Plutonomy: The Rich Get Richer

Although this post focuses on material produced in 2006 it serves as a good introduction to the subcategory of income and wealth inequality. In the first decade of this century Citigroup Global Markets Inc.’s Group Research wrote several reports dealing with “plutonomy.” They use this phrase to describe the thesis that “the rich [referring here to the top 1% of income and asset holders, or in some cases to the top 10%] are the dominant drivers of demand in many economies throughout 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.”

This post summarizes the report “Revisiting Plutonomy: The Rich Getting Richer,” which was produced in March 5, 2006. Unfortunately, Citigroup took this series of reports off the Internet, and they are now difficult to find. For this reason the post will largely quote from this March 5, 2006 research report since the link to this report may not be operable. Note that this report was produced before the start of the “great recession.”

Introduction

“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 the plutonomy countries. Also, new media dissemination technologies like internet downloading, cable and satellite TV, have disproportionately increased the audiences, and hence gains to ‘superstars’ – think golf, soccer, and baseball players, music/TV and movie icons, fashion models, designers, and celebrity chefs etc. The ‘content’ providers, the tech whizzes who own the pipes and distribution, the lawyers and bankers who intermediate globalization and productivity, the CEOs who lead the charge in converting globalization and technology to increase profit share of the economy at the expense of labor, all contribute to plutonomy. Indeed, David Gordon and Ian Drew-Becker of the NBER demonstrate that the top 10%, particularly the top 1% of the US – the plutonomists in our parlance – have benefitted disproportionately from the recent productivity surge in the US. (See “Where did the Productivity Growth Go? Inflation Dynamics and the Distribution of Income,” NBER Working Paper 11842, December 2005.) By contrast, in other countries, such as Japan, France, and the Netherlands (read much of continental Europe), egalitarianism has kept the rich to a similar share of income and wealth that they accounted for in the 1980s – in other words, they haven’t really gotten any researcher in relative terms.”

Survey of Consumer Finances

The first part of the report compares the mean income and share of income and net wealth of the top two deciles, the next two quintiles, and the remaining 40% of US households. The data comes from the Federal Reserve’s Survey of Consumer Finances for the years 1995, 1998, 2001, and 2004. The report notes that it lumps “the bottom 40% into one to emphasize how relatively small their income and wealth shares are.” Thus, for 2004 the “top 10% earn over four times as much as the bottom 40% combined.

“The share of the wealth continues to be even more aggressively skewed with the top 10% accounting for 57% of national wealth, as they did in 2001. In total, the top 20% account for 68% of total income; the bottom 40%, for just 9%.

“The overall point here is that the rich continue to be in great shape, in relative terms. Indeed, their net wealth to income ratio has risen since the 2001 survey was published. It now stands at 8.4. In other words, net wealth is over eight times annual income. In 1995 this ratio was a relatively meager 6.2. We think that rising wealth is the real reason they the rich hare happy to keep consuming, and are behaving rationally in so doing. They simply do not need to save as much to maintain a healthy wealth balance, as they did in prior decades, because their net wealth is growing rapidly.”

It’s never been more expensive to be rich

In this section the authors reference the Cost of Living Extremely Well ([CLEW] Index which Forbes Magazine has developed. Forbes has been tracking a basket of 40 ultraluxe items since the Reagan era. It has gone up every year by an average of 5%. This compares to the U.S. Consumer Price Index that has risen 3% a year on average. For example, CLEW in 2017 contained a basket of goods divided into six categories: (1) entertainment and toys, (2) fashion, (3) food and drink, (4) household, (5) services, and (6) travel.

Just to give you a feel for what kinds of goods these are I provide three illustrative items from each of the six baskets and their 2017 price and place of purchase.

Entertainment and toys

• Opera: Metropolitan Opera tickets for two, for six Saturday night shows (New York) $5,250
• Motor Yacht: Hatteras 75 (North Carolina) $5.6 million
• Sporting Shotguns; Pair of 12-gauge, side-by-side from James Purdey & Sons (New Jersey) $307,160

Fashion

• Handbag: Hermes Clemence Jypsiere, bull-calf leather (France) $8,500
• Shoes: Men’s black-calf wingtips, custom-made, John Lobb (U.K.) $5,331.17
• Coat: Russian Sable, Bloomingdale’s (New York) $265,000

Food and Drink

• Caviar: Kilo of Petrossian Special Reserve Ossetra (California, New York) $12,500
• Champagne: Case of 750ml Dom Perignon 2006 (New York) $1,919.40
• Dinner: La Tour d’Argent tasting menu, excluding wine and tip (France) $416.50

Household

• Sheets: Queen-size Purity Doppio Ajour linen set (Italy) $2,100
• Sterling Silver Flatware: Five-piece dinner set for 12 (Massachusetts) $12,960
• Sauna: 8 by 10 by 7 feet in Nordic Spruce (Minnesota) $18,276

Services

• School: Year’s tuition, room, and board at Groton (Massachusetts) $55,700
• Face-lift: Experienced surgeon (New York) $18,500
• Spa: Coed weekly rate, the Golden Door (California) $8,850

Travel

• Car: 2018 Rolls-Royce Phantom (New Jersey) $530,000
• Helicopter: Deluxe Executive VIP Sikorsky S-76D (Connecticut) $16.7 million
• Airplane: Learjet 70. Bombardier (Canada) $11.3 million

“CLEWI is an inflation index of the cost of luxury goods… In 2005, the CLEW Index rose 4.0%, while the US CPI rose at 3.6%. Luxury goods still have relative pricing power. The 0.4% gap might not sound all that impressive, but bear in mind that a stronger US dollar probably helped check this [CLEW] inflation rate (many luxury goods come from Europe, but the CLEWI is measured in dollars). At any rate, the year to year fortunes of the CLEWI versus the CPI are less relevant. The long-term chart says it all [from 1976 to 2004 the CPI increased by about 300% compared to about 700% for the CLEWI]. The most recent data point just confirms that in the search for pricing power, we’d rather be in luxury goods, than low end consumer business.”

The 4 conundrums

Oil and the consumer:

“We have heard constantly that oil will slow consumption down as it eats into disposable income. But it remains a conundrum to many that consumption has remained robust…We don’t see a conundrum…in the plutonomy countries the rich are such a massive part of the economy that their relative insensitivity to rising oil prices makes US$60 something of an irrelevance. For the poorest in society, high gas and petrol prices are a problem. But while there are many in number, they are few in spending power, and their economic influence is just not important enough to offset the economic confidence, well-being and spending of the rich.

Consumer confidence and consumer spending:

Another puzzle is why consumer confidence and spending have not moved in sync with prior patterns. Here the report authors quote former Fed Vice-Chairman Roger Ferguson’s 2001 statement: “‘A somewhat puzzling feature or the recent period has been that, despite the sharp weakening in sentiment, household spending appears thus far to have held up well. How these apparently conflicting signals will be resolved going forward is not at all apparent from today’s vantage point, and will bear close scrutiny.’ The authors note that this “thesis came up again last year in relation to Hurricane Katrina, when consumer confidence fell sharply, yet consumption (except for autos) was just fine.'”

“Again, we see this as being a lot easier to understand if viewed through the prism of plutonomy. While the average consumer might not be feeling great, the important consumers – the richest 20%, who account, as we’ve shown, for 58% of the income – are in good shape. Rather than focus on consumer sentiment indicators like the Conference Board sentiment index, we highlight our own February Citigroup Smith Barney/CNBC Affluent Investor Poll. Affluent investors appear quite optimistic about the future proposals. Indeed the more affluent they are, the more upbeat they are about the future prospects….

“The point here, again, is that the rich are feeling a great deal happier about their prospects than the ‘average’ American. And as the rich are accounting for an ever larger share of wealth and spending, it is their actions that are dictating economic demand, not the actions of the ‘average’ American.”

Low savings rates

“The ‘disaster waiting to happen scenario’ we hear most from our clients, is the low savings rates in countries such as the UK and US. Well, we disagree that this is such a big problem in the near term, the time horizon that matters for most equity investors…the low savings rate in the US (and we believe the same holds true in the other plutonomy countries like the UK, Canada, and Australia) is a function of the savings rate of the richest 20%…The richest quintile [in the US] are primarily to blame for the overall fall in the savings rate in recent years – although their low savings behavior has likely been joined in the past few years by the housing-pumped non-plutonomist US consumer.

“The rich are being perfectly rational. As their wealth/income ratios have been rising, and as we highlighted earlier, the latest SCF data suggest wealth/income has grown even larger, why should they not consume from their wealth rather than just their income? The more rich people there are in an economy, and the more affluent they feel (as they do right now), the more likely we believe an economy will be able to experience falling savings rates. When your wealth has soared, the need to save diminishes. Rational, but apparently a conundrum and an accident waiting to happen, according to the perma-bears [someone who is always negative about the future direction of the markets]. Not to us.”

Global imbalance and the US dollar

“The perma-bears told us the current account deficit in the US [a current account deficit occurs when a country imports more goods, services, and capital than it exports] was too high. It could only be lowered by raising the savings rate of the household sector, which in turn would only be accomplished by rising interest rates and/or a dollar collapse. We disagree. To us plutonomists, the current account deficit is largely a function of the savings rate, which is a function of the propensity to save by the rich. As we highlighted above, they are rationally consuming out of their stock of wealth (which incidentally keeps going up) as well as from their incomes. To them, dollar devaluations are a mild inconvenience, but not a reason to change their spending and dis-savings habits. Here’s the real conundrum: if a dollar collapse is the primary way to adjust to global imbalances, we would have expected the bilateral trade deficit between the US and the Eurozone to have moderated following the dollar’s more than 50% devaluation against the Euro between November 2000 and November 2004. Did that happen? No. The bilateral trade deficit (on a rolling 12-month total basis) nearly doubled from $47.5 billion to $83.6 billion. The bottom line to us is that plutonomics is a better explanation of these ‘nasty’ deficits, and currency manipulation just doesn’t change the habits of plutonomists enough to make a difference.”

Plutonomy and the equity markets

“…so long as the rich continue to get richer, the likelihood of these conundrums resolving themselves through traditionally disruptive means (currency collapses, consumer recessions, etc.) looks low.”

“Secondly, if the rich are to keep getting richer, as we think they will do, then this has ongoing positive implications for the businesses selling to the rich. We have called these businesses ‘plutonomy stocks’.” Here the authors make three points: (1) “While we have concerns about the spending power of the middle-income consumer in the US in the event of a housing slowdown, the richest 10% are less exposed to a housing slowdown, as their wealth is more diversified.” (2) “Not only is demand for luxury goods likely to be strong in the near future, but pricing power is good too. A rosy combination.” (3) “…emerging markets are doing well. The recycling of commodity price liquidity is not only benefitting the emerging markets themselves, but is creating a new breed of brash, confident millionaire consumers. This is a boon to Plutonomy stocks.”

In October 2005, Group Research created a Plutonomy stock basket. This basket contains 24 stocks, less than one-third of which are US stocks. Some of the more recognizable names include Bulgari, Burberry, Coach, Four Seasons Hotels, Hermes, Polo Ralph Lauren, Porsche, Sothebys, and Tiffanys. The point the authors make is that this basket of 24 luxury stocks had a cumulative annual growth rate from 1985 to 2006 of 17.8%. The MSCIA AC World Index [a basket of 2,700 stocks from 23 developed countries and 24 emerging markets] had annual growth rate of about 1/6th this rate.

What could go wrong?

“Our whole plutonomy thesis is based on the idea that the rich will keep getting richer. This thesis is not without its risks. For example, a policy error leading to asset deflation would likely damage plutonomy. Furthermore, the rising wealth gap between the rich and the poor will probably at some point lead to a political backlash. Whilst the rich are getting a greater share of the wealth, and the poor a lesser share, political enfranchisement remains as was – one person, one vote (in the plutonomies). At some point it is likely that labor will fight back against the rising profit share of the rich and there will be a political backlash against the rising wealth of the rich. This could be felt through higher taxation (on the rich or indirectly through higher corporate taxes/regulation) or through trying to protect indigenous laborers, in a push-back on globalization – either anti-immigration, or protectionism. We do not see this happening yet, though there are signs of rising political tensions. However, we are keeping a close eye on developments.”

Conclusion

The authors start their conclusion with this statement: “We should make clear that we have no normative view of whether plutonomies are good or bad. Our analysis is based on the facts, not what the society should look like.” They then close with the following two paragraphs.

“This lies at the heart of our plutonomy thesis: that the rich are the dominant source of income, wealth, and demand in plutonomy countries such as the UK, US, Canada, and Australia, countries that have an economically liberal approach to wealth creation. We believe that the actions of the rich and the proportion of rich people in an economy helps explain many of the nasty conundrums and fears that have vexed our equity clients recently, such as global imbalances or why high oil prices haven’t destroyed consumer demand. Plutonomy, we think explains these problems away, and tells us not to worry about them. If we shouldn’t worry, the risk premia on equity markets may be too high.

“Secondly, we believe that the rich are going to keep getting richer in coming years, as capitalists (the rich) get an even bigger share of GDP as a result, principally, of globalization. We expect the global pool of labor in developing economies to keep wage inflation in check, and profit margins rising – good for the wealth of the capitalists, relatively bad for developed market unskilled/outsourceable labor. This bodes well for companies selling to or servicing the rich. We expect our Plutonomy basket of stocks – which has performed well relative to the S&P index over the last 20 years – to continue performing well in the future.”

Comment

In reading this report I was reminded of F. Scott Fitzgerald’s line in his short story “Rich Boy” that begins with this comment: “Let me tell you about the very rich. They are different from you and me.”

As I mentioned at the start of this post the overall issue discussed in this report, income and wealth inequality, will become a main theme in Part 1 of this blog as that part begins to deal with the ’70s and thereafter.

Two things struck me about this report. One is the implied if not explicit cheering for the wealthy gaining increased shares of national income at the expense of labor and those in the bottom 40% of the income distribution. Of course, in part the authors are addressing their clientele and are disinclined to raise troubling questions or issues. The second is the apparent total lack of concern the rich have of regarding economic insecurity. They have no financial or spending problems and do not foresee any. They are unbothered by the ups and downs of the economy or the market. I am reminded of an earlier post that discussed research findings that people in high socioeconomic status have a very difficult time, are perhaps unable, to empathize with others, especially those in lower socioeconomic status.

Regarding the data and analysis in the report, it is worth remembering, first, the inequality dimension they describe is probably before the Bush 2003 tax cut took effect and before the Republican/Trump tax cut of 2017. Both tax cuts, especially the Republican/Trump tax cut, substantially benefitted the top 1% and even the top 10%.

Second, the report pre-dated by a year or so the arrival of the “great recession,” which the authors, along with many others, did not foresee. The recession saw a dramatic drop in asset prices, especially financial assets, that disproportionately hit the rich. However, the rich rebounded more quickly and to a greater degree than the non-rich. By 2018 those in the top 10% saw their median income increase by nearly 27% above what it was in 2007. Those in the 80th to 90th percentile were back to where they were at the start of the recession. Everyone else was worse off than they were before the recession started.

My reading of the other data suggests that the authors underestimated the significance to the increased consumption prior to the 2007 recession of middle-class consumption fueled by borrowing. This borrowing largely occurred through inflated housing values in a trend that is often called “private Keynesianism.”

While the authors of this report may at times seem a bit polemical, the reality is that their overarching theme began dominating the US in the ’70s transition decade. By “overarching theme” I mean (1) the continually rising share of national income going to capital and the declining share going to labor and (2) the continually increasing inequality in income and wealth. By and large, this has occurred regardless of the political party controlling the presidency or Congress.

Although it is difficult factually to argue against such domination, the real question is why did this happen/why is it continuing to happen? One can argue that this result is (1) largely beyond the control of any nation state, e.g., globalization, technological change. Or that it is (2) largely the result of unintended consequences of policy decision consciously made and enacted. Or that it is (3) largely the intended result of policy decisions consciously made and enacted. My own view is that all three have secured the dominance of this theme with the primary cause being (3).

Consequently, my position suggests at least the possibility that we have moved from a Madisonian democracy in which the majority rules accompanied by significant safeguards to the minority to a country in which the minority rules with perhaps largely insignificant protections for the majority. In my view, this anti-majoritarianism developed over a long period of time though multiple events and decisions by many diverse contributors working through a coherent thought perspective. I consider, for example, the very recent 5-4 Supreme Court decision on gerrymandering, Rucho et al. v. Common Cause et al., and the 5-4 Supreme Court 2010 Citizens United decision to be two key decisions along these lines. Much of this blog, in both parts 1 and 2, wrestles with trying to understand, explain, and describe the issues relating to this dominant theme.