4/22/14 – Some Thoughts on Capital in the Twenty First-Century by Thomas Piketty

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Apr 22, 2014 2:00:00 PM

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A caveat about this post: I haven’t yet read the book, so this is neither a review nor a real engagement with Piketty’s arguments. I’ll get to that—I just ordered the Kindle version, and have a couple of very long plane rides coming up, which should be ideal.

What I find fascinating so far are the extreme reactions to what appears to be, at base, a fairly simple thesis: Capital accumulations can grow faster than an economy as a whole, and over time will become a greater part of that economy. This is neither politics nor economics; it’s math, and it is inescapable.

Take, for example, a $1 billion fortune in a $10 trillion economy, so the fortune is 0.01 percent of the economy as a whole. Over 50 years, say, if the economy grows at 3 percent while the fortune grows at 5 percent, the fortune will be more than two and one-half times the initial size as a percentage of the economy. Given this simple math, you have to accept that capital accumulations will, over time, become larger as a proportion of the economy.

There are assumptions baked in here, of course—no spending and the return rate differential being key—but they affect the details, not the substance of the argument. Piketty, then, is being variously lauded and attacked for something else—namely, his policy recommendations.

As I haven’t read the book yet, I won’t comment on the recommendations, but apparently Piketty himself knows they’re nonstarters. Nonetheless, they’ve struck a chord. Piketty has met with the U.S. Treasury secretary, given a talk to the President’s Council of Economic Advisers, and been praised by liberal economists, all while being roundly excoriated by those of a more conservative bent.

Let’s step back for a moment from the policy recommendations, which are generating heat but not light, and consider the thesis itself, and what it means here in the U.S. going forward.

According to the UC-Santa Cruz Sociology Department, the top 1 percent of the U.S. population controlled more than a third, or 34.6 percent, of all wealth in 2007. The top 5 percent controlled 61.9 percent, while the top 10 percent controlled 73.1 percent and the top 20 percent controlled 85.1 percent.

Using these numbers, let’s assume a 4-percent annual growth rate for the assets (pessimistic, I believe) while the economy as a whole grows 3 percent per year (optimistic). If we extrapolate 20 years into the future, the top 1 percent will control 42 percent of all wealth; the top 5 percent, more than 75 percent; the top 10 percent, 88.7 percent; and the top 20 percent, essentially all of the wealth. Using different assumptions only changes details.

If you accept these conclusions—and the facts and assumptions, in my opinion, seem reasonable—then you have some things to consider. Are you happy with 80 percent of the U.S. population being economically marginalized in 20 years or so? If not, what will you do about it? Do you expect that 80 percent to be happy about the situation? What do you expect them to do about it? These are disturbing questions, with no easy answers. Much of the current commentary seems to revolve around avoiding them.

Looking at the demographics, with the aging of the Baby Boom generation and their well-known lack of retirement savings, it’s easy to see how a large part of the population could become insolvent over that time period. Looking at the behavior of asset prices over the past couple of decades, it’s also easy to see how those with assets—the top 20 percent—could continue to grow their net worth as they pay down mortgages and save. These trends seem well supported in the real world.

From a policy perspective, you can expect to feel a lot more heat around this topic, as the argument will only become more urgent over time. This will be the defining economic conflict of our time, and Piketty’s book is just the starting gun.

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