Increasing inequality is bemoaned by the left worldwide, with the Financial Times’ Edward Luce doubtless making President Obama choke on his cornflakes by claiming that “US inequality will define the Obama era.” Yet contrary to the left’s fond belief, the increasing inequality and the crass behavior of the super-rich are responses, not to inadequate levels of taxation, but to two decades of monetary policy that has imposed negative real interest rates on the world economy. Ben Bernanke, his predecessor Alan Greenspan, and their imitators abroad are responsible for the rise of a global nouveau riche class that is not only uniquely privileged, but in many (though not all) cases uniquely unpleasant in its ethics and behavior.
If you compare the first “Forbes 400” list of the richest Americans in 1982 with the 2012 list, you will notice a startling change. Whereas a clear majority of the 1982 list – 32 of the top 50 – had inherited their money, in 2012 a larger majority of the list – 34 of the top 50 – were self-made, coming from families that were poor or middle class, and in most cases without a significant business presence. Over such a short period (many of the top names of 2012 were already on the 1982 list) that’s a remarkable change. Incidentally, if you look at an earlier list prepared by BC Forbes in 1918 (a year in which income tax records were available to the public) you find that even in that era of high inequality and low income taxes, 17 of the top 30 fortunes were inherited and only 13 self-made. Thus it’s 2012, not 1982, that is the anomaly.
Another change since 1982 is that the rich have got richer; the combined net worth of the Forbes 400 was 2.8% of US GDP in 1982, and 11.5% of GDP in 2012 – in other worlds, the average wealth of a Forbes 400 member had increased by over 4 times as a share of the U.S. economy, thus by 8 times in real terms, or by over 20 times in money terms.
Internationally, the contrast would be even greater, with the increase in average wealth since 1982 greater than in the United States and the swing from heirs to the self-made more pronounced. However internationally we have enjoyed the enormous growth of emerging markets and the emergence of Russia and the ex-Soviet bloc, so the comparison is not quite a fair one.
The United States economy, however, is approximately as capitalist as it was in 1982, and roughly of equal importance to the world economy, so the change in the U.S. super-rich must have been caused by factors other than politics or U.S. economic performance. The stock market boom of 1982-2000 helped of course; by 1997, halfway through the period (after a tenfold multiplication in the Standard and Poor’s 500 index since 1982) the fortunes were much larger than in 1982, although less than half in real terms their size today..
Naturally, you’d expect the proportion of self-made billionaires to have increased between 1982 and 1997, because of the huge bull market in U.S. stocks, and indeed it had, but only from 18 out the top 50 to 23, a proportion close to that of 1918. Only since 1997 has the great switch to self-made ultra-rich taken place, with a corresponding further increase in fortune size that’s not explained by the relatively modest growth in stock values (less than doubling in nominal terms, up only 10-20% in real terms) during the period.
The explosion in self-made super-rich from 1997 to 2012 and the increase in their net worth were due to the same cause: the highly expansionary monetary policy instituted by Greenspan in February 1995 and exacerbated by Bernanke since 2006.
The mechanism is quite simple. Interest rates close to or below the rate of inflation favor borrowers over lenders, since borrowers are able to attract borrowed capital at close to no cost in real terms. Hence highly leveraged strategies, which rely on borrowing large amounts of money and investing in relatively low-yielding assets, create wealth very rapidly, enabling the nouveaux riches to overtake established wealth holders.
Of course, established wealth holders could leverage themselves too, but they don’t because the downside risk is too great. If as in 2008 a highly leveraged operation meets with a sharp downturn, its wealth can easily be destroyed. That’s unacceptable for the established rich, but it’s an acceptable risk for those whose fortune is recent and not well established — the upside benefit to them of becoming truly wealthy exceeds the downside risk of losing the wealth they have.
You can see the result of this attitude in the long career of Donald Trump, who has filed several times for bankruptcy, either directly or through parts of his real estate and casino empire, but nevertheless continues to enjoy the lifestyle of a multi-billionaire and in the current environment of high asset prices and low interest rates is almost certainly genuinely worth several billion.
The last five years of Ben Bernanke, which have seen short term interest rates reduced to zero, have intensified the tendency for new money to outshine old – if only because many of the new money moguls have learned from the 2008 debacle that bankruptcy can be avoided and that the risks of leverage, at least for the borrower, are much lower than they used to be.
The key to getting rich in the modern economy is thus no longer the ability to build a good long-term business, but access to cheap leverage. Thus typical members of the Forbes top 50 in 2012 were Ray Dalio (33rd) and Steve Cohen (40th) both heads of massive hedge fund groups, with Cohen’s SAC Group already mired in what we may politely call controversy, with several insider trading indictments handed down. Dalio is now the richest of my Harvard Business School (’73) classmates, beating out Tom Stemberg, the founder of Staples, yet his and Cohen’s businesses are quintessential beneficiaries of Bernanke-era leverage, and I wouldn’t put long odds on them still gracing Forbes’ list in 2022, let alone 2042.
Technology has also had an effect; businesses that are largely virtual and essentially ephemeral, such as Google and Facebook, can be built up much more quickly than old-fashioned businesses requiring massive investments in bricks and mortar or worldwide sales forces. Of course, virtual fortunes can vanish as quickly as the hula-hoop craze. For example Ted Waitt, a founder of the PC seller Gateway, a somewhat less virtual business than the two modern giants, was 41st on the 1997 list, with a net worth of $3 billion, yet in 2009 the entire company was sold to Acer for only $710 million, leading Waitt to enter the Forbes top 50 and subsequently leave the Forbes 400, both by the age of 46.
Globally, the same tendency is even more apparent. Russian and Chinese billionaires, in particular, are noted for their ability to obtain debt financing and use leverage. The massive swings in value in Russia since the fall of Communism, the low real interest rates that have prevailed in that country and the ability of those with political connections to get loans at especially favorable rates from the banking system have enabled the nouveaux riches to acquire control over a proportion of the Russian economy that would be impossible in the West. Similarly in China, the state-controlled banking system has been a generator of massive fortunes unknown to the glory days of the Song dynasty.
There are three conclusions to be drawn. First, the prevalence of nouveaux riches is a temporary phenomenon produced by pathological monetary policies worldwide; once those monetary policies are changed, most of the fortunes built largely on leverage will vanish. Those built on virtual technologies will also mostly prove short-lived, although they may be succeeded by other such fortunes just as the hula-hoop was succeeded by the Twist.
Second, adopting leftist policies of high tax rates will only cement the current wealth structure in place. It will make it impossible instead of over-easy to create new fortunes, and will thus increase the dominance of the current nouveaux riches in the world economy. Globally, if you want an economy dominated by the less scrupulous members of the Russian mafia, socialism is the way to go about it.
Third, the unspeakable vulgarity of modern plutocrat culture is also a passing phase. By 2030, London house prices will have crashed, and the majority of nice homes will again be owned by those with long-established money, once again able to compete in the housing market. The rootless and stateless Davos class, spending 12 months of the year in travel, will again consist of salaried top international businessmen and bureaucrats, doubtless with excellent expense accounts, but without the real money, which will instead be rooted in timelessly elegant country estates. The ultra-rich will no longer have to perpetuate their tottering overleveraged empires through pointless international “deals” but will settle to building family dynasties, while deploying their long-term fortunes in ways that are truly enjoyable. Their lifestyles will feature less frequently in the gossip columns, where the glitterati of Hollywood will seamlessly replace them, and the taste of their home furnishings and possessions generally will immeasurably improve.
Resentment of the super-rich is generally an unpleasant emotion, detracting from life’s fulfillment and leading to immoral and economically counterproductive government meddling. Currently, however unpleasant are the current plutocrats, resentment should be turned squarely towards the source of their ill-gotten wealth: Ben Bernanke and his funny money colleagues worldwide.
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(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.)