Piketty, Right or Wrong? The Global Wealth Game
How can it be that wealth grows faster than income for a sustained period of time?
- If Piketty and others expect wealth to continue growing faster than income, debt must grow faster as well.
- The existing debt level of China – at 250% -- is already at the level of the developed economies in the west.
- The Western world’s aggregate debt level is 275% of GDP, the developing countries’ is 175% of GDP.
- As long as the value of assets bought on credit grows faster than the interest expense, the game can go on.
- As attractive a world of ever increasing wealth would be, it is only a dream.
- It is much more probable that wealth and debt will shrink together.
Thomas Piketty and his followers get support from Credit Suisse. In the newest release of its Global Wealth Report, the team of analysts at Credit Suisse supports the French economics professor’s – and top-selling author’s – thesis of growing wealth and wealth concentration in the world.
The bank’s analysts, like Piketty, predict a continuation of the existing trend. Wealth will continue to grow faster than income, leading to ever higher wealth and wealth concentration.
Obviously, Credit Suisse shares Piketty’s view that “r” – the return on capital – is constantly higher than “g” – the growth of the economy. In contrast to Piketty and his followers, Credit Suisse doesn’t see a problem in such a development. The bank perceives it as only a temporary phenomenon – and it is, of course, good for its own business.
In the emerging market economies, Credit Suisse expects a broader distribution of wealth once more people rise into the middle class and start saving. On the other hand, the analysts do not expect a similar change in the western world.
Different growth for different worlds
As long as the growth rate of their economies remains low – which is a reasonable assumption given demographics – wealth is expected to grow faster, leading to higher wealth and more wealth concentration.
Piketty and Credit Suisse therefore not only agree on the historical development, but come up with a similar view concerning the future. Both are extrapolating existing trends.
Piketty expects a real return on capital of 4 to 5%, Credit Suisse estimates future profits and works with a regression analysis based on past data.
Both also come up with only one future – instead of working with scenarios, as one would expect, given the fact that the influencing factors are quite volatile.
But how can it be that wealth grows faster than income for a sustained period of time? Credit Suisse comes up with a simple mechanism. People with higher income can save more – this leads to a higher demand for existing assets, bidding up the price.
Higher values for financial assets and real estate lead to higher incomes of the wealthy, allowing them to save even more and therefore bid up the prices of existing assets even further.
That makes wealth accumulation a kind of perpetuum mobile of unlimited wealth, detached from the harsh realities of the real economy. Those owning the assets are therefore unaffected by the business cycle. Recession or boom, the wealthy are always the winners.
At the same time, economists like Larry Summers see excess savings, which could be translated in growing wealth relative to income, as the main reason for the slow growth we have to deal with in our “secular stagnation.” In short, it’s a world of too much savings and not enough consumption and investment.
But are we really facing a period of ever faster growth in wealth and stagnating real economies? I doubt it.
More debt makes more wealth
Piketty, Summers and Credit Suisse only look at the symptoms – not at the true causes behind this development. The key element they neglect is the continued and excessive growth in debt. Without constantly increasing overall debt levels, the growth in wealth would be impossible.
There are several mechanisms in which debt underpins the growth in wealth. Normally, a higher concentration of incomes and wealth would lead to stagnating or shrinking incomes for the broader population – and therefore a drop in demand. The higher the income and wealth, the lower the share which is actually used for consumption.
In order to be able to consume in spite of stagnating income levels, broader sets of the population start to borrow money. That is exactly what happened in the United States over the last 30 years.
As long as real estate prices were rising – thanks to ever more and cheaper debt – this could go on. In Europe, it was governments that increased their spending on social welfare – which, in turn, was financed by credit, creating more debt.
Without all this credit-financed demand, the level of GDP, employment and profits would be lower in Europe and the United States – and stock prices as well.
Debt boosts asset prices
Even more important is the direct impact of higher debt levels on the valuation of assets. The possibility to take on credit leads to more demand for assets. The lower the required share of equity, the higher the demand for the asset.
That connection was easily visible in the run-up to the last crisis in the United States, but also in Ireland and Spain. An ever bigger proportion of new loans were made on the assumption that rising asset values in themselves would cover the costs of the credit. “Ninja-Loans” (No Income, no job, no assets) were the most extreme version.
The leverage effect makes it even more attractive to buy assets on credit. As long as the return on an asset is higher than the interest rate, any substitution of equity by debt leads to a higher return on equity. The demand for the asset increases even more.
China as a “richly” indebted country
That is why Credit Suisse expects a continuation of the existing trend of growing wealth for China as well. Of course, the bank does not mention that the existing debt level of China – at 250% – is already at the level of the developed economies in the west.
Without these debts, the demand for and valuation of real estate in China would certainly not be on the current level.
Over the last 40 years, the development of wealth and debt is pretty synchronized. If Piketty, Credit Suisse and others expect wealth to continue growing faster than income, they implicitly assume debt to continue growing faster as well.
Indeed, since the start of the crisis in 2009, politicians and central banks have done as much as possible to keep the house of debt from cracking. Global debt has grown from $105 trillion to $150 trillion since 2007.
The western world has to deal with a debt level (government, corporations and households) of 275% of GDP, the developing countries with 175% of GDP, both up 20 percentage points since 2007.
But can it go on?
It will not be possible to have debt grow faster than income forever. As long as the value of assets bought on credit grows faster than the interest expense, the game can go on.
But even in an environment of zero interest rates, this has come to an end, at the latest when no one has any debt capacity or willingness left. Once we have reached this point, asset prices will collapse. What remains is an unbearable debt load.
As debt is used to stabilize economic demand, it is only a question of time until we reach a limit. The debt capacity is limited and many countries have reached this limit.
All efforts to increase the debt capacity — whether by lowering standards and interest levels and/or to induce those with some countries like Germany which have some capacity remaining to take on more debt — can only buy time.
As attractive a world of ever increasing wealth would be, it is only a dream. It is much more probable that wealth and debt will shrink together. This will happen either because of a collapse of the house of debt that has been built up – or through drastic taxes as proposed by Piketty. As for politicians, it doesn’t matter whether or not Piketty`s theory is wrong, if it is useful.