has, this report will be a quaint reminder of rose-tinted times. And there are certainly market forces (dollar slide, inflation) that could eat a lot of what’s left, some of which (e.g. dollar slide) would hurt the lowest 40% less.

    Inequality can become a problem. You can look all the way back to Sparta for an excellent example. To me, however, it’s secondary to the more fundamental question of whether an economy is building wealth or dissipating it.

    Citi’s whole price-insensititve plutonomy model is based, note, on an effective dissipation of wealth. I believe it’s not a bad description of where we’ve been going for well over a decade now, and their notes about dollar falling 50% vs. Euro while America’s European trade deficits increased gives us some excellent hard data to hang it on.

    The longer term question is whether their description still applies, and whether it’s going to remain as it is, get stronger, or enter its twilight.

  4. The departure of manufacturing from these shores has much to do with this. As does the practically worthless school system. In the near future we can look forward to failing infrastructure and government debt that eats up useful investment. If a health care reform bill passes this year, I expect medicine will start down the same slippery slope. Nor do I expect any quick fixes. It is going to be a long century before the god-awful reactionary socialist impulse stops kicking its heels and dies.

  5. Here’s the thing I wish people who talked about income inequality spoke to occasionally:

    “Married people in America pay 75% of all taxes.”:http://www.taxfoundation.org/news/show/1410.html Half of all Americans pay no income taxes; yet the married somehow end up with 75% of the bill.

    Sure, that’s because a married couple is a strong economic unit compared to, say, two unmarried singles. Still, we want successful marriages, right? Shouldn’t we want them at least as much as we want ‘income equality’? Shouldn’t our public policy encourage them by not taxing them disproportionately?

    Essentially, our concept is that married parents pay for their own children; while families that divorce or never marry have their children subsidized… by those same married parents. Meanwhile, we know that stable marriages yield children who grow up to be better educated, and more successful in a host of ways — in other words, that there are strong benefits to society as a whole from such families v. other forms of childrearing (to say nothing of choosing not to have children, who then provide nothing to society in future generations). And, hey, they pay more taxes too — them today, and likely their kids tomorrow.

    So, married couples are a great deal for society all the way around. Let’s raise taxes on them, in order to address the ‘inequality’! It’s only fair.

    “But wait, Grim,” you say. “We’re not talking about _married people_. We’re talking about _the rich_… the top 10%!”

    OK. “Take a look”:http://www.ntu.org/main/page.php?PageID=6 at these figures, and you’ll find that the top 10% pay 71% of income taxes. Married people pay 75%.

    In other words, it’s almost exactly the same group of people. The overlap is nearly a unity.

    So what’s the real source of inequality?

  6. I should clarify that first link to read “75% of all Federal income taxes,” not “of all taxes.” Obviously there are a number of non-income taxes that aren’t figured here.

  7. Interesting thing i’ve noticed in the healthcare debate- the Democrats are in a budgetary bind, but theyve finally got their big chance to soak the rich… er, make them ‘pay their fair share’.

    Now the House has a millionaire surcharge to pay for _part_ of the healthcare cost, but the nose counters seem to think this is DOA in the Senate. Baucus is going with a combination of Medicare slashing fantasy and taxing gold plated plans… old people and labor, two of the lefts most critical constituencies.

    Something is weird here. Ive heard right out of democrats mouths that a tax on the wealthy would be a job killer. THAT should be big news. Why is it a job killer now, but wasn’t when Bush was supposedly giving away the farm with his tax cuts? Have democrats (some anyway) had a come to Jesus moment and realized: 1.they are rich, and so are the swing voters that won them the last election 2.taxing the rich kills jobs, because the rich create jobs 3.you can’t tax the rich because they know how to hide their money, or go Galt if that fails.

    Interesting times.

  8. Both parties have forgotten the middle class. If wealth distribution is not centered there than an economy and a society is headed for trouble. I do no think this is a political issue. We should not be focusing on how rich the rich are or how much the poor have fallen behind, but rather keeping the wealth of the middle class stable and large. the rest will take care of itself.

  9. Did the comparisons and I think the plutonomy portfolio doesn’t do great – not horrible.

    I’ll post some graphs tomorrow.

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