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The Savings Glut And The 1%

Damon Linker does a fine job [1] tearing into the absurdity of Jamie Dimon’s (of JP Morgan Chase) and Henrique De Castro’s (of Yahoo) stratospheric compensation in the wake of lackluster to poor performance of the public corporations in their respective charge. We’ve heard that news before, but so long as it doesn’t change, it’s still news.

But in passing, he makes a point that I think is worth another look. Apropos of why the 1% continues to get richer at a faster rate than other segments of the population, he says:

Part of it is undoubtedly a result of the greater opportunities for wealth generation enjoyed by rich people everywhere. Turning $1 million into $10 million is usually easier than acquiring the $1 million in the first place — and, all things being equal, turning $10 million into $100 million is even easier.

Why, though, should that be the rule? Why should returns to wealth “accelerate” in this fashion? It’s not a law of nature by any means.

With any enterprise, greater scale brings greater efficiencies in some areas, and worse efficiencies in others. Greater scale gives you greater bargaining leverage in contract negotiations, standardization can reduce the overhead associated with all sorts of decision making, etc. But, on the other hand, greater scale means that the process of moving information up the chain of command gets more difficult and expensive, the growth of vested interests within an organization that conflict with one another and are not aligned with the interests of the organization as a whole, and standardization can substantially reduce flexibility. At the very largest scales, it becomes impossible to grow because the market becomes saturated.

What all of the above should mean is that larger fortunes/businesses are more readily preserved, either growing or decaying slowly, while smaller ones have a greater chance of both growing rapidly and evaporating completely. It should not, in general, be the case that larger fortunes or businesses grow more rapidly more easily than smaller ones.

Moreover, right know we are purported to be in the middle of a long global savings glut [2] (though that concept is, of course, disputed), where there is too much savings chasing too few legitimate investment opportunities. This is one explanation for low long-term rates and persistently recurrent asset bubbles. But if returns to capital are low in general, how does it become easier to grow a large fortune than a small one? Shouldn’t low returns to capital mean that big pools of money stagnate? Isn’t this precisely what Bill Gross was complaining about [3]?

In an overall low-return environment, returns should scale inversely with the size of the investment opportunity. There should be no liquid asset classes that present attractive returns, and any large opportunities that are less-liquid but could attract large pools of capital should also show degraded returns because of the high degree of competition to invest. Whereas small, below-the-radar opportunities should still exist simply because they are too small to be worth the time of a large pool of capital to investigate. An environment of high real interest rates should be the one where capital holds the whip hand.

If it is indeed easier to make $100 million out of $10 million than to make $10 million out of $1 million, that suggests a process of cartelization in the investment world. In other words, the distinction between self-dealing in contracts for wages versus greater “opportunities” for the very wealthy to achieve high returns to capital may be specious. Both situations may involve a substantial element of self-dealing.

Alternatively or additionally, it’s yet more evidence that real interest rates are actually quite high.

14 Comments (Open | Close)

14 Comments To "The Savings Glut And The 1%"

#1 Comment By collin On January 28, 2014 @ 1:22 pm

In terms of the global economy, I would argue it is a global labor glut came first that occurred from 2000 – Today. (Which led to the savings glut.) The impact of the two income middle class and moving of Chindia (1/3 of world population) into more a middle class creating hyper competitive work environments and thus keeping wages in check for the developed world. This controls the demand as well as creating a economic instability that has slowed family formation. (I am simplifing here a lot) So now most successful middle class couples in developed world don’t marry until ~30ish and only have 1 – 2 children.

My guess the next ten years we continued pressure from Chinese wages (workforce has already dropped), India Stagflation, and the developed world having a new more urban, smaller but one income family. (I have joked Economst will call this the home schooling revolution.) Then wages will bounce back in 5+ years.

#2 Comment By Charles H. Featherstone On January 28, 2014 @ 1:52 pm

Or, it’s more evidence that markets are rigged in favor of those with lots and lots. That risks are socialized while returns are privatized. It’s easier to turn $10 million into $100 million because the system was built to do just that, has been that way for at least 100 years, and the risks are minimal to non-existent.

Investment banking came to be in the 18th and 19th century because no one would invest the equivalent of today’s $100 million in anything unless the state guaranteed a return on that investment, and a return much higher than any ostensibly “free market” could promise.

#3 Comment By Noah172 On January 28, 2014 @ 2:35 pm

Why, though, should that be the rule? Why should returns to wealth “accelerate” in this fashion? It’s not a law of nature by any means

It is not a law of nature, nor a rule across all economies either now or throughout history, but it is the state of things in America’s current political and economic situation:

Capital gains taxed at a much lower rate than ordinary income.

Carried-interest rule.

A watered-down estate tax.

Relatively low effective tax rates for the wealthy (thanks to favorable complications in the corrupt tax code).

Free trade.

Mass immigration.

Weak private-sector unions.

Soaring ratio of CEO compensation to employee compensation (abetted by stock-price-obsessed, lax-oversight boards of directors).

The decline of productive industry in favor of the FIRE sector.

Massive federal indebtedness that serves (as Michael Kinsley wrote a quarter century ago) as a giant welfare program for the bond market.

Historically high costs for housing, education, and health care hindering wealth accumulation for the middle and lower classes (but not hindering the already rich).

#4 Comment By Zathras On January 28, 2014 @ 4:37 pm

“If it is indeed easier to make $100 million out of $10 million than to make $10 million out of $1 million, that suggests a process of cartelization in the investment world.”

Maybe, but if you look at what is really going on, this is not the case. The big reason why it is easy to do this basically comes down to risk aversion. The math for the most potentially lucrative investments looks like the following: you have an 80% chance of losing all your money and a 20% chance of making 10x your money. You expected profit = .8*0M + .2 * 10M = 2M, or doubling your money. The 99% are going to jump on one of these, since the chance of loss is so large. On the other hand, the 1% can go into a bunch of these projects, and on the average they can spread the risk and make tons of money. Romney’s record at Bain is a perfect example of this pattern.

#5 Comment By Fran Macadam On January 28, 2014 @ 10:31 pm

If real interest rates are actually high, then there should be a general deflation, which is not the case. Inflation exceeds interest rates by a significant amount, eviscerating the value of savings and making life difficult for those on fixed incomes that once depended on returns exceeding that of inflation.

In reality, the inflation is serving those into whose hands it is first being delivered – those self same financial cartels as mentioned by Noah Millman. They are delivered an initial purchasing power by the “free” money roughly equivalent to that afforded in value to the existing money pool. By the time the supply and demand effect percolates down to the bottom of the purchasing chain, the trickle-down effect on the economy most people exist in will feel more like a form of water torture, where prices rise but wages don’t.

#6 Comment By Michael N Moore On January 28, 2014 @ 10:53 pm

The result of the profound imbalance between the swollen pool of investment capital and shrinking purchasing power are investment bubbles and facilitators who destroy surplus money by generating bogus investment opportunities. The result is liar loans and companies with no revenues and skyrocketing stock values.

#7 Comment By EliteCommInc. On January 29, 2014 @ 1:53 am

“It should not, in general, be the case that larger fortunes or businesses grow more rapidly more easily than smaller ones.”

In response to this and other observations, the wealth is concentrated and when a loss occurs or that wealth is spent it does flow throughout the general, marketplace but rather is contained in it own bubble.
In short I think the wealthy spend their wealth among each other as opposed to those not in their circles. Concentrated wealth is or has become concentrated spending.

When Berkshire-Hathaway started their stock price was $65.00 or so that was in 1965. Today the “A” Stock price is $126,000. If I am in the one percent and I have five million seeking a solid return — (minus the bailout) I am going to roll it over into BH, as opposed to some brokerage selling shares at $200.00 And that share price may be relatively high for most investors. If I read it correctly the average stock price is about $67 a share. But it is unlikely that the top 1% are investing their money that low of a price range.

When one reads about market collapses and who are the players making decisions about how to respond they are not talking to 40K salaried accountants. Not even 75K.

When the rules are made about managing money in the economy — they are made with where the money exists and more and more — it’s concentrated among the top 5 and 1 percent.

It is unclear what effect 70 trillion dollars has on the overall economic outlook. But suppose there is a glut — unless that money flows throughout the general population — money will remain concentrated among the wealthy.

It would be helpful to examine the power if wealth to control messaging thereby some level of control about what we think is happening and how and by whom.

#8 Comment By Puller58 On January 29, 2014 @ 9:32 am

Simpler explanation is that the system is rigged.

#9 Comment By Max Planck On January 29, 2014 @ 10:30 am

“In short I think the wealthy spend their wealth among each other as opposed to those not in their circles. Concentrated wealth is or has become concentrated spending.”

This is an excellent point often overlooked in the “conservative” worldview, where wealth accumulation is an unquestioned good leading to more consumption which supposedly helps society as a whole. Basically, it drives the sale of Hermes ties and Cartier watches higher, and yes, this sort of consumption is highly contained, and does little for growth and employment. When we tax investment income at half- or even less than half- of our labor, we are creating some fairly perverse incentives.

#10 Comment By Egypt Steve On January 29, 2014 @ 3:56 pm

Noah17 is right. If the savings rate is artificially high, then taxes are too low across the board. Mutatis mutandis, we really do need to get back to something like an Eisenhower-era tax structure, to keep extreme wealth at work in this country. That’s Eisenhower, as in the Republican hero who conquered Europe and destroyed Hitler — not Karl Marx.

#11 Comment By Johann On January 29, 2014 @ 4:47 pm

What Noah172 said.

#12 Comment By EliteCommInc. On January 29, 2014 @ 6:12 pm

“This is an excellent point often overlooked in the “conservative” worldview, where wealth accumulation is an unquestioned good leading to more consumption which supposedly helps society as a whole . . .”

Just to be clear —

I making an observation not a reason for advancing any form of policy. policy

#13 Comment By Gazza On January 30, 2014 @ 5:41 am

“That’s Eisenhower, as in the Republican hero who conquered Europe and destroyed Hitler”

Hmm… I think you find that it was Uncle Joe Stalin that destroyed Hitler.

#14 Comment By Gazza On January 30, 2014 @ 5:42 am

Agreed. What Noah172 said.