The past two decades have been wonderful for the luxury goods business as demonstrated by the position at the top of the world’s billionaire Rich List of Bernard Arnault, chairman of LVMH Moët Hennessey Louis Vuitton. Cheap money has boosted asset prices ad infinitum and the top 1-2% of the world’s population with significant inflated-value assets have spent a lot of their winnings on high-priced rubbish. But interest rates are no longer near zero, and asset prices must inevitably fall. Surely that portends a slump in the luxury goods market, even as ordinary consumers continue to spend.
The market for luxury goods in a society is largely governed by its Gini coefficient of inequality (named after Corrado Gini, the world’s greatest Fascist economist). In the late 18th century, Britain was already considerably richer than France, in terms of average income and wealth, because the Mississippi crash of 1720 had deprived the French economy of capital. Yet luxury goods were a French specialty; whether Gobelin tapestries, champagne or high-quality porcelain, the very top end of the market was dominated by artisanal French producers. The reason was the Gini coefficient: in 1800, after a decade of presumably egalitarian strife and populism, France still had a Gini coefficient of 73.3, the highest of any substantial country in the world, compared to Britain’s 58.9.
A second period of very high inequality and a thriving luxury goods market occurred in the United States during the Gilded Age. The United States protected domestic manufacturers by the high Morrill Tariff of 1862, which was raised further in successive Republican administrations. Had Britain, at that point operating a firmly free trade policy, been remotely economically competent, it would have joined with France and Germany (both themselves relatively free trading until 1879) to demand a reduction in U.S. tariffs, once the Civil War emergency was over. That did not happen, and so U.S. industry and American workers were given a massive subsidy for several decades, mostly at the expense of the British Empire.
In principle, that subsidy could have been used to create a ‘workers’ Nirvana’ of unprecedentedly high wages, paid from the tariffs’ subsidy to U.S. manufacturers. However, the cheap labor lobby, always unwilling to allow workers’ living standards to improve, put a stop to that by flooding the country with indigent immigrants from Southern and Eastern Europe. With revenues artificially high and labor costs held down, the result was a cornucopia of wealth to the American upper classes, producing the world’s first dollar billionaires and a massive boom in luxury goods, with such symbols of opulence as Tiffany and Fabergé flourishing.
The ’robber barons’ reign was ended by two factors: World War I, which produced progressive income taxes that cut them down to size, and the blessed 1924 Immigration Act, which sharply reduced the influx of cheap labor and thereby allowed ordinary Americans for the first time to share in the wealth their country produced. The result, after a brief period of economic stress caused by appallingly poor policies in the 1930s, was a ‘workers’ Nirvana’ that lasted until 1973, just a few years after the 1924 Immigration Act had been replaced by the excessively permissive Hart-Celler Immigration Act of 1965.
During the ‘workers’ Nirvana’ period, with higher wages and very high top rates of income tax, U.S. inequality was sharply diminished, and the market for luxury goods went into sharp decline. The 1930s saw Stutz, Duisenberg and Pierce-Arrow automobile manufacturers closing, while even Packard, the premier luxury manufacturer before 1930, was forced to go down-market with its 1937 models. Only Ford and General Motors were able to subsidize their high-priced brands with sales of their mass-market models. Then after World War II, there was a burst of innovation in the market while excess demand from the war years was absorbed. Packard outsold Cadillac until 1950 but then went into rapid decline, merging with Studebaker in 1954 and closing in 1958. Given the vast increase in overall U.S. wealth in the decades after World War II, the disappearance of the luxury U.S. automobile brands, notably Packard is striking. It demonstrates the reality that, in an era of declining Gini coefficients, however good times are for business as a whole and ordinary consumers, the luxury goods business is very unattractive.
The same trend was seen at that period in other luxury goods. De Beers had monopolized the diamond market since 1888 and had done very well before 1929 by marketing primarily to the very rich, partly by appealing to their wish to be associated with royalty and the titled aristocracy, both of which groups had asserted their status through resplendent jewelry. Then in the 1930s, sales fell off a cliff, a danger to De Beers since production was independent of sales, so there was a danger of flooding the diamond market with excess product and causing prices to crash.
Therefore in 1938 De Beers partnered with the advertising agency N.W. Ayer, who determined that sales to ordinary people could be increased by creating a situation where almost everybody pledging marriage felt compelled to buy an engagement ring. Ayer’s advertising, featuring glamorous engagement rings bought for film stars and the rich, was highly effective in democratizing the market – “the big ones sell the little ones.” Ayer’s slogan “A Diamond is Forever,” first aired in 1948, then enabled De Beers to profit from the enormous increase in ordinary people’s wealth that followed World War II, even while royal and aristocratic displays of jewelry were declining.
Since the early 1990s, the opposite tendency has prevailed. The U.S. Gini coefficient, which was around a healthy 43 in 1991, has risen substantially to 49, and the society is showing a Latin American tendency of vastly different social and political mores between an ever-wealthier elite and a struggling mass population. The U.S. is not yet Brazil, or ancien régime France, but the tendency towards ever worse economic management, driven by an elite whose outlook on politics is ignorant and frivolous, indicates that if loose monetary policy, over-regulation and the climate change mania are given their sway, the result will be disastrous, both economically and socially.
In such a scenario, luxury goods would continue to sell well in relation to other goods, as the wealthy retreated ever further into ‘Petit Trianon’ isolation. The qualifier is however important; such a future would be one of sharply declining productivity (already in President Biden’s America and Rishi Sunak’s Britain a problem) and therefore of declining overall wealth, as the mass markets brought by industrialization’s success became impoverished and then disappeared. Moreover, the misery that such policies inflicted upon the mass of the people would inevitably produce 1789-like disturbances, that would probably break the power of the managerial elite and would certainly break its windows – not good for the luxury market!
More likely, there will be a reaction. Indeed, the first step in such a reaction, a move to much higher interest rates, has already taken place. A market where the Federal Funds rate is above 5% cannot indefinitely hold Treasury bond rates below 4%, and Treasury bond rates around 5% are wholly incompatible with current levels of stock prices, real estate prices, fine art prices or asset prices in general, even if inflation reduces the effect of those higher interest rates on the economy as a whole.
In a world of economic reaction, where regulations are scythed down, productivity growth has resumed and Gini coefficients begin to decline again (as they will, with lower asset prices) the luxury goods market will undergo a transition similar to that of 1930-60. Some luxury goods manufacturers will scale down their product offerings, aiming at a broader market; they are unlikely to be successful in doing this unless like De Beers they control production and do not have to compete with broad-market producers of greater efficiency. Others will retreat into the shrinking world of the ultra-rich, in which case they may be able to charge even higher prices but will find their sales volumes sadly reduced.
Either way, I would not today buy shares in luxury goods producers. Marie Antoinette does not represent a sound long-term investment!
-0-
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)