Piketty and Plutonomy: The revenge of inequality

Plutonomists – the very rich – cannot be ignored. Thomas Piketty’s magnum opus, the controversial, surprise bestseller, “Capital in the Twenty-First Century” has made sure of that. We first wrote about plutonomy about a decade ago – the theme has certainly resonated since then. We think analyzing plutonomies – economies where economic growth is powered by and largely consumed by the wealthy few – is critical for investors as they grapple with today’s complex markets. More so after the Piketty tome, where he asserts the power of compound interest, and the rising gap between investment returns (r) and economic growth (g) is likely to have dramatic consequences for income inequality. He projects the global private wealth to national income ratio to rise from 440% in 2010 to record highs of 500% by 2030. These levels were last seen in 1910. This ties in squarely with BofA Merrill Lynch enterprise theme of A Transforming World, under the rubric “Markets” where “income inequality” is a key sub-theme. Ten implications of plutonomy for investors:

1) Plutonomy plus asset inflation equals lower national household savings rates. Why? When the rich account for a major proportion of the economy, and experience a stock market boom, they drop their savings rates from current income. And vice versa. If plutonomists get over the shock of the global financial crisis, take comfort in their vastly expanded wealth from QE-driven asset inflation, and reduce their savings rate which doubled to 38.2% after the financial crisis of 2008, the US C/A deficit could expand again, a big positive for EMs.

2) Consumption volatility for plutonomists is significantly higher than the average. Economic and earnings surprises are linked to their behavior.

6) Absent policy intervention, in the longer term, EMs are likely to become entrenched and egregious plutonomies. The forces that propagate plutonomy – the Rule of Law, patent protection, financial deregulation, high profile immigrants (returnee emigrants for EMs), greater global linkages, rising military spending that is a key innovation driver, and vast untapped catch-up markets (health, education, environment, financial services etc.) – are all gathering momentum in EMs.

7) According to Piketty, global Wealth is likely to rise from €313tn in 2010 to €667tn in 2030 – a rise of €354tn. EM Wealth is projected to rise from €158tn to €437tn – i.e., 80% of incremental Global Wealth creation. Great for Asset managers, capital markets players, insurance firms, private banks (and investment professionals) operating in EMs.

8) Financial re-regulation will likely put a damper on the incomes of some finance professionals, reducing income inequality at the level of the top 0.1% of households (>US$1.5mn income) but not for the top 0.01% households (>US$7.2mn).

9) EM education boom.

10) Rising EM political polarization.

According to Piketty, global wealth is concentrated in the hands of the plutonomists – the top 1% wealth holders in the US account for about 35-40% of private wealth (45% in 1910). The top 0.1% (wealth >US$20mn) own about 23% of US wealth, about the same as the bottom 90% put together. In 1978, they owned just a fourth of what the bottom 90% owned. In emerging markets, wealth concentration data are scarce, but in Russia, Malaysia, Israel, the Philippines, Taiwan and Chile, the uber-plutonomists account for a much larger share of their economies, than their compatriots in the US.

Given that larger fortunes enjoy larger pre-tax returns, we expect this wealth concentration to grow – the rich are likely to get an even larger slice of an expanding private wealth cake. We are aware of the debate over Piketty’s math, but are generally comfortable with the thrust of his analysis.

When wealth and income are as concentrated as they are, and expected (a la Piketty) to get even more so, examining the “average” consumer or “average” investor makes little sense. Examining the fat tail – the behavior of the plutonomists, rather than that of the multitudinous many – is more advantageous to investors. That’s what we have attempted in this report.