Monday, June 3, 2013

Explaining Wealth Inequality Without Needing a PhD

I kept hoping someone else out there would have done it so I did not have to.  But for some reason, everyone keeps beating around the bush so I guess I will have to be the one to connect the dots.  First, the most important thing in capitalism is capital and people with capital makes the rules.  Second, accumulating such capital via smart allocation of savings is just another skill that some people are good at.  Whether that is through impeccable speculation in financial markets or shady lobbying of the government process, the result is the same: money is taken in, saved, and compounded.  It is that simple.

So you have a bunch of people who get richer every day through the magic of compounding.  If the economy holds up, by definition, these people's assets will grow exponentially.  The greater the amount, the faster it grows.  But no economy goes up in a straight line.  As Minsky said, stability is destabilizing.  Basically a successful investment gets people to put more and more money in.  Soon you have people putting in money who are blinded by potential riches and the mania implodes, leading to those who take part losing a large percentage of their wealth.  This is how asset inequality usually sorts itself out in "free markets."  

So in America, you have the top 20% controlling just about all of the financial wealth, ie stocks, bonds, etc and the higher % you go, the more seemingly egregious amount of financial wealth they own.  During bull markets, asset inequality grows because as the markets go up, so do these individuals' net worth.  Combine this with our current society's allergy towards saving money and the gap gets even wider.  However, our government's standard operating procedures have essentially outlawed true market crashes for the sake of stability and thus have guaranteed the continued increase in wealth inequality.  Imagine how much further the bear market would have gone without TARP, large deficits, and a Fed which did not try to induce a wealth effect by pushing individuals into stocks.  If stocks were truly allowed to be liquidated a la Andrew Mellon, I guarantee you nobody would be talking about asset inequality.  Just look at the gap between rich and poor before and after 1929.  

It is not a coincidence that asset inequality started to increase in 1982 as that was the beginning of the secular bull market.  Unfortunately, the current bear has not been allowed to do its job, which is to redistribute the wealth so someone else can get a turn living like a king.  This is the natural cycle and it has been disturbed in the name of stability.  But ultimately short term stability is destabilizing as more and more wealth is held by fewer hands.  Volatility and instability and chaos will happen and should happen.  Forcing it to not happen when it naturally wants to will just ensure a bigger cataclysm in the future.  In the extreme, insurrection is not out of the question as the masses redistribute the wealth in a violent fashion, whether the powers that be want to or not.