About two years ago, I read Walter Scheidel’s book titled “The Great Leveler”, which traces the history of how economic inequality usually, and sharply, decreases through catastrophes and mass violence. The bottom line of the book is that mass-mobilization warfare, transformative revolutions, state collapse and catastrophic plagues have been responsible for destroying the fortunes of the rich. How does this politically charged concept of “inequality” rise to the point of being vulnerable to the leveling forces in the first place? And can we look out and try to anticipate market responses as this cycle of widening wealth distributions also starts to turn back inward? I have frequently witnessed intelligent debates on how the government’s policies increases or decreases the wealth gap. But it has been very tough to find sufficient data to conclusively argue either point of view, until now.
Now many of the facts are out in a number of well researched reports, of which I will mention two here. In the recently published Global Wealth Report by Credit Suisse, the authors provide ample evidence that the action of central banks globally has been to create a massive wealth boom for the rich, primarily because the stimulus has gone into asset prices such as stocks, bonds and homes. Another recent publication by the Joint Center for Housing Studies of Harvard University, The State of the Nation’s Housing 2021, concludes that “households that weathered the crisis without financial distress are snapping up the limited supply of homes for sale, pushing up prices and further excluding less affluent buyers from homeownership. A disproportionately large share of these at-risk households are renters with low incomes and people of color.” The numbers are simply staggering. In 2020, even though global economies went through a shock, easy monetary and fiscal policies boosted the wealth of the world by almost $28 trillion (coincidentally global central bank balance sheets expanded by roughly the amount) which was not uniformaly distributed at all.
I hasten to add that I do not think that there is a sinister motive or conspiracy here. If central banks are indirectly responsible for the rise of economic inequality today, it is mainly because to them all problems look like those that can be solved by injecting more money into the system. For those, including this writer, who can take advantage of the flow of liquidity via asset accumulation, every liquidity injection during a crisis provides an opportunity, bringing resonance to the saying “let no crisis go to waste”. Witness the hundreds of billions of bonds being purchased by the Fed and the ECB even as the global economy is booming and asset prices continue to make new records.
The main risk of the central banks’ liquidity inundation philosophy arises from the fact that the financial plumbing is not quite set up to direct the massive amount of liquidity and pipe it to the proper places, so it both overflows and is sucked off in directions where it was not intended to go, and also that once started, it is almost impossible to stop. Central bank policies have not only boosted asset prices which have boosted the wealth of those with assets which was probably not the intention, but also resulted in a setup where central banks are deathly afraid of withdrawing liquidity for risk of upsetting the asset markets. But once they eventually cave in the face of data, e.g. if the current Fed’s song “inflation is transitory” changes, the next crisis could be precipitated, and will set up the next set of opportunities for asset owners to become even wealthier.
Before we get into investment strategies that this dynamic suggests, a few highlights from the Credit Suisse report:
· Rich countries and regions (US and Europe) gotten richer whereas poor countries (India, Latin America, Africa) have gotten poorer.
· Countries that suffered worst from COVID-19 and could afford it generally had the most outsized response from their central banks, resulting in the largest wealth gains.
· The wealth gains within a country were also extremely non-uniform. The wealth gap between the ultra-rich and the ultra-poor widened to new high. This discrepancy also shows up in gender and minority wealth growth rates.
The report correctly concludes that accumulated asset wealth provides those with assets a reserve, or insurance, with which they can better withstand significant future hardships and financial downturns. The corollary is that those without the precautionary savings are more exposed to downturns, resulting in an increasing need for government provided catastrophic insurance, whose only source is some sort of re-distribution from the haves to the have nots.
So what does this observation tell us about the likely outcomes for policy and the markets?
First, on policy. As my good friend and former PIMCO colleague Paul McCulley has said in the afterword to my new monograph: “simply put, central banks are losing their status as the putative only game in town” and that “Sovereign governments are relearning the verity that central banks are their own creation and should be harnessed to maximize the collective welfare of their citizenry, serving as the handmaiden of fiscal policy rather than the disciplinarian of fiscal policy.”
Or in the words of Bassetto and Sargent’s paper titled “Shotgun Wedding: Fiscal and Monetary Policy”: “From the point of view of sequences of government IOUs called bonds and money, institutional arrangements that delegate decisions about bonds and money to people who work in different agencies are details. Central bank independence is a convention or a fiction.”
In other words central banks have become tools of the government whose agenda in the coming years will shift from increasing growth to assist in redistributing and re-alignment. I do not have a dog in this race, and I have no axe to grind. In most democratic societies, the elected government is nothing but the people. So if the people are indirectly responsible for allowing central banks to amplify inequality currently, then the people, via their power, will have to re-distribute the wealth in order to create the need for better safety nets as the leveling processes accelerate in the future.
The simplest way that the re-distribution will work is for taxes to rise for the wealthy, and we see it already in the proposals of the current White House. “What the Fed giveth, the taxman will taketh”. Betting otherwise is probably not a good odds at least for the next four years.
The simplest sequence is for asset prices, especially equities, to rise further still, so that some new tax policies can tax a good portion of the increase in asset values which would be re-distributed to non-asset owners. For bond markets, the simple fact that yields are so low today does not allow tax revenues on the income to be significant, but the prices of bonds rise as yields fall, so there is plenty of scope for taxation of increased asset values, which could be quite problematic for many global bond markets where yields are negative. So any tax on the value of the bond holdings could be a second driver of lost wealth over a long enough horizons; and don’t forget that other hidden tax – inflation.
For illiquid assets such as real estate, the lack of transparency makes valuation, and thus taxation, somewhat problematic. Thus, real estate, like many digital assets such as Bitcoin, is likely to provide investors stores of value somewhat protected from re-distribution, but further decrease their liquidity and transparency. With increased re-distribution through helicopter drops of money, I can see a pressure on raw materials and consumable commodity prices rising, whereas the threat of wealth taxation resulting in storage commodities (such as gold) will result in downward pressure on these commodities.
The competing objectives of asset taxation for re-distribution versus allowing free flow of capital across international boundaries will result in different outcomes for the global currencies in the world. For example, of the $70 trillion in US equities, households now own “only” 38%, or $26 trillion, but foreign investors, no doubt due to low prospective returns in their own countries, including due to negative yields in Europe and Japan, own almost 16% or $11 trillion of US equities (Source: Goldman Sachs and Fed data), which is the highest recorded share of foreign ownership of US equities in history. Any taxation of the value of the equity market will thus be partially funded by foreigners, which, on balance could be negative for the US dollar if they decide to find other places to invest. With the substantial amount of foreign ownership of US bonds, this could also result in a fall in demand for US fixed income assets.
Observing very long cycles of divergence and re-convergence in wealth distributions, it appears to me that the pendulum is ready to start swinging back toward the middle as the leveling process re-starts. Inflection points such as these are usually disruptive and volatile. I do hope that the leveling processes are not violent this time, and the pendulum is not a wrecking ball. We could look back in a decade from now and wonder why it took us so long to realize that the actions of central banks caused adverse consequences for the distribution of wealth. My guess is that we all see the connection already but don’t really care; since almost everyone feels a little bit wealthier, and the relative differences are not large enough yet to overshadow the increased absolute level of wealth. But since asset prices are the main reason for this phenomenon of widening wealth distributions, and government agencies are the main reason for the increase in asset prices, we should not be surprised if asset prices and indirectly the action of the other agencies of government are also the main drivers for a compression of the wealth distribution in the years to come. Some market participants, including myself, believe the environment could be ripe for a lot of action in the fat left and right tails of asset price distributions.