The Independent Market Observer

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

Posted by Brad McMillan, CFA®, CFP®

Find me on:

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

and tagged On My Bookshelf

Leave a comment

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.


Subscribe via Email

Crash-Test Investing

Hot Topics



New Call-to-action

Conversations

Archives

see all

Subscribe


Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly in an index.

The MSCI EAFE (Europe, Australia, Far East) Index is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.

One basis point (bp) is equal to 1/100th of 1 percent, or 0.01 percent.

The VIX (CBOE Volatility Index) measures the market’s expectation of 30-day volatility across a wide range of S&P 500 options.

The forward price-to-earnings (P/E) ratio divides the current share price of the index by its estimated future earnings.

Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided on these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®