Does Income Concentration Cause Bubbles?

Bubbles – the devastating kind – seem to occur during a period of time when income is becoming increasingly concentrated at the top.

That then raises a question. Do large bubbles cause income to become more concentrated, or does the concentration of income cause the bubbles?

We've had two bubbles since the distribution of income began changing in the 1970s, with the second verse worse than the first, and that leads me to think it might be that income concentration causes bubbles and not the other way around (it's possible that bubbles and income concentration aren't related at all - a third variable causes both or the relationship is spurious - but that seems unlikely to me).

It's interesting to note that the first bubble - the dot.com bubble in stocks in that popped in 2000 - occurred when the concentration of income (including capital gains) hit a level very similar to the concentration of income in 1929, particularly for the top .01%. The concentration of income accelerates from 1995-2000 in both diagrams as the dot.com the bubble is inflating, and a similar concentration of income is evident as the housing bubble is inflating:

Top 10% (source: Piketty and Saez)


Top 0.01% (source: Piketty and Saez)

So what causes what?

Comments

[ken melvin]

I think both were fueled by the salaried middle income investors who thought the only way to get ahead was to take a risk, who saw others getting rich investing. The wealth disparity feeds into this sense that there is no other way to get ahead.

[lonesome moderate]

That then raises a question. Do large bubbles cause wealth to become more concentrated, or does the concentration of wealth cause the bubbles?

We've had two bubbles since the distribution of income began changing in the 1970s, with the second verse worse than the first, and that leads me to think it might be that wealth concentration causes bubbles and not the other way around (it's possible that bubbles and wealth concentration aren't related at all - a third variable causes both or the relationship is spurious - but that seems unlikely to me).

I would think that a surplus in investment capital would be the most important factor in creating a bubble.

[bullbust]

Isn't that putting the cart before the horse?

Bubbles benefit those at the top of the pyramid. Booms and busts aid wealth concentration, as they concentrate the loot to the pyramid's apex.

Which is why I will say that Greenspan's undetectable-bubble and mop-up-after-bubble policies were deliberate choices to achieve that exact end - concentrate wealth to the top.

[DoF]

Why is it unlikely that a third variable causes both?

Bubbles and concentration of wealth share a common cause: monetary expansion.

The (abbreviated) theory behind this view is fairly straightforward:

Concentration of wealth occurs because monetary expansion transfers wealth from late receivers to early receivers. The early receivers get the money before prices rise. Then they spend it and the recipients spend it, each group of recipients bidding up the price level until the last group receives the newly injected money at which point the price level will be considerably higher.

The bubble occurs because monetary expansion leads to lower interest rates which make poor investments appear cost effective. A portion of the new money bids up the price of those poor investments causing an unsustainable boom.

I'm curious as to why this seems unlikely. Have you encountered this view before and found some step in the argument improbable?

[Manfrommiddletown]

This seems extremely plausible, and more importantly turns the argument that interfering with the redistribution of wealth from the masses to elites results in social losses on its head.

The argument that you seem to be making suggests the opposite, that the increased concentration of wealth results in deadweight social losses manifested in bubbles.

This is a worthy subject for further investigation.

[eightnine2718281828mu5]

If you give too much money to the middle class, you get over-expansion of productive capacity in response to elevated demand.

If you give too much money to the investor class, they can't spend it, so they invest it.

Since the universe of suitable investment vehicles preferred by the investor class is smaller than the universe of consumption opportunities presented to the middle class, you get a bubble in investment vehicles.

Also, consumers can't get access to 30/1 leverage opportunities for consumption. Leverage is the crack cocaine of the investor class.

[Alex Tolley]

Wouldn't it be a good idea to get data from more than 2 events? What about other bubbles, like the famous South Sea bubble - isn't there some data on income distribution than can be inferred from this period, as well as other hitorical bubbles?

[JSmith]

I am guessing inflation, or its lack thereof, is a major factor in bubble formation.

Maybe with low income inequality, excess money goes to inflation, but with high income inequality, excess money goes to bubble generation.

In the case of rising inflation, the excess money generation is killed off quite quickly by the fed, but in the case of a bubble, well, they stay on the side lines. At least that seems to have been the case of at least the past fifty years.

[eightnine2718281828mu5]

I'm also thinking that the housing boom was the investor class shoving their leveraged money at the housing market, which in turn was leveraged by consumers taking advantage of no-down payment loans. So in that case, consumers *did* have access to 30/1 leverage.

Crack pipe economics.

[Bruno Breyer Caldas]

Its very likely that wealth and bubbles are correlated but not casualty related. It could be one variable that affects both, it could be many variables that affect each one independently and thus, a spurius regression.

Its more likely, just like "DoF" showed, that monetary expansion is the cause of both.
Wealth concentration can be explained as being partly an excess of liquidity that enters the economy because of low interest rates. Such rates incentive higher risk taking by the ones that have monye to take risks (very rich people). Those losing money (if there wree no bailout) in the crisis (banks, similars and cosenquently bank owners and similar which are very rich BTW.) are mainly the ones that took those risks.
Money expasion has been high for more than a decade, specially after 2001. Bubbles and wealth concentration, as seen, can be both the consequence of one factor: Liquidity.

Of course none of them last long, since the demand for those excess investments will not exist and there will soon be a recession. just like Hayek and the austrian cycle forecasts everytime.

P.S: The ones that lose more money in busts are mainly rich people, therefore, bubbles do not benefit rich people the most.

[ds]

Thank you for this post!! The question of income inequality is the 500 pound gorilla that has been sitting in the room for a long time now.

It seems certain to me that our economic system in recent times promotes income inequality which, in turn, causes bubbles. In the past, as central banks printed money, the benefits of growth would flow to businesses, and in turn, workers would demand a share of the profits. If this continued to an excess, the central banks would see this as inflation would begin to rise.

But in today's economy, workers have essentially zero leverage. Wage growth is almost completely arbitraged out -- so much so that, over the last boom cycle, real wages declined! So, because wages don't grow, we never see any evidence of inflation, and the fed continues to print money as if, by some magical transformation, our modern economy is immune to the effects of excess liquidity. But that money goes somewhere -- and since the earners of capital income have a lower marginal consumption rate, they plow that money back into asset markets.

Central banks and politicians really missed the boat on this one. Everyone is screaming about a crisis now. Why was no one screaming crisis when wealth distribution hit 1929-like levels? Why was no one passing an emergency workforce bailout plan in 2006, when the average worker hadn't seen a raise in 6 years? Why did people think that, so long as we shaft the average worker, we can avoid all of the pitfalls of an excessively levered economy? And how is "the consumer" the engine of economic growth when, relative to output, that same consumer's income has flatlined for the past 20 years?!?!

[eightnine2718281828mu5]

Republicans think that more capital is always better, but add too much rapid-gro to your garden and all you'll have are rotting vegetables. (Sorry for getting all 'Being There')

[chris]

Feedback loop?

[Cynthia]

It's a toss up as to whether wealth concentration follows or precedes market bubbles. But it pretty clear that the more bubbles we have in the market, the more concentrated wealth becomes in society. And as long as we have Uncle Sam around to protect the wealth of the wealthy every time bubbles burst, we'll keep having more bubbles and more concentration of wealth!

[bakho]

Too much money chasing too few investment opportunities.
Once a bubble starts, it becomes an upward spiral if there is a lot of excess investment capital that can fuel the bubble.
In times with less investment capital, the capital has better investments than a speculative bubble.
Times of wealth inequality typically mean that the wealthy have excess capital to invest.
Bubbles help create wealth inequality.
Bubbles do not have to form if there are sufficient investment opportunities.

[ken melvin]

What's it called when the model is used to explain the model?

[jh]

This is all about income concentration, but you use the word "wealth" a few times (even in the title). Picky, fine, but Saez and Kopczuk have estimates of wealth concentration in the US, and those figures look much different.

[Mark Thoma]

Not picky at all. I noticed that too and thought I had edited those out after I added the graphs, but seem to have missed a bunch - thanks, I'll fix that. I always screw titles up since they're in a different box, but thought I'd fixed the text. Grrr.

[jh]

Personally, I go more towards the bubbles-to-income causality. If it were an income-to-bubbles story of a small group of people chasing returns, I'd expect to see the wealth concentration preceeding the boom, but the Saez and Kopczuk estimates show no great increase in wealth leading up to the dot-com bubble. (I don't think they've updated those figures, but I may have just missed that.) Plus, I buy the argument that foreign capital has played a large role in fueling these bubbles (eg, Eichengreen's argument about the role of Chinese investment in the housing bubble), and I don't think there's any plausible mechanism for domestic income concentration to affect that. I suppose someone could tell a story about naive nouveau riche going in for investment fads -- but that seems kind of far-fetched.

In terms of micro explanations for income concentration, I think Rosen's superstars is still the most convincing basic story. And bubbles would seem to be a great breeding ground for superstars -- not just the dot-com wunderkind, but also the Wall Streeter (or AIGer) who calls the dot-com/housing boom or finds new ways to profit from it. So, I'm not at all sure, but that's how I'd lean.

[Jesse]

Asset bubbles, most bubbles, are similar to Ponzi schemes.

As we know from simple mathematical analysis, there are a narrow group of beneficiaries ina Ponzi scheme as it creates no wealth, merely transfers wealth in a concentrated manner.

In both 1929 and 2000-3 we have seen similar phenomena.

Is this cause, or effect?

From the data I have seen it is an effect. The concentration of wealth at the 10% and higher suggest the effects of a Ponzi like pyramid scheme.

Please note that I am not arguing conspiracy or intent, not at all. But I think there are some important lessons to be learned here.

An even more interesting study might be the relationship between concentartions of wealth in the upper 10% of the population and real wage growth in the median popularion, and the impact of this on the economic structure and growth.

Would this imply an export mercantilist structure, run by an oligopoly? Would this type of structure arise from a heavy concentration of wealth with low domestic consumption in the ordinary essentials?

All interesting questions. Now for some likely grad assistants to gather and prepare the data. :)

[Winslow R.]

'Bubbles' result from money instability. I think there are two major components. Income consolidation acts at the micro level leading to money instability. On the macro level, the money instability arises from the ratio of vertical/horizontal money.

Horizontal money system (Used to extract interest for the interest farmers)

Anyone that understands money creation realizes the money created with private debt nets to zero when added to the debt that created it. Debt created money is highly unstable because of its ability to deleverage itself to zero. Not sure how to emphasize this point.

Vertical money (Creates income - Used to extract taxes for the tax farmers)

Government created money has only future tax obligations so has no current debt that can wipe it out. It is very stable. Few people seem to understand this.

Rubin, Delong, Summers pushed us in the direction of horizontal money and destruction of vertical money (with the surplus). They were pro banking and anti government deficit spending.

You can track the ratio of Federal debt/Total Debt with the Z1 from the Fed. Fed debt became especially important as tsy secs replaced gold as the capital upon which the credit system was based.

Some data points - Federal debt/Total Debt

17% 1974 Recession
19% 1975 Recovery
19-24% 1981-1991 Reagan/Bush years
27% 1994 Clinton Peak Ratio Gov Debt/Total Debt
18% 2000 Clinton Surplus
17.5% 2001 Recession
18% 2003 Weak Recovery
16% 2008 Great Depression II

We are now at a point where the amount horizontal money exceeds vertical money sufficiently to add to the instability resulting from income consolidation. Add the two together and we have an economic nightmare. 1974 not so bubbly as income was well distributed.

[Richard H. Serlin]

Some of my quick thoughts on this:

The first bubble, internet, just seemed like it was a fairly classic case of something new that was highly unknown, and with great promise, this started a lot of get rich quick dreams that then fed on themselves, that is, once the initial price increases got rolling, they were justification for more people jumping in, and then more price increases, and so on.

The second bubble appears to have been mostly deregulation allowing for a lot of deception and opaqueness which lead to a lot of bad decisions, and the unprecedented amount of mortgage lending to bad risks (in general and relative to the size of the mortgage) allowed a lot more money to be bid on homes.

I could see how a bubble, like a pyramid scheme, could help concentrate wealth.

And,one might argue that wealth concentration puts more of the investment wealth in the hands of those who are more sophisticated and savvy, or those who hire advisers who are, and perhaps these people are less susceptible to buying based on non-fundamentals, or buying for "bubble reasons".

So bubbles causing concentration appears more plausible than vice-versa. The bubble causes a lot of the middle class to lose money, and the CEOs, savvy, and lucky leave with a ton of money. And, the less money controlled by the financially unsophisticated, the less likely a bubble.

[Matt]

OK, I will take a shot.

As the global economy moves toward efficiency, the firm focuses on the most profitable business lines placing the surplus into aggregated investment funds.

Investment funds grow but cannot find opportunities because all the firms are frozen on their current, best line of business.

Investment funds then start looking for new opportunities that are directly related to firms line of income, creating volatility and forcing the firm to draw back and look around.

[Gegner]

Your assessment is correct, large concentrations of wealth do indeed cause 'bubbles'. The Dot.gone era was a perfect example of too much profit chasing too few investment opportunities.

It was not so much the housing boom but the SIV bubble it created that had similar causes. Too much cash looking for a place to park.

Rather than let the funds 'sit' the investors leapt on any opportunity to put the funds to 'work'...too bad it usually turns out to be a scam.

[Brian Shriver]

Mark:

Good question. Traditional macro just assumes that saving flows into investment, conflating a few steps. If we pick apart the process, we can answer your question.

In the real economy you have nodes transfering money to each other (in exchange for goods, etc). Households, firms, government, rest of world. Aggregate surplus is zero. But income distribution matters because the more imbalanced and/or polarized the distribution of surpluses/deficits is, the more money has to flow through the financial system. If someone is making more than they are spending, they either hoard cash or they forward it to someone else via primary financial flows (loans, etc). The more imbalanced the real economy, the greater the primary flow volume will be.

A portion of financial flows are used for investment, but plenty is used for accelerated consumption, market speculation, etc. Anyone who thinks that saving equals investment should have their head examined. To say nothing of trade deficits caused by "savings gaps".

So, to answer your question, income imbalances (including chronic trade deficits) create the preconditions for bubbles to form - a wall of liquidity that needs to find an investment home. If the primary flows exceed the available investment opportunities, investors don't immediately realize that expected returns are falling. Instead a bubble typically forms and then collapses, a la Minsky or Soros.

My opinion, at least. Please email me if you like the idea!

[Xenophon]

Do you think the Federal Reserve might have had a hand in this? Doh!

[bakho]

The Ponzi scheme analogy is a good one. Those that get in at the bottom, feed off the bubble while it expands and leave before the collapse will profit. Those left holding the bag will lose.

Features of bubbles are always lack of transparency, underestimation of risk and an upside "promise" that is much greater than the downside. When large amounts of capital have few productive investment alternatives, bubbles can get larger by attracting that capital. Wealth inequality contributes to the size of the bubble, but not the number of small bubbles that are always out there. Wealth inequality makes some bubbles much more noticeable and more dangerous because of their size.

[robertdfeinman]

Apparently it is only a "bubble" if the middle class participates. So the dotcom "bubble" happened when firms in the industry went public and there was a rush to buy in. This was, of course, after the big killings had been made by the venture capitalists.

The housing "bubble" happened why the middle class started to trade up and build McMansions emulating the real mansions that had been going up for a decade or more before.

If you look around you will see many "bubbles" in specialized markets. For example, the fine art market has seen many bubbles in the past several decades: Impressionist Art, Pop Art, etc. Similarly there have been micro bubbles when, say, some clothing or accessory designer suddenly becomes fashionable and a woman's purse ends up selling for $10K.

In all these cases the money comes first. The wealthy have more money than they can spend on realistically priced goods, so they go for status items which have a high price and the price is what is important for bragging rights. When "everyone" has an Impressionist painting than they lose their status and the bubble bursts.

There is even experimental evidence for this. A recent study found that the price of an art object was not determined by the object, but by where it was purchased. An equivalent item sold at Christie's or Sotheby's fetched more than the same object at a less prestigious dealer. This was not just a matter of exposure to the market, but the buyers wanted to be able to brag that they had bought it at a prominent auction house.

Bubbles are caused by too much money chasing too few goods - even if the scarcity is man made.

[Ninja Zombie]

Isn't it funny how the housing bubble and the current economic crises are caused by all the stuff you were already against?

[Alex Tolley]

II repeat, speculating on 2 recent incidences of bubbles is not a way to analysis. This is as erroneous as plotting a chart with only 2 data points.

Let's add a 3rd, the stock and housing bubble in the early 1970s. But didn't that occur while income/wealth concentration was much lower than the 2000s. What about the stock bubble of the mid 1960's? Are not these counter examples that disproves the hypothesis?

[John]

www.indexinvestor.com (which warned back in May, 1997 we were headed for a crisis), wrote about the consumer spending and borrowing issue in this month's issue of their journal. They basically conclude that consumer behavior was a necessary, but not sufficient contributor to the current chaos. Here is what they wrote: "In their paper “Household Debt in the Consumer Age: Sources of Growth – Risk of Collapse”, Cynamon and Fazzari explore the sources of the dramatic changes in consumer spending and borrowing behavior over the past twenty five years. They start with a critical question: what determines your consumption preferences? In contrast to many economists who tend to dodge this question, Cynamon and Fazzari accept the conclusions reached by anthropologists, sociologists and psychologists – that our consumption preferences are determined not only on rational analysis of costs and benefits, but also by our past consumption decisions (i.e., by habit) and by social considerations. Regarding habits, the authors note that they “create an asymmetry in that…consuming less than the habit level resonates more than a same size increase in consumption relative to the habit level.” This is strongly reminiscent of Prospect Theory’s finding that underperforming a given reference point (e.g., the cost of an investment, the return on an index, or the portfolio returns one’s brother-in-law brags about) hurts roughly twice as much as outperforming said reference point feels good.
While habit formation has undoubtedly contributed to the rise in consumer spending in recent years, we believe that other factors have had a stronger effect. The most important are those related to the social aspects of consumption decisions. At the most basic level, evolutionary biologists have suggested a logical motive for conspicuous consumption by males – an attempt to signal one’s relative possession of valued resources, in order to attract the most desirable mate. This accounts for the male ostrich’s plumage, and presumably some part of some humans’ desire to conspicuously consume. However, that seems to explain only a very small part of what has been driving this latter process. While a number of writers have delved deeper into this issue over the years (e.g., Affluenza by John De Graaf, or Luxury Fever by Robert Frank), we have found Juliet Schorr’s analyses particularly insightful. In her paper, “Understanding the New Consumerism: Inequality, Emulation and the Erosion of Well-Being”, Schorr argues that the last twenty years have been characterized by a critical shift in consumer attitudes and behavior. To begin with, she asserts that today in the United States (and to varying degrees other developed countries) “much of the function and motivation for consumption derives from social communication and symbolic action, rather than the desire to meet basic needs like food, shelter and clothing.” Put differently, people buy many products not only because of what they do (i.e., their functionality and performance) but also because of how consuming those products makes them feel. More importantly, “the ‘new consumerism’ is first and foremost defined by an unusually large increase in the dominant norm of consumer aspiration. The previously dominant norm of ‘comfort’ has been replaced by a norm of ‘affluence’ or ‘luxury’. In structural terms, this can be described as a shift to a situation in which the upper twenty percent of the income and wealth distribution (whose consumption patterns are roughly synonymous with affluence and luxury) becomes a widespread emulative target throughout society. This is what I call ‘vertical’ or ‘hierarchical’ emulation…To make this clearer, consider the old consumerism. This is the world of Thorsten Veblen…in which consumer aspirations and expenditures were prompted by comparative processes that were mainly horizontal and proximate…The phenomenon of ‘keeping up with the Joneses’ was mainly neighborhood based, and operated through face to face contact. Mrs. Smith went next door to see Mrs. Jones’ new refrigerator…These neighborhoods were relatively economically homogenous (i.e., the Smiths and Joneses were of roughly similar economic status), and consumption comparisons were mainly intra-class.”
Schorr then describes the three factors that led to the demise of the old consumerism, and the rise of the current system. “The first was the dramatic growth in income and wealth inequality that has occurred over the past twenty years.” In previous articles, we have described the many factors which have contributed to this, including the impact of information technology (which increased the productivity and incomes of highly skilled knowledge workers, while automating and eliminating many traditional middle management/middle income jobs), globalization (which simultaneously increased the potential market and potential income for highly skilled workers, even as it increased competition and depressed wages for unskilled workers), and social trends (e.g., the tendency of more educated people to marry each other, work a high number of hours and not divorce, while people at the lower end of the educational scale do just the opposite). The impact of these trends over the past forty years is shown in the following table (all income ranges were converted U.S. 2007 dollars in the underlying calculations, to eliminate the impact of inflation):
Share of U.S. Households in Different Income Categories
Source: U.S. Census
Year $100k
2007 25% 11% 32% 12% 20%
1997 26% 11% 34% 12% 17%
1987 27% 12% 36% 12% 13%
1977 29% 12% 39% 11% 9%
1967 31% 14% 42% 8% 5%
As you can see, this table tells a number of different stories. On the positive side, and consistent with the continuing increase in the United States’ productivity over the past forty years, the percentage of households in the lowest two income categories (which one might label lower and lower middle class) has declined. On the negative side, the shift across the rest of the spectrum (e.g., the change in the size of the middle, upper middle, and upper classes) has been lopsided, with the traditional middle (defined as between 75% and 150% of median household income) shrinking, and the upper class quadrupling in relative size. In terms of Schorr’s analysis, it is not hard to see why the consumption patterns of the upper middle and upper income groups have substantially increased their gravitational pull on the population as a whole, as these groups went from 13% of households in 1967 to 32% of households today.
Equally telling is a comparison between the way people view themselves in terms of the class distribution, and what the Census income statistics show. The following table makes this comparison, using 2007 class self-identification data from the Pew Foundation report “Inside the Middle Class: Bad Times Hit the Good Life” (1% of the latter did not answer this question).
Lower Lower Middle Middle Upper Middle Upper
Self-Reported 6% 19% 53% 19% 2%
Census Income 25% 11% 32% 12% 20%
Difference (19%) 8% 21% 7% (18%)
If self-identified social class drives desired consumption patterns, while income potentially puts a limit on actual purchases (in the absence of reduced saving and/or increased debt), then this table makes quite clear the underlying tension propelling spending and the temptation to borrow to pay for it.
The second trend identified by Schorr was the entry of large numbers of women into the workforce. Schorr notes that “the 1950s and 1960s were a period of high levels of civic engagement and neighborhood socializing. Women met together in morning ‘coffee klatches’; they talked together at playgrounds and schools; they entertained at ‘cocktail hours.’ This fostered horizontal, proximate comparisons. [However, with the entrance of more women into the workforce], the workplace has replaced the neighborhood as an important site for social interaction. But because the corporation is a more hierarchical organization than the neighborhood, women were increasingly exposed to the consumer choices of those above them on the status ladder, which fueled vertical aspiration.”
Both of the first two trends were amplified and reinforced by the third -- changes over time in the media and the way people use it. Schorr notes that since the 1970s, “Americans have been interacting less with their neighbors, families and friends, and spending more time watching television” – and, more recently, on the internet. Schorr notes that “the media has two important functions in fostering the new consumerism. First, it has served as a major conduit of information on the consumption patterns of the top twenty percent. Second, it has imparted an upward bias to people’s sense of the prevailing consumption norms, because media, particularly television and the movies, tend to lifestyles and possession of consumer goods at levels that are far above the actual norm…They tend to depict the ‘average’ household at a lifestyle which is, in fact, at the upper middle or above…[As a result], studies have shown that people who are heavy television viewers greatly overestimate how the average American lives and the possessions they have.” Moreover, other researchers have found that as incomes rise, the amount of time spent watching television tends to decline (see, for example, “Neighborhood Environment as a Predictor of Television Watching Among Girls” by MacLeod, Gee, Crawford and Wang).
Thus far, we have looked at some of the drivers of the sharp increase in desired consumer spending over the past twenty years, and in particular for spending on goods such as housing that make one’s status visible to one’s peers. However, before we turn to how that spending was paid for, it is worth asking one more question: What caused a sufficient percentage of the households at the top of America’s income distribution to consume so conspicuously (e.g., via the sharp increase in so-called “McMansions” and the number of expensive cars on the road), that they triggered the destructive “consumption arms race” described by Schorr and other authors? To be sure, not all of these households consumed conspicuously. In fact, there is evidence that conspicuous consumption declines with the increasing wealth of one’s peer group (see, for example, “Conspicuous Consumption and Race” by Charles, Hurst, and Roussanov and “First Impressions: Status Signaling Using Brand Prominence” by Han, Nunes and Dreze). But enough of this consumption occurred to inspire a lot of envy and imitation in people who ultimately could not afford the spending they undertook. So we have to ask, what positive feedback loops drove this conspicuous spending by households at or close to the top of the income distribution, and what negative feedback loops failed to inhibit it? And will these change in the future, or new ones emerge to take their place?
Undoubtedly, many factors and trends contributed to conspicuous spending by affluent and other households, and the relationships between them are probably complex and non-linear. For that reason, a full understanding of them is beyond our grasp. We can however, still gain a “coarse grained” view of some of the key dynamics that were at work. To varying degrees, these probably included the following:
• Over time, Western societies have gradually been giving greater weight to the freedoms of the individual relative to his or her duty to any collective group (with this trend probably having done further in the United States than anywhere else). Underlying this development has been the growing popularity of a psychotherapeutic view of the world and the individual’s role in it, the mainstreaming of the 1960s liberation philosophy and post-modernist attacks on traditional institutions. The rise of individualism also reflected a sharp reduction in voluntary social group membership due to growing pressure to spend more time at work (to keep pace in an increasingly competitive and insecure economy), and a richer range of competing leisure time media offerings, both of which have been well chronicled by Robert Putnam in his book Bowling Alone.
• Another contributing factor was the weakening appeal of traditional institutions that were more concerned with long term than short term goals, that believed in sacrifice rather than instant gratification, and that sought to balance collective harmony individual self-fulfillment. For example, numerous pages have been written about the drop in respect for traditional elites as the Vietnam War and the “War on Poverty” failed to achieve their respective goals. Many have also written about falling participation in organized religion (and especially so-called “Mainline” Protestant churches) for reasons too numerous to list here.
• Finally, tax policy was also supportive, with falling marginal rates for affluent taxpayers.
• Hence, when many people discovered that their pursuit of liberation yielded alienation and anomie rather than the expected increase in happiness and fulfillment, they sought new sources of social connection and individual meaning. Many of these began on the fringe and have gradually become mainstream social trends – for example, a concern with environmental quality has morphed into a broader “environmentalism” that for some verges on nature worship. Similarly, the last forty years have seen a growing focus on the human body in a variety of forms, including exercise, nutrition, sports, surgery and sexuality. Recent decades have also seen the growing popularity of practices and organizations focused on individual “spirituality” and therapy (e.g., yoga and self-help books and websites) designed to help disconnected individuals find meaning and establish behavioral norms. Finally, over the past twenty to thirty years, a substantial portion of the U.S. population has also turned to increased consumption – “shopping therapy” – to connect with other people and construct a story about the meaning of their lives.
With respect to the housing bubble in particular, we believe that two further motivating factors were at work. The first was the recognition by many people, particularly after the technology bubble burst, that they had not saved enough for retirement. In the face of strong social pressures to avoid cutting down on consumption to boost savings, the attractions of boosting one’s net worth by “playing the real estate market” were clear. The second factor was the observation that, whatever one’s personal doubts might have been about housing valuations, other people seemed to be making a lot of money from real estate. This undoubtedly caused many people to set aside their personal doubts, lever up and “get into the game.” Economists are divided as to whether that behavior represents irrational herding or a rational weighting of private versus public information (on the former, see “Thought and Behavior Contagion in Capital Markets” by Hirshleifer and Teoh; on the latter, see “Bubbles, Rational Expectations and Financial Markets” by Blanchard and Watson). Regardless of the underlying causal factors, it is clear that over the past decade, more and more people began to see residential real estate as an attractive investment, beyond its traditional role of providing shelter.
What are the chances that any of these trends will reverse in the future, and dampen consumer’s desire to spend, and in particular spend on housing? Clearly, with so many people having been burned, the bloom will be off the housing rose for many years. And perhaps a growing concern with environmental sustainability will reduce the urge to consume for some. Rising marginal income tax rates on the affluent would also constrain spending, as would (more powerfully) a switch from a progressive income tax to a progressive consumption tax (which would discourage conspicuous spending while not penalizing saving). But since the chances of the latter being enacted seem slim, in the absence of a fundamental shift in social attitudes towards conspicuous consumption, we must conclude that the desire for high consumption spending is unlikely to fall very much in the years ahead. Perhaps even more important, the frustration of this desire should generate rising anger, with unpredictable political and policy consequences. At minimum, we expect higher income taxes on affluent taxpayers, and perhaps a greater social acceptability of bankruptcy – a collective willingness to “hit the reset button” so to speak."

[anne]

[Why should the distinction between income and wealth be significant in terms of generating market instability, since no rationale I can think of evidently makes for such a simple distinction?]

[Anonymous]

The distribution of income in large part began with turning US housing into a commodity more resembling pork bellies than shelter for families. The housing market has been a virtual pyramid scheme for decades, with previous financail scandals and bubbles associated with overinflated prices, while the real estate industry itself has turned into a sales model resembling that of a used car lot. Ever since everyone has wanted to get rich overnight through investing in real estate, and squeezing every penney out of companies for short term profits, the natinoal economy has been based on credit and inflation, and more recently, new-fangled securities without any real value.

[Denis Drew]

The same thing that causes a lopsided income distribution, one segment getting the upper hand economically, allows said segment to to get the upper hand politically which in turn allows it to carry out its worst animal spirit wishes unchecked.

[kthomas]

anne, you're right (of course). What matters is the distribution. Still, we've WAY too many MBA making lots in income but generating no real wealth for the nation. There's a distinction.

[Xynthia P.]

I'm no economist, but isn't it clear that, politically, the function of the housing bubble/Ponzi scheme was the pacification of the income-stagnant lower-middle and middle class? That is, that it enabled them to keep doing what their wages would no longer allow--consume? Also, it's interesting that what they were encouraged to consume--houses, and their decor--is psychologically crucial for people to feel that they are safe and possess some kind of protected 'territory". The housing Ponzi scheme didn't, obviously, create an ownership society, but it at least created the illusion that people were owners and controlled their 'space'. I just don't think it's a coincidence that people have becomes devotees of HGTV, etc, who peddle what can only be described as housing porn, or housing fantasies. Clearly, housing porn fed some deep evolutionary need for control of one's space and territory. For years, the housing Ponzi scheme has kept people from seeing what they actually are: nearly powerless peons in a giant techno-industrial oligarchy.

[anne]

The question is why should there be a difference to the interesting conjecture about bubbles using income or using wealth?

[kthomas]

"...the housing Ponzi scheme has kept people from seeing what they actually are: nearly powerless peons in a giant techno-industrial oligarchy."

Ouch. That's it, I'm hitting the bottle tonight!

[Dunc]

Presumably if the rich pocket all the money, there's not enough people with purchasing power to buy whatever the poor are producing, thus leading to a recession. Seems logical enough to me.

[anne]

Clarifying, I think the conjecture on income distribution and bubbles is especially interesting and only wonder why any difference in conjecture would come in looking to a relation between wealth distribution and bubbles.

[Holly W.]

I've wondered a little about this question myself for the past week or so, as we've all been trying to sort through what created this mess.

How much of the housing bubble was contributed to by seeming neglect for the concerns of the middle class in this country? As the stock market went sideways, bank interest paid on savings sank to pathetic lows, wages stagnated, and healthcare and energy costs rose, owning a house you could milk for cash started looking like the best, and possibly only, way to support a middle class lifestyle.

During the tech bubble, there seemed to me to be a sense of genuine good times for most people: wages were rising, and the cost of healthcare, energy, and consumer goods was holding steady or in some cases actually decreasing; being able to dabble in a frothy stock market seemed like icing on top of a pretty good cake.

But the housing bubble seemed to carry more of a whiff of desperation, IMO. Most Americans weren't dabbling in exotic securities or making money in the derivatives market; they just wanted the dream of purchasing a home, which seemed increasingly out of reach, and a way to make some money when savings accounts and the stock market didn't seem very promising and working seemed less and less rewarding. It's not altogether surprising to me that some people were willing to agree to completely crazy mortgage terms; fear combined with the hope of a small free lunch can make even smart people behave pretty dumbly.

I know alot of people claimed we had a "Goldilocks" economy going through the past 7 years, but did it really feel that "just right" to most people? So what I wonder is, how much did the sensation of not getting ahead by normal means contribute to this bubble? Is that a symptom of income inequality? Or is it just that under the Republican administration/congress, the middle class was essentially left to fend for itself, and the financial industry was able to take advantage of that?

P.S. I'm not quite sure how to tie all that "global savings glut" into this tale. This bubble clearly wasn't just about Americans, even if we seem to be a big chunk of it.

[LVTfan]

I assumed that much of what showed up in the Piketty & Saez data in 2000 was the realization of capital gains, and some ripple effect from that.

When such a large share of our (recognized) income is in the hands of a very small segment of our population, their whims and incentives can produce very large shifts in the aggregates. And while I'm not a big believer in trickle down economics, when those who have large share of our income reduce their spending, it certainly does have ripple effects on the other 95% of us, particularly along the coasts.

If we want to head off the next round and reduce our concentrations of wealth, income and power, we might learn a lot from the writings of Henry George. Google wealthandwant or lvtfan or his name for more information. Also Homer Hoyt's work on land values. More important than most people realize.

[jh]

anne -- The difference in considering wealth and income inequality is important because there is a coincidence of income concentration and bubbles (whether it means anything or not, how regular that coincidence is, are fair questions), but there doesn't seem to be a coincidence of wealth concentration and bubbles. Income inequality spiked in the late 1920s, around the dot-com bubble, and recently around the housing bubble. Wealth inequality (using the Kopczuk/Saez estimates) was high in the late 1920s, but did not increase significantly during the dot-com bubble. (I don't know of any comparable numbers for the housing bubble -- the estimates stop in 2000 or 2001, iirc.) So if there is a connection (if...), you'd have to look at some link to income inequality, not wealth inequality. And if the story is a few people with investment dollars to burn pushing some price past its fair value, you'd expect to see bubbles driven by wealth concentration.

[Peter]

Clearly, if it wasn't for the forced migration of traditional
retirement schemes to stock-market related schemes then the "bubble"
could not have happened. How else could said bubble be capitalized ?

So I think that, and the destruction of manufacturing in favor of
parasitic financial instruments, is what allowed for the present
gilded age which is presently sinking the country (and the globe).

[anne]

JH:

"Anne -- The difference in considering wealth and income inequality is important because there is a coincidence of income concentration and bubbles (whether it means anything or not, how regular that coincidence is, are fair questions), but there doesn't seem to be a coincidence of wealth concentration and bubbles."

By 2004, the upper 1% of American households controlled 57.5% of corporate shares. I know the data well, but I am bothered by the seeming distinction between wealth and income in the 1990s which I think is artificial and only reflects an increasing personal real estate dependence as opposed to the control of wealth that brings income.

[anne]

JH:

"Wealth inequality (using the Kopczuk/Saez estimates) was high in the late 1920s, but did not increase significantly during the dot-com bubble."

I think this is wrong; wrong in failing to account for wealth that directly adds income. The increase in housing prices from, say, 1995 I would argue masked pronounced wealth concentration that in time adds to income concentration. Here I am thinking of the conclusions of David Cay Johnston, as well as mine.

[anne]

I think Mark Thoma's surmise most interesting, but I think the surmise becomes stronger thinking of wealth or control of income producing assets.

[BJ Feng]

Share of U.S. Households in Different Income Categories
Source: U.S. Census
Year $100k
2007 25% 11% 32% 12% 20%
1997 26% 11% 34% 12% 17%
1987 27% 12% 36% 12% 13%
1977 29% 12% 39% 11% 9%
1967 31% 14% 42% 8% 5%

I suggest everyone review John's post. We can clearly see that poverty is declining in relative terms. The increase in inequality comes from more Americans becoming richer, so many of the middle class are doing so much better that they've migrated upwards, though clearly they still see themselves as middle class people. As John posted, the Pew Center finds that most Americans do not view income inequality as an issue.

Lower Lower Middle Middle Upper Middle Upper
Self-Reported 6% 19% 53% 19% 2%
Census Income 25% 11% 32% 12% 20%
Difference (19%) 8% 21% 7% (18%)

Let me ask what kind of person is so envious and spiteful that they see a problem with more Americans doing a whole lot better off? As the stats clearly show, poverty has been reduced, ALL AMERICANS ARE BETTER OFF!

And to the extent that income inequality creates social tension, that's only true if people see a clear difference between classes. The above self reported stats should make even the most dense person understand that income inequality is not visible here in the United States. A solid 92% see themselves in the middle 3 brackets, they believe they are middle class, or close to middle class.

In certain places like Mexico, income stratification is obvious. At a certain point, people can no longer see themselves as belonging to a class, a person who has no shoes, tattered clothing, and squatting in a shack can't believe they are middle class people no matter how deluded. In America, it is very hard to tell apart people from the middle 3 brackets. We see the opulent lifestyles of celebrities like Paris Hilton on TV, but she represents the vast minority of even the rich. Most "rich", making over $250,000 cannot live like Paris Hilton or the people you see on TV, if they could, that lifestyle would no longer be shocking, and you wouldn't see them on TV anymore.

In summary, ALL AMERICANS HAVE PROSPERED over time. An unprecedented number of Americans have migrated to the upper realms of income classes, while poverty has been reduced. Income inequality can only become a problem if people stop identifying themselves with their fellow citizens, if there is a clear difference between the "haves" and "have-nots". With 92% of people identifying themselves within the middle three brackets, we are far far far away from reaching that point. If ever there was a strawman issue, income inequality is it.

[Ciphernerd]

"P.S: The ones that lose more money in busts are mainly rich people, therefore, bubbles do not benefit rich people the most."

This is only true if you think of rich people as actually owning all the stuff that they own on paper. After a bubble bursts, debtors suddenly realize how little of the world they own.

[Patricia Shannon]

BJ
Are your income distribution figures adjusted for inflation, including food and housing?
Are job stabilities comparable?

This reminds me that Reagan did away with income averaging in 1986. That's not going to be reflected in those figures.

[jh]

anne -- You're free to disagree with the estimates, but I like the Kopczuk/Saez series because of its length and consistency. They suggest that wealth concentration hasn't changed much since at least 1985 or so (whether one looks at top 1%, .1%, or .01% wealth shares), and has been pretty much the same since WWII, excepting a slight dip in the 1970s-early 80s. The caveats are that the estimates only go up to 2000 or 2001, so perhaps there's been a big change since (although that would still leave the dot-com bubble to be explained), and, of course, estimates can be wrong.

And of course I'm not trying to say that wealth is not heavily concentrated, just that those estimates don't show a change in the amount of concentration.

[ken melvin]

In '67 $25K was big money.

[anne]

JH: I understand but this is simply not possible,

"they suggest that wealth concentration hasn't changed much since at least 1985 or so (whether one looks at top 1%, .1%, or .01% wealth shares), and has been pretty much the same since WWII, excepting a slight dip in the 1970s-early 80s."

Not remotely possible.

[anne]

http://www.nytimes.com/2006/01/29/national/29rich.html?ex=1296190800&en=784822e4b0735ee5&ei=5090&partner=rssuserland&emc=rss

January 29, 2006

Corporate Wealth Share Rises for Top-Income Americans
By DAVID CAY JOHNSTON

New government data indicate that the concentration of corporate wealth among the highest-income Americans grew significantly in 2003, as a trend that began in 1991 accelerated in the first year that President Bush and Congress cut taxes on capital.

In 2003 the top 1 percent of households owned 57.5 percent of corporate wealth, up from 53.4 percent the year before, according to a Congressional Budget Office analysis of the latest income tax data. The top group's share of corporate wealth has grown by half since 1991, when it was 38.7 percent.

In 2003, incomes in the top 1 percent of households ranged from $237,000 to several billion dollars.

For every group below the top 1 percent, shares of corporate wealth have declined since 1991. These declines ranged from 12.7 percent for those on the 96th to 99th rungs on the income ladder to 57 percent for the poorest fifth of Americans, who made less than $16,300 and together owned 0.6 percent of corporate wealth in 2003, down from 1.4 percent in 1991....

[anne]

http://www.nytimes.com/2006/01/29/national/29rich.html?ex=1296190800&en=784822e4b0735ee5&ei=5090&partner=rssuserland&emc=rss

January 29, 2006

Corporate Wealth Share Rises for Top-Income Americans
By DAVID CAY JOHNSTON

In 2003 the top 1 percent of households owned 57.5 percent of corporate wealth, up from 53.4 percent the year before, according to a Congressional Budget Office analysis of the latest income tax data. The top group's share of corporate wealth has grown by half since 1991, when it was 38.7 percent....

[The idea the wealth has not become increasingly concentrated since 1991 or 1985 or 1945 is completely impossible; knowing tax structure alone would explain so.]

[anne]

The idea that income would become increasingly concentrated, concentrated in a pronounced way, for many years while wealth distribution did not become similarly concentrated is impossible.

[jh]

anne -- That's fine, I understand your beliefs. I'll stick to the Kopczuk/Saez estimates, though. First, because it directly estimates wealth concentration, while the CBO estimate relates to a type of wealth held by a percentile of top incomes -- sort of a cross-concentration, suggestive, maybe, but not measuring the thing we really are interested in. Second, because there are other questions about that methodology (the timing of the capital gains realization, the effect that would have directly on income, those sorts of things). And finally, because, well, I think Saez does good work, and having looked at the wealth paper, I don't see how their strategy would miss the mark so badly. (At least in terms of changes.)

I wouldn't say income concentration without wealth concentration is "impossible", either. It depends on the distribution of incomes over time, the assets they're invested in, consumption/saving, etc etc etc. And the great thing is that we can measure them independently.

In any case, the figures posted do show income, not wealth, and accuracy is important.

And that's all I'll say on this, because I have no desire to get into a shouting match.

[anne]

http://www.nytimes.com/2006/01/29/national/29rich.html?ex=1296190800&en=784822e4b0735ee5&ei=5090&partner=rssuserland&emc=rss

January 29, 2006

Corporate Wealth Share Rises for Top-Income Americans
By DAVID CAY JOHNSTON

In 2003 the top 1 percent of households owned 57.5 percent of corporate wealth, up from 53.4 percent the year before, according to a Congressional Budget Office analysis of the latest income tax data. The top group's share of corporate wealth has grown by half since 1991, when it was 38.7 percent....

[Share of corporate wealth of top 1% in 1991 = 38.7%, 2003 = 57.5%. Them's the facts. Duh.]

[anne]

The idea that income can be increasingly, markedly concentrated over the years but not wealth is actually comical.

Share of corporate wealth of top 1%:

1991 = 38.7%
2003 = 57.5%.

Something's happening.

[KThomas]

BJ, seriously...."In summary, ALL AMERICANS HAVE PROSPERED over time."

I can't believe you had the stones to type that.

[ken melvin]

Bats or marbles?

[moo]

A normal little kid enjoys finding a coin. But the richer you are, the smaller the happiness high you get from an additional $. So rich people are more vulnerable to gambling addiction. Therefore concentration of income causes bubbles. Consumption of cocaine amplifies hysterical and antisocial behavior. Financial markets can be made less hysterical by legalizing weed.

[bakho]

Kevin Phillips documents a lot of bubbles in his book, Wealth and Democracy. N is much greater than 3. For most of US history, there has been large wealth inequality.

[Patricia Shannon]

In 1978, $25,000 was decent money.
I was making about that much, and bought a house for about that much (I think for $27,000).

[BJ Feng]

Patricia, John's article explains,

"The impact of these trends over the past forty years is shown in the following table (all income ranges were converted U.S. 2007 dollars in the underlying calculations, to eliminate the impact of inflation):
Share of U.S. Households in Different Income Categories
Source: U.S. Census
Year $100k
2007 25% 11% 32% 12% 20%
1997 26% 11% 34% 12% 17%
1987 27% 12% 36% 12% 13%
1977 29% 12% 39% 11% 9%
1967 31% 14% 42% 8% 5%"

Anne, your numbers are skewed by very wealthy entrepreneurs like Warren Buffet and Bill Gates among many others (Michael Dell, Larry Ellison). By and large it was their company to begin with, and they sold off pieces to the public, but kept a substantial amount of stock. As the company prospered, so did they along with many employees.

How many good playing jobs were created by these folks? And we've all heard the stat that Microsoft made hundreds of employees into millionaires. Yes, the technology boom allowed many companies to become huge megapowers overnight, and people like Jeff Bezos and the Google guys kept a huge amount of stock, but by and large it was deserved. We're lucky to have these companies in the United States, there's a good reason why these new type companies were "invented" here in America instead of some other place like France or Germany or China. Once the tech revolution began, those firms were copied en masse, but they remain the dominant players in their fields on Earth. If that means greater corporate wealth concentration, then so be it, they've created so many jobs, done so much good, all thanks to the American capitalist model.

You know, many of those companies started with just a few million dollars in initial seed money. Youtube was created by two guys living at home, Facebook had minimal capital requirements. Gee, with all the money government spends on re-education and job creation, how come government can't create an Amazon.com? I mean that would provide lots of good paying jobs right? And government has plenty of money, less than a billion would be needed to create several Netflix, or Ebay type companies. We really don't need the private sector right? All we need is the will to fashion a policy of job creation. Just pass legislation mandating 10 revolutionary type businesses be created, it's so easy, all we need is Congress to act! Because government can always accomplish what it sets out to do, government can innovate if it is allowed to, government can provide. We don't need greedy people like Zuckerman who still refuses to sell Facebook, or Jerry Yang who is still filthy rich even with Yahoo's poor recent performance. These guys are just greedy exploitative jerks, we need regulation to prevent them from starting another company that might make them even richer. Government should step in instead.

[uhoh]

> We're lucky to have these companies in the United States,
> ... instead of some other place ... they've created so many
> jobs, done so much good, all thanks to the American
> capitalist model.

And these rich folks eat thanks to the great American farmworker, and they drive thanks to the great American asphalt worker, and they fly thanks to the great American air traffic controller, and they have workers thanks to the great American schoolteacher, and they sleep at night thanks to the great American police officer and firefighter.

And they're on top thanks to the great American social contract.

Remember that?

[Patricia Shannon]

BJ
Do you have a link to those figures?

[Patricia Shannon]

http://www.washingtonpost.com/wp-dyn/articles/A61178-2004Aug12.html
Tax Burden Shifts to the Middle
Presidential Campaigns Draw Differing Conclusions From Report

By Jonathan Weisman
Washington Post Staff Writer
Friday, August 13, 2004; Page A04

Since 2001, President Bush's tax cuts have shifted federal tax payments from the richest Americans to a wide swath of middle-class families, the Congressional Budget Office has found, a conclusion likely to roil the presidential election campaign.

The CBO study, due to be released today, found that the wealthiest 20 percent, whose incomes averaged $182,700 in 2001, saw their share of federal taxes drop from 64.4 percent of total tax payments in 2001 to 63.5 percent this year. The top 1 percent, earning $1.1 million, saw their share fall to 20.1 percent of the total, from 22.2 percent.

Over that same period, taxpayers with incomes from around $51,500 to around $75,600 saw their share of federal tax payments increase. Households earning around $75,600 saw their tax burden jump the most, from 18.7 percent of all taxes to 19.5 percent.

The analysis, requested in May by congressional Democrats, echoes similar studies by think tanks and Democratic activist groups. But the conclusions have heightened significance because of their source, a nonpartisan government agency headed by a former senior economist from the Bush White House, Douglas Holtz-Eakin. The study will likely stoke an already burning debate about the fairness and efficacy of $1.7 trillion in tax cuts that the president pushed through Congress.

"CBO is nonpartisan, it's independent, and right now it works for a Republican Congress with a former Bush economist at its head," said Jason Furman, economic director of the presidential campaign of Sen. John F. Kerry (D-Mass.). "There's no higher authority on the subject."

[acerimusdux]

This is what I have been arguing; that inflation targetting (at too low a rate) also played a part by helping to increase wealth inequity.

The assumption seems to be that the lower inflation, the better. But, inflation has a significant redistributive role. Inflation is essentially a flat tax on wealth--one with 100% compliance and zero administrative and collection costs. We should consider the impact of changes in the inflation rate in comparison with an change in taxes or a change in outstanding debt.

I think it should also be apparent that too much concentration of wealth in the hands of too few would be likely to be a drain on economic growth. There is only so much the rich can spend on. At a certain point, they don't want to spend it, so much as store it. They might be inclined to invest it, but in order for investment in providing new products and services to be profitable, there has to be demand for those new products and services. With a dwindling share of wealth and income, the middle class gets to where it can't afford any more.

So as profitable capital investment opportunities dry up, you start to see more flowing into long term assets, such as real estate and commodities, which can be held as a store of wealth.

And, it seems to fit in with history. The gold standard, and low tax rates on upper brackets in the 1920s led to similar results as extreme inflation targetting and low rates on upper brackets in this decade. Inflation and interest rates fall, personal savings falls, capital investment falls, asset bubbles emerge, and income and wealth inequality rises.

[anne]

Asking whether increasing income inequality may contribute to bubbles is an important question, and there may be a reason to ask in terms of income alone initially, but any implication that increasing income inequality does not mean increasing wealth inequality is distorted and pernicious in masking a social-economic change of prime importance.

We have for years changed tax structure expressly to favor wealth accumulation by the wealthiest, but the idea that wealth amasses has no necessary relation to income for the country allows the myth of rags to riches to persist as though that were a norm rather than an increasing oddity as wealth inequality and income inequality increase.

[anne]

Simply looking to the concentration of corporate wealth from 1991 to 2004, a concentration is which all the richest lost ground to the richest, shows starkly that wealth is becoming increasingly concentrated with income. How could it be otherwise though in terms of changes in tax structure alone, and of course the prime pressure for favorable tax structure comes from the wealthiest.

The matter is clear:

http://www.nytimes.com/2006/01/29/national/29rich.html?ex=1296190800&en=784822e4b0735ee5&ei=5090&partner=rssuserland&emc=rss

For every group below the top 1 percent, shares of corporate wealth have declined since 1991. These declines ranged from 12.7 percent for those on the 96th to 99th rungs on the income ladder to 57 percent for the poorest fifth of Americans, who made less than $16,300 and together owned 0.6 percent of corporate wealth in 2003, down from 1.4 percent in 1991....

[anne]

http://www.nytimes.com/2005/06/05/national/class/HYPER-FINAL.html?ex=1275624000&en=f1af44c9cec8c79e&ei=5090&partner=rssuserland&emc=rss

June 5, 2005

Richest Are Leaving Even the Rich Far Behind
By DAVID CAY JOHNSTON

¶Under the Bush tax cuts, the 400 taxpayers with the highest incomes - a minimum of $87 million in 2000, the last year for which the government will release such data - now pay income, Medicare and Social Security taxes amounting to virtually the same percentage of their incomes as people making $50,000 to $75,000.

¶Those earning more than $10 million a year now pay a lesser share of their income in these taxes than those making $100,000 to $200,000....

[There is no accident to increasing concentration of wealth.]

[John V]

I think the answer is "neither". Have you ever looked into corollaries involving Fed policy?

We all know interest rates had been too low in the years preceding the current housing bubble. There were also people arguing back in the 1990s that interest rates were too low.

Your question almost sounds like you're asking if one symptom causes the other or vice-versa. But they are still just symptoms.

Now I'm not saying income concentration in a broad sense is necessarily a terrible thing....for reasons mentioned by BJ and John above. Some of it is simply the result of capitalism and is not a problem. Nor is income inequality in a general sense a bad thing either...and for the same reasons.

BUT, there may be an "extra" level of income inequality and concentration that are accelerated and/or increased because of loose Fed policy.

Loose Fed policy makes risk taking easier...easier than the market would allow with interest rates if reflecting a more true supply/demand rate rather than an artificially low one administered by fiat.

The people most likely to take advantage of these rate cuts are also the people with more money to begin with and they tended to get returns before price signals inflated prices producing better returns.

That last paragraph is a little hazy but I think the general idea is clear.

The idea of bubbles causing income concentration or vice versa strikes me as a side show to what lies beneath both of them: extremely low interest rates that fuel excessive risk taking and, in turn, excessive gains for those with the money to jump in early in the bubble.

**The concentration of wealth and/or income I'm talking about is that which goes over and above the natural level that results simply from the more productive taking advantage of opportunities and excelling more than those who don't.

PS: all this is happening in an era post-gold standard circa 1971(?). Regardless of whether the gold standard is good/bad idea....for my part I don't necessarily favor a gold standard...but a good consequence of it is that it makes the Fed accountable to SOMETHING that it cannot increase on a whim...meaning money supply is bound to something...meaning interest rates are somehow bound to something. Real interest rates can't spiral into negative value bound by this tether.

Food for thought.

[Real Person from the Real World]

I've said this before and I'll say it again, and probably no one will read it again.

Banks pay maybe 2-4%, more or less, and you may have to move from bank to bank continually, to get the deal of the month. Mortgages at best run maybe 6-8%, while gas is careening between $3.50 and $4.50 a gal, and credit cards charge 20% and up...while many salaries pay poorly to very poorly, variable (contract) feast or famine, and fewer with benefits.

The cost of everything may not be inflating up, but when you salary is increasingly going nowhere and cannot cover what you need, WHERE do you go for a decent return on the little you can put away? Mutual funds (stock), preferred stock, stocks, maybe bonds. Only the really poorest minimum wage people don't have a at least a tiny amount of money in stock or mutual fund, if only for an IRA.

The wealthiest investors can, of course, take best advantage. The poorer ones get the scraps.

Ultimately, I don't think it is as much wealthy investors as it is, the lack of decent wage paying jobs that is at the heart of things. The wealthy will always be able to skim the cream off the top, and try the latest get rich quick fads, but short of putting your pay under your mattress, as the old cliche from the depression era went, where does joe and jane 6pack put their money?

[Mark Thoma]

It's pretty easy to connect low interest rates to income concentration. Saying the Fed lowered interest rates is an easy way to set the pre-conditions, but here's a story where wealth inequality causes bubbles independent of the Fed:

We get rational bubbles whenever the interest rate falls below the growth rate of the economy; when the interest rate falls until it is near the growth rate of the economy we have nearly-rational bubbles; so anything that pushes interest rates way down can produce this effect. High wealth inequality means that those who could use the goods can't afford them and those who can afford them already have them, hence a savings glut, hence low interest rates, hence a vulnerability to nearly-rational bubbles...

I'm still working this out, as well as other theoretical foundations, and hopefully I'll do a post on it at some point. But there are economic mechanisms whereby income inequality leads to bubbles (there are also sociological mechanisms and I'm working on those too).

[anne]

Mark Thoma:

"High wealth inequality means that those who could use the goods can't afford them and those who can afford them already have them, hence a savings glut, hence low interest rates, hence a vulnerability to nearly-rational bubbles..."

Clever; and notice that whatever Federal Reserve short term interest rate policy was from 1980-1981 on, long term interest rates steadily fell through each Fed cycle. From 1994 on, long term interest rates were less and less effected by Fed short term rate increases.

[John V]

Dr. Thoma,

Thanks for the response. I do look forward to seeing what you come up with.

However,

High wealth inequality means that those who could use the goods can't afford them...

I don't quite get the significance or insight of such a definition.

To me, high income inequality is just that: high inequality. The later impact of such inequality is a little more hazy and dependent on context.

To me, if people who use goods cannot afford them, there's something wrong...not morally but systemically.

Part of it can be people simply refusing to accept their limitations and borrowing at all costs...like a man who makes $20K per year INSISTING on taking on excessive debt to buy his girl friend a $7K diamond/platinum engagement ring when he should look for something more modest that IS available.

The other part...and the part that matters here IMO...is that this cheap credit causes overconsumption of certain goods and it prices out others who then cannot afford what they want...or borrow excessively to have it.

For example, I'm still convinced that housing prices are generally still very over-priced. This is the result of people with means buying more than need simply because they can. This drives up demand and hence prices and contributes to dangerous bubbles...rational or otherwise.

It's rational for someone to see housing prices appreciating (regardless of whether it's because of a good reason) and wanting to buy a new house to take advantage of the appreciation for himself and improve his net worth and status. People with means also buy houses to resell because it makes economic sense in real time (because of the combination of cheap credit and appreciation of value) to make money or rent them out for long term gains. All these actions make homes more valuable than they otherwise would be.

Just a thought...

[BJ Feng]

Mark Thoma, there is a widespread belief that bubbles need middle class participation to form. Looking back at the .com bubble, the housing bubble, and the 1920's stock mania, we see a large amount of middle class involvement. The same is true if we look back further to the South Sea bubble in England. For a bubble to form, there has to be enough widespread participation that it affects society at large, so when the bubble pops, it is felt by the majority of members and enters into the national consciousness. Other asset class rises and declines isolated to the rich do not merit classification as a bubble.

Take the art world for example. There have been periodic booms and busts in the paintings of masters. From what I understand, Andy Warhol's works have recently sold for 10x more than just a few years ago, he is hot, but other artists have seen similar increases. Should the art world experience a sharp decline, it would hardly merit much attention because it is contained within the realm of the wealthy--it would not be a bubble. There are other examples, such as prices for high end and rare wine. For a bubble to be called a bubble, we need more than just the wealthy involved.

[BJ Feng]

Real Person, you are right, the rich do have more opportunities, and just as importantly, they USE them. Part of the reason is due to regulations that protect "unsophisticated" (read not-wealthy) investors from themselves. You need a minimum of $2 million in assets in order to invest in a hedge fund. Therefore, I cannot copy Yale's or Harvard's investment strategy, I actually have a very similar strategy, but I am unable to enter the "alternative investments" asset sector. Alternative investments are incredibly important because they have low correlations with other asset classes and thus can really help by lowering portfolio volatility and increasing average gains. Ordinary investors are largely locked out of ways to profit from stock market declines. They can short stock themselves, or buy into an inverse ETF, but that requires a lot of expertise and more importantly, time. Short positions must be covered quickly as they are situational. Only the rich have widespread access to managers who are able to both go long and short without limitation.

The rich also have knowledge, which is equally as important. Real estate is the only asset class where an ordinary person can attain hedge fund like leverage (or even greater!). A typical 20% downpayment is equivalent to 5x leverage.

Unfortunately, the middle and lower classes don't understand that personal, residential housing for themselves is a LIABILITY, it is not an investment! They should use the leverage to buy income producing properties like apartment buildings and commercial spaces to generate positive cash flow. That cash flow can then be used to either lower leverage, or increase leverage by investing in another property. It is not a good strategy to use the incredible borrowing opportunities to buy a home for yourself!!! And the rich do not buy cash flow negative properties, hoping for appreciation. That is a big no no. You cannot take that kind of risk when using leverage. A property that does not generate positive cash flow should not be considered!

I've always thought that an economics course along with an investment course should be mandatory in high school. Economics and asset management are subjects that EVERYONE will come in contact with in a meaningful way. I very rarely use geometry in my day to day life, but economic factors and my investments affect me every second of every day. It is criminal that we're not teaching what is important to everyone.

[John V]

Agreed 100%, BJ.

[Real Person from the Real World]

It amazing how quickly discussion about consumption becomes about obvious overspending on luxury and conspicuous consumption, not about critical goods and services: car repair, hospitalization, gas for the car, college tuition: someone above pontificates thus: "Part of it can be people simply refusing to accept their limitations and borrowing at all costs...like a man who makes $20K per year INSISTING on taking on excessive debt to buy his girl friend a $7K diamond/platinum engagement ring when he should look for something more modest that IS available." Aside from the fact that buying an engagement ring is likely a once in a lifetime thing, and that some people are foolish, but then that is where marketing and sales come in, selling dreams. Also TV programs showing rich, outrageous spenders born with a silver spoon in their mouths, like Paris Hilton. Of course there are those with good incomes that overspend, but if factually there is so much income inequity in this country, the issue is less about a 7k diamond, and more about hospital bills for a diabetes related medical emergency, or a washing machine conking out, or the roof repair. And inequity also means some service providers like the roofer, or doctor keep their prices and income high, because all the other roofers and doctors charge about the same. No consideration, however, for the fact that all the jobs where we made things are gone overseas, and all we have are commodity jobs that pay low wages, or sales jobs.

[reason]

I think the answer is no, you can have bubbles even with a perfectly even distribution of money. The importance of the bubbles however is tied up with the total amount of leverage being created (with the increase in debt levels obliquely referenced by Winlsow R.).

As I have mentioned before, increasing levels of leverage are inimical to a sustainable economy (it might, in some cases, be sustainable financially, but not ecologically). We need to rethink finance, leverage which is a claim on future resources, has to be costlier. We need to work out how to increase the money supply without increasing debt constantly. (And to those who claim it is impossible because you cannot save without someone else incurring a debt, poppycock, the circular flow of income is balanced as long as your saving is matched by someone else dissaving.)

[Patricia Shannon]

BJ Feng says...

Mark Thoma, there is a widespread belief that bubbles need middle class participation to form. Looking back at the .com bubble, the housing bubble, and the 1920's stock mania, we see a large amount of middle class involvement. The same is true if we look back further to the South Sea bubble in England. For a bubble to form, there has to be enough widespread participation that it affects society at large, so when the bubble pops, it is felt by the majority of members and enters into the national consciousness. Other asset class rises and declines isolated to the rich do not merit classification as a bubble.

Take the art world for example. There have been periodic booms and busts in the paintings of masters. From what I understand, Andy Warhol's works have recently sold for 10x more than just a few years ago, he is hot, but other artists have seen similar increases. Should the art world experience a sharp decline, it would hardly merit much attention because it is contained within the realm of the wealthy--it would not be a bubble. There are other examples, such as prices for high end and rare wine. For a bubble to be called a bubble, we need more than just the wealthy involved.

Good point.

[Patricia Shannon]

Real Person from the Real World says...

It amazing how quickly discussion about consumption becomes about obvious overspending on luxury and conspicuous consumption, not about critical goods and services: car repair, hospitalization, gas for the car, college tuition

Very true.