American Plutonomy: There has been a lot of controversy in recent years in the US on inequality and last month Tom Perkins, a co-founder of Kleiner Perkins Caufield & Byers, a leading Silicon Valley venture capital firm, in a letter to The Wall Street Journal, compared activism in San Francisco against the tech 'elite,' to the 1938 Kristallnacht (Night of Broken Glass) pogrom against Jews throughout Nazi Germany and Nazi-controlled parts of Austria and Czechoslovakia. Beyond the bizarre bile of a billionaire, there is an economic metric that cuts to the key impact for the economy: in 2012, the richest 5% of Americans accounted for almost 40% of consumer spending.
We reported on Finfacts Premium in 2011 that research by Mark Zandi, chief economist of Moody's Analytics, the economics consultancy unit of the eponymous ratings agency, showed that the top 5% were responsible for 37% of consumer outlays in 2010.
Last month a new paper by Barry Z. Cynamon and Steven M. Fazzari, economists working with the Federal Reserve Bank of St. Louis and the Weidenbaum Center on the Economy, Government and Public Policy at Washington University in St. Louis, showed that in 2012, the top 5% of earners were responsible for 38% of domestic consumption, up from 28% in 1995.
Since 2009, when the US recession ended, inflation-adjusted spending by the richest Americans has risen 17%, compared with just 1% among the bottom 95%.
The paper says that more broadly, about 90% of the overall increase in inflation-adjusted consumption between 2009 and 2012 was generated by the top 20% of households in terms of income, according to the study, which was sponsored by the Institute for New Economic Thinking, a think-tank that is supported by George Soros, the hedge fund billionaire.
The economists say that rising inequality reduced income growth for the bottom 95% of the income distribution beginning about 1980, but that group’s consumption growth did not fall proportionally. Instead, lower saving led to increasing balance sheet fragility for the bottom 95%, eventually triggering the Great Recession. We decompose consumption and saving across income groups. The consumption-income ratio of the bottom 95% fell sharply in the recession, consistent with tighter borrowing constraints. The top 5% ratio rose, consistent with consumption smoothing. The inability of the bottom 95% to generate adequate demand helps explain the slow recovery.
They say that at least since John Maynard Keynes, the leading Depression era economist, economists have predicted that greater inequality would reduce consumption as a share of income because they assumed that saving rates tend to rise with income. "Paradoxically, however, most of this period with rising income inequality was also a period during which the ratio of consumption to income increased."
In the period 1960-1980, inflation-adjusted incomes of the top 5% and the remaining 95% increased at almost the same rate: 4% a year for those at the top, and 3.9% for everyone else. However incomes diverged between 1980 and 2007, with those at the bottom seeing annual rises of 2.6%, while income growth for the top 5% accelerated to 5% a year. Meanwhile, the paper says the debt-to-income ratio rose almost 12 times as much for those at the bottom as for those at the top between 1980 and 2007.
The authors say that "original disaggregation of Survey of Consumer Finances data show that the increase in the debt-income ratio in the decades prior to the Great Recession was much more pronounced for the bottom 95% than it was for the top 5%. The net worth of the bottom 95% did not fall much behind the top 5% by 2007, but financial net worth that excludes the value of owner-occupied housing plummets for the bottom 95% even though it rises for the top 5%. The collision of these trends with limits on further leverage ultimately forced a historic collapse of consumption, leading to the Great Recession, as predicted in broad terms by Minsky’s (1986) financial instability hypothesis."
We show that by 2012 there was a massive shortfall of consumption spending relative to pre-recession trends for both the bottom 95% and top 5%, albeit for different reasons. Recognizing that US aggregate demand growth was not excessive before the recession, we conclude that inequality has sharply constrained the spending of the bottom 95% of households, while the decline in the spending of the top 5% of households is primarily a response to the recession itself. We argue that demand drag caused by inequality is now constraining the U.S. economy. The result is aggregate consumption substantially below comparable trends for past U.S. recoveries."
Steven Fazzari told The New York Times that depending on a relatively small but affluent slice of the population to drive demand makes the economy more volatile, because this group does more discretionary spending that can rise and fall with the stock market, or track seesawing housing prices. "The run-up on Wall Street in recent years has only heightened these trends, said Guy Berger, an economist at RBS, who estimates that 50% of Americans have no effective participation in the surging stock market, even counting retirement accounts."
Sears and JC Penney, retailers whose wares are aimed squarely at middle-class Americans, are both in dire straits.
Finfacts 2013:Inflation-adjusted household income of typical US family in 2012 below 1989 level
Finfacts 2013: Company cash hoards rise to $8tn; Taxes, squeezed labour and 'trapped' cash
The word plutonomy is derived from plutocracy (from Greek ploutos meaning wealth and kratos, meaning power or rule ), and was introduced to a general audience in 2009 when Michael Moore in his documentary film, 'Capitalism: A Love Story' (see video below) revealed the existence of two Citigroup client notes produced by a team headed by Ajay Kapur, then Citigroup's chief global equities strategist.
In March 2006, the Citigroup analysts wrote:
Back in October, we coined the term 'Plutonomy' (The Global Investigator, Plutonomy: Buying Luxury, Explaining Global Imbalances, October 14, 2005). Our thesis is that the rich are the dominant drivers of demand in many economies around the world (the US, UK, Canada and Australia). These economies have seen the rich take an increasing share of income and wealth over the last 20 years, to the extent that the rich now dominate income, wealth and spending in these countries. Asset booms, a rising profit share and favorable treatment by market-friendly governments have allowed the rich to prosper and become a greater share of the economy in plutonomy countries. . . . [T]he lawyers and bankers who intermediate globalization and productivity, the CEOs who lead the charge in converting globalization and technology to increase the profit share of the economy at the expense of labor . . . contribute to plutonomy...[W]e think that global capitalists are going to be getting an even greater share of the wealth pie over the next few years, as capitalists benefit disproportionately from globalization and the productivity boom, at the expense of labor."
In the October 2005 note, the analysts said that plutonomies have occurred before in sixteenth century Spain, in seventeenth century Holland, the Gilded Age and the Roaring Twenties in the US. "What are the common drivers of Plutonomy? Disruptive technology-driven productivity gains, creative financial innovation, capitalist-friendly cooperative governments, an international dimension of immigrants and overseas conquests invigorating wealth creation, the rule of law, and patenting inventions. Often these wealth waves involve great complexity, exploited best by the rich and educated of the time.
They projected that the plutonomies (the US, UK, and Canada) "will likely see even more income inequality, disproportionately feeding off a further rise in the profit share in their economies, capitalist-friendly governments, more technology-driven productivity, and globalization."
In a plutonomy [there is no such animal as “the US consumer” or “the UK consumer”, or indeed the “Russian consumer”. There are rich consumers, few in number, but disproportionate in the gigantic slice of income and consumption they take.]
There are the rest, the “non-rich”, the multitudinous many, but only accounting for surprisingly small bites of the national pie. Consensus analyses that do not tease out the profound impact of the plutonomy on spending power, debt loads, savings rates (and hence current account deficits), oil price impacts etc, i.e., focus on the “average” consumer are flawed from the start. It is easy to drown in a lake with an average depth of 4 feet, if one steps into its deeper extremes. Since consumption accounts for 65% of the world economy, and consumer staples and discretionary sectors for 19.8% of the MSCI AC World Index, understanding how the plutonomy impacts consumption is key for equity market participants...Since we think the plutonomy is here, is going to get stronger, its membership swelling from globalized enclaves in the emerging world, we think a “plutonomy basket” of stocks should continue do well. These toys for the wealthy have pricing power, and staying power. They are Giffen goods, more desirable and demanded the more expensive they are.]
Citigroup's plutonomy notes:
October 2005 [pdf]
March 2006 [pdf]
Citigroup was bailed out by the United States government in 2008.
As for the sense of victimhood at the top, Ken Langone, a founder of Home Depot, recently said that Pope Francis’s broadsides against inequality would reduce donations to the Catholic church - - it was a revealing comment about the enduring power of money.