You don’t need a very sharp eye to detect the number of speeches in Washington taking aim at “the rich” and the number of new policies that aim to redistribute wealth from “the wealthy” to “the middle class.” Like all wars in Washington this one is being fought with symbols and rhetoric. People argue about who is, or is not, middle class and whether each policy will, or won’t, impact that ill-defined middle class.
I have been writing and talking about the reasons why this class war had to happen for a number of years. To me it is the unavoidable side-effect of the same change in capital markets that created the fast-growing global economy and lifted three billion people around the world out of poverty.
First, let’s clarify who is attacking whom. It is the capital market and the people who make their living in the capital markets, not “the rich”, that are under attack. That’s because, since 1980, the capital markets have both facilitated and enjoyed three decades of growth.
The chart, above, shows the change that precipitated the class war. In 1981, Reagan was elected after a decade of rising inflation and rising interest rates that had all but destroyed the capital markets. In 1980, inflation was 15%, CD rates were over 20%, the 30 year Treasury yield was 15%, and the top (federal) marginal tax rate was 70%. Inflation had driven investors out of stocks and bonds and into hard assets like gold and silver–50% of total assets were held as hard assets. Growth was zero. The stock market was trading at single-digit multiples of earnings; the Dow was 860 in mid-1981.
Tax cuts and falling inflation over the next 2 decades forced investors to gradually move their wealth from hard assets to stocks and bonds. During the same period there were further change–deregulating brokerage markets and the spread of high speed telecom networks around the world–that made it easier, cheaper and faster to move capital from one use to another or from one location to another. Moving capital from a low-return use to a higher-return use increasses its value. You have to pay someone to move it.
Stock and bond prices soared, as did the amount of work to be done in the capital markets. Moving all that capital took a lot of people. And people working in fast-growing industries make a lot of money. As the chart above shows, the compensation of financial market workers roughly doubled compared with everyone else.
Everyone else includes the people NOT working in the financial sector. It also includes people left behind when capital owners moved it from where it was (say, a manufacturing business in Michigan) to where it would earn a higher return in a different industry or a different country.
This shift in relative income and wealth is the principal driver behind the shift in politics that elected Obama. It is increasingly clear that he believes he was elected with a mandate to redistribute wealth and income through government spending, tax rates and regulations. Recent experiments have included price and wage controls. I have seen this movie before; it doesn’t work.
The problem is that, whatever your political objectives, we need markets and market prices if we want to stay rich. Market economies are much, much more efficient at producing goods and services than other forms of economic organization. At its core is a vast parallel-processing information network that transmits information about scarcities and wants ONLY to the people who need it so they can make decisions. We transmit that information in little packets we call prices. Any policy that interrupts those transfers by interfering with market prices will lead to a dramatic drop in productivity and output.
Policies to control prices and wages, taxes subsidies to encourage politically correct businesses and a tsunami of taxes and spending are extremely destructive to growth and average living standards. But that does not mean they are going away. The change in income and wealth distribution that created the class was are real and lasting. I am concerned that the growing class war may end up as the defining characteristic of the U.S. economy this decade.
NOTE: Senior moment alert. I pulled the charts in this piece from a recent article but can’t remember the right person to cite. If you know, please let me know so I can give proper credit. Thanks.