Archives for posts with tag: deficit

La folie des banques centrales, Patrick Artus et Marie-Paule Virard, 2016

 

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Lorsque l’argent ne coute rien

On compte sur les banquiers centraux pour relancer la croissance, combattre la déflation, aider a résoudre l’endettement des Etats, conjurer l’éclatement de l’euro, faire repartir l’investissement…on a fini par vouloir régler avec la monnaie tous les problèmes, et d’abord ceux de l’économie réelle. Or le recours systématique à l’inondation monétaire dès qu’un déficit de croissance se fait jour n’a aucun sens.

En continuant à inonder la planète de liquidités, les banquiers centraux jouent un jeu dangereux et l’issue pourrait bien faire de la crise de 2007-2008 une aimable répétition avant un nouvel accident plus dévastateur encore. L’inflation étant revenue à un niveau inférieur à l’objectif de 2%, les banquiers centraux se sentent désormais les mains libres pour s’occuper de la croissance et de l’emploi dans un contexte ou la pression des politiques et des opinions publiques jouent dans ce sens. Par ailleurs, les politiques monétaires sont de plus en plus inefficaces à mesure que les pays sont de plus en plus endettés (plus on est endetté, moins on s’endette a nouveau). L’abondance de liquidité existante amène à pratiquer l’inondation monétaire pour espérer obtenir un résultat.

Un relèvement des taux américains serait le signe que l’injection massive de liquidités qui dopent les marchés depuis 2007, touche à sa fin. Et avec elle la période d’argent facile qui a permis de se refaire après la crise de 2007 et déclencher un incroyable boom sur les actifs financiers.

Il n’existe aucune limite technique à l’augmentation du bilan des banques centrales: une banque centrale peut toujours créer de la monnaie pour acheter des actifs.

Le Quantitative Easing fonctionne de la manière suivante. La banque centrale crée de la monnaie en créditant des lignes de dépôt des institutions financières, cette monnaie étant la contrepartie d’achat de titres (de la dette) détenus par les institutions financières sur les marches financiers. Pour ces institutions, ces créances sont donc converties en argent frais, leur permettant de distribuer d’avantage de crédits, ce qui est censé doper l’activité et la croissance. En outre, l’achat d’obligation fait baisser leur rendement (la demande fait monter leur prix donc leur rendement baisse) ce qui incite les investisseurs à acheter d’autres actifs (dont les prix montent créant un effet de richesse). De plus la baisse des rendements obligataires entraine une baisse des taux de prêts bancaires: autant de vitamines pour l’économie. En tirant l’ensemble des rendements vers le bas, le QE  peut espérer favoriser la dépréciation de la monnaie et rendre les exportations plus compétitives. Avec son programme de QE de 1140 milliard d’euro (10% de la masse monétaire) en 18 mois (fin Sept 2016), la BCE fait mécaniquement baisser le cours de l’euro.

La situation ou le taux d’intérêt est durablement inférieur au taux de croissance est bien pathologique puisqu’elle incite les acteurs économiques à s’endetter au-delà du raisonnable. C’est bien ce que l’on observe depuis une quinzaine d’année. De même en pratiquant une politique de taux d’intérêt à long terme très bas associée a la monétisation des dettes publiques dans les cadres du QE, elles ont encouragé les gouvernements à laisser filer les déficits publics (parce que les intérêts à payer sur la dette sont très faible). Lorsque la dette est détenu par la banque centrale, l’état lui verse les intérêts sur cette dette, mais ensuite la banque centrale, qui transfère ses profits a l’état, les lui rend

La base monétaire mondiale tourne autour de 20 000 milliards de dollars. Nous pensons que la liquidité mondiale va continuer d’augmenter pendant plusieurs années.

Les bulles sur les prix d’actifs sont de retour: la politique laxiste des banquiers centraux n’a pas fait revenir l’inflation (celles de salaires ou des biens) mais elle a nourri l’inflation des prix des actifs notamment actions et immobilier. Les banques font apparaitre un effet de richesse nécessaire à la stimulation de la demande par l’enrichissement des détenteurs de portefeuilles.

Avec des politiques monétaires très expansionniste et des taux d’intérêt à long terme demeurant inferieurs a la croissance nominale, les valeurs boursières sont tirés vers le haut.

A NY, le Standard & Poor’s 500 a progressé de 72% entre sept 2010 et sept 2015. Le Nikkei s’est apprécié de 93%. A Londres le QE a plutôt nourri la bulle immobilière. A Shanghai, la bourse s’est envole de 150% entre Juin 2014 et Juin 2015 et a alimente le train de vie d’un nombre croissant de Chinois de la classe moyenne. La bourse devient dans un certain nombre de pays un instrument de politique monétaire.

Les banques souhaitent compenser une demande trop faible en raison du manque de pouvoir d’achat des revenus salariaux par une expansion ininterrompue du crédit et des revenus non-salariaux. La manœuvre est périlleuse: les pires excès sont à craindre si les investisseurs sont incités à croire que les banques centrales encouragent la prise de risque et les ‘assurent’ contre une baisse des actifs. Il y a alors formation de bulle doublée d’une augmentation de l’endettement (grâce au taux d’intérêt faible).

Une remonte des taux d’intérêt provoqueraient des pertes massives sur les portefeuilles d’obligations achetés avec des coupons très faibles par les investisseurs.

Le recours au QE lorsque la situation des marches financiers est bonne ne peut que faire enfler les bulles: c’est bien la preuve qu’une banque centrale ne devrait pas utiliser celle-ci comme instrument de politique monétaire pour soutenir l’économie.

A l’été 2015, les perspectives de croissance des pays émergents a provoqué des sorties de capitaux de ces pays 10 fois plus importantes qu’il y a dix ans, ce qui explique l’effondrement de leurs devises (les devises –hors China- ont perdu 30% contre le dollar depuis Janvier 2014)

La création monétaire – indispensable lorsqu’il se produit une crise de liquidité en 2009 – ne sert strictement à rien lorsqu’on parle de la faiblesse de la productivité, de l’innovation, du niveau de qualification de la population active,  de l’insuffisance de l’investissement dans les infrastructures…Ces politiques ont des effets pervers sur le plan structurel: elles protègent les faibles contre le risque de défaut (grâce a des taux d’intérêt bas) mais les incitent aussi à profiter de cette protection. Elles contrarient le processus de ‘destruction créatrice’ en évitant la disparition des ‘faibles’ (et cela au détriment des agents économiques les plus dynamiques). Elles favorisent le développement de la partie de l’économie liée aux prix des actifs, a l’endettement, a la spéculation…

En Chine, la politique monétaire provoque une accélération du crédit qui ne finance pas l’investissement des entreprises, mais la construction, les infrastructures avec le risque d’excès à la fois d’investissement et d’endettement.

Au japon le programme de QE a fait perdre (volontairement) 35% de la valeur du yen face au dollar depuis l’automne 2012 (même politique de dévalorisation de la monnaie en Europe et en Chine) mais les exportations n’ont pas suivi. On a parlé de ‘dépréciation sans exportation’ avant de conclure que les stratégies de change des années 80 avaient perdu de leur pertinence avec la globalisation des chaines de production.

Dollar, euro, yen ont cédé plus de 20% de leur valeur en 3 ans. En l’absence de coordination internationale, on risque d’assister à une surenchère qui fera encore plus de dégât sur la croissance mondiale.

Il y a fort à parier qu’une remonté des taux d’intérêt n’est pas pour demain car la première banque qui le fera exposera sa monnaie a l’appréciation.

Même les périodes de croissance avec baisse du chômage ne font plus revenir l’inflation. La théorie économique qui lie la baisse du chômage a l’inflation par le biais de l’augmentation du pouvoir d’achat et des salaires ne fonctionne plus (la courbe de Phillips liant croissance des salaires, prix et taux de chômage, n’est plus vérifiée).

Des reformes pour éviter le pire

  1. Les banques centrales doivent laisser de cote l’objectif d’inflation (qui restera faible certainement) et veiller plus à la stabilité financière (contrôle des prix d’actifs, de la liquidité…)
  2. S’adapter à une faible croissance potentielle (plutôt que d’essayer de retrouver les niveaux élevés d’antan).
  3. Faire en sorte que le FMI coordonne les politiques monétaires et de changes.
  4. Renoncer aux politiques monétaires expansionnistes qui durent trop longtemps et notamment lorsque le problème de l’économie n’a rien à voir avec la politique monétaire mais est lie a l’absence de réformes etc. qui bloque la croissance.
  5. Se donner un objectif de liquidité mondiale et commencer à réduire les liquidités très doucement. La base monétaire devrait progresser a peu près comme le PIB mondial en valeur. Ce dernier a progressé de 8-9% par an entre 2000 et 2009. La base monétaire a augmenté de 17% par an

 

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The End of Alchemy, Mervyn King, 2016

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The post-war confidence that Keynesian ideas – the use of public spending to expand total demand in the economy – would prevent us from repeating the errors of the past was to prove touchingly naïve. Expansionary policies during the 1960s, exacerbated by the Viet-Nam war, led to the great inflation of the 1970s, accompanied by slow growth and rising unemployment – the combination known as stagflation.

My own accounts of event (re the crises) will be made available to historians when the twenty-year rule permits their release.

Today we are stuck with extraordinary low interest rates, which discourage saving – the source of future demand – and, if maintained indefinitely, will pull down rates of return on investment, diverting resources into unprofitable projects. Both effects will drag down future growth rates.

Three bold experiments since the 1970s:  to give central banks much greater independence in order to stabilize the inflation; to allow capital to move freely between countries and encourage a fixed exchange rates (in Europe, between China and US); to remove regulations limiting  the activities of the banking and financial system (more competition, new products, geographic expansion) to promote financial stability.

Three consequences : the Good was a period between 1990 and 2007 of unprecedented stability of both output and inflation – the Great Stability with inflation targeting spreading to 30 countries; the Bad was the rise of debt level: eliminating exchange rate flexibility in Europe and emerging markets led to growing trade deficits and surpluses. Richer country could borrow to finance deficits and long term interest rates began to fall (too much saving). Low long term interest has an immediate effect: the value of assets (today’s value) – specially houses – rose. As value increased, more borrowing was needed to buy those assets – from 1986 to 2006, household debt increase from 90% of household income to 140% (in the UK). The Ugly was the development of an extremely fragile banking system. Separation between commercial and investment banking was removed. Trading of new and complex financial products among banks meant that they became closely connected: a problem in one would spread rapidly to others. Equity capital (funds provided by shareholder of the bank) accounted for a declining proportion of overall funding. Leverage (the ratio of total assets (liabilities) to equity capital rose to extraordinary level (more than 30 for most bank, up to 50 for some before the crises)

Total saving in the world was so high that interest rates, after allowing for inflation, fell to level incompatible in the long run with a profitable growing market economy.

No country had incentives to do something about imbalances. If a country had, on its own, tried to swim against the tide of falling interest rates, it would have experience an economic slowdown and rising unemployment, without having an impact on the global economy or the banking sector.

In 2002, the consensus was that there would eventually be a sharp fall in the value of the US dollar, which would produce a change in spending patterns. But long before that could happen, the banking crises of September and October 2008 happened.

Opinions differ as to the cause of the crises: some see it as financial panic as confidence in bank creditworthiness fell and investors stopped lending to them- a liquidity crises. Other see it as the outcome of bad lending decisions by banks – a solvency crises. Some even imagine that the crises was solely an affair of the US financial sector.

The story of the crises

After the demise of the socialist model, China, Soviet Union, India embraced the international trading system. China alone created 70 million manufacturing jobs, far exceeding the US 42 million jobs in US and Europe combined (in 2012). The pool of labour supplying the world trading system more than trebled in size (depressing real wages in other countries). Advanced countries benefited from cheap consumer goods at the expense of employment in the manufacturing sector. China and other Asian countries produced more than they were spending and saved more than they were investing a home (in the absence of social safety net, and a one child only policy in China preventing parents to rely on their children when retiring). There was an excess of saving, which pushed down long term interest rates around the world. Short term interest rate are determined by central banks but long term interest rate result from the balance between spending and saving in the world as a whole. IN recent times, short term real interest (accounting for inflation) have actually been negative (official rates have been less than inflation).  In the 19th century, real rates were positive and moved within 3% to 5%. It was probably 1.5% when the crises hit and since then has fallen further to around zero. Lower interest rate and higher market prices for assets boosted investment. It appeared profitable to invest in projects with increasing low real rates of return. For a decade or more after the fall of Berlin wall, consumer benefited from lower prices on imported goods. Confronted with persistent trade deficit, developed countries (US, UK, part of Europe) relied on central banks to achieve growth and low inflation by cutting short term interest to boost the growth of money, credit and domestic demand. This was an unsustainable path in many, if not most, countries. Saving in Asia and debt in the West produce major macroeconomic imbalance. Normally capital flow from mature to developing countries where profitable opportunities abound. Now emerging economies were exporting capital to advanced economies where opportunities were more limited. Most of these financial flow passed through the western banking system leading to a rapid expansion of bank balance sheets (all bank’s asset – the loans to customers – and liabilities – the deposit and loans taken by the banks). As western banks also extended credit to household and companies, balance sheets expanded. As asset prices increased, debt levels increased (more expensive to buy new houses, so more borrowing). With interest rate low, the bank also took more risk, in an increasingly desperate hunt for higher return. Central banks, by allowing the amount of money in the economy to expand, did little to prevent this better yield seeking behavior. In addition pensions funds and insurance were trying to find ways of making their saving more attractive. Banks created new financial instruments based (derived from ) basic contracts (hence ‘derivative’) such as collateralized debt obligation (CDO), more risky but with better return assets. Because return were higher (even if sometimes the financial instruments were very risky or even fraudulent) there was no shortage of buyers. Financial assets increased rapidly:  from ¼ of GDP in the US, it was 100% by 2007. It was 500% of GDp in the UK, even higher in Ireland. Bank leverage rose to 50 to 1 (for 1 dollar provided by shareholder, the bank borrowed more than 50). Substantial profits were made so regulators took an unduly benign view of these developments. The interaction between the macroeconomic imbalances (extra saving) and the developing banking system that generated the crises. Most policy maker believed that unsustainable pattern of spending and saving, would end with the collapse of the US dollar. The dollar was the currency in which emerging economies were happy to invest (the renminbi was not convertible – China in 2014 owned US$4tn). So the dollar remained strong and it was the fragility of the banks that first revealed the fault lines. First law of financial crises: an unsustainable position can continue for far longer than you would believe possible. The second law of financial crises: when an unsustainable position ends it happens faster than you could imagine.  In august 2007, BN Paribas announced it stopped paying investors on three funds invested in the sub-prime market. End of 2007 market liquidity in a wide range of financial instrument dried up: the banks were vulnerable to the US sub-prime mortgage – loans to households on low incomes who were highly likely to default. In September, central banks did not believe the problem could bring down large bank: the stock of mortgage was only US$ 1tn, so losses could not be large enough for the system as a whole. This time however banks had made large bets on sub-prime markets (derivative contracts). Although those bets cancelled out as whole, some banks were in the money, other were under water. Because it was impossible to tell those apart in the short term, all banks came under suspicion. They stooped lending to each other. Banks needed injection of shareholder’s capital (not new loans as central banks were offering). Two options: either to recapitalize or to drastically reduce lending – for the economy, the former was preferable. The system staggered for a year. In Sept 2015 Lehman Brothers failed, generating a run on the US banking system by financial institutions (such as money market funds). The run spread to other advanced economies: banks around the world found it impossible to finance themselves (because no one new which bank were safe. It was the biggest global financial crisis in history. With Bank unable to refinance themselves, the Central Bank had to intervene (with recapitalization of banks starting less than a month later). The problem was that government ended up guaranteeing all private creditors of the banks, imposing on future taxpayers a burden of unknown attitude.  Between autumn of 2008 and summer 2009, 10 millions jobs in US and Europe were lost, world trade fell more rapidly than during the Great Depression. In May 2009, the US treasury and Fed announced that banks could withstand the losses under different adverse scenarios. The banking crises ended but the economic crises remained. By 2015 there had still been no return to the growth and confidence experience earlier.

The strange thing is that after the biggest financial crisis in history, nothing much has changed in terms either of the fundamental structure of banking or the reliance on central banks to restore macroeconomic prosperity.

In practice buyers and sellers simply cannot write contracts to cover every eventuality, and money and banks evolved as a way of trying to cope with radical uncertainty.

In the middle of 2015, we were still searching for a sustainable recovery despite cuts in interest rates and the printing of electronic money on an unprecedented rate. Central banks have thrown everything at their economy and the results have been disappointing.

The sharper the downturn, the more rapid the recovery. Not this time.

From an imbalance between high and low-saving countries, the disequilibrium has morphed into an internal imbalance of even greater significance between saving and spending within economies.

Central bank had to create more money by purchasing large quantities of assets from private sector – the practice known as Quantitative Easing. QE was long regarded as a standard tool of monetary policy – but the scale on which it has been implemented is unprecedented.

Pounds, shilling and pence where already used in 1066 (Domesday book was the first inventory of wealth done at the time). The decimalization of anglo-saxon monetary unit happened on 1971.

The amount of money in the US economy remains stable at around 2/3 of GDP. The share of bank deposit in total has also been roughly constant at 90% (no less than 97% in the UK) (the rest is in coins and banknotes). The amount of money in the economy is determined less by the need to buy ‘stuff’ and more by the supply of credit created by private sector banks responding to borrowers.

The ability to expand the supply of money in times of crisis is essential to avoid a depression. The experience of emergency money reveals that the private sector will not always be able to meet the demand for acceptable money. [in short : Acceptable money is money accepted by all banks, based of confidence in these banks to meet their obligation if needed – what was missing in the early days of the crisis. In those days, only government was able to issue assets that were acceptable by all banks]

The creation of independent central banks with clear mandate to maintain the value of a currency in terms of a representative basket of goods and services, proved successful in stabilizing inflation in 1990s and 2000s. The conquering of inflation over the past twenty-five years was a major achievement in the management of money, and one, despite the financial crisis, not to be underrated.

5,500 tons of gold are in the vault of the Bank of England (worth US$235bn). 6,700 tons are in the Federal Reserve Bank of New York. The US hold 8,000 tons in reserve, 10,784 tons are in reserve in the Euro area, 1,000 tons in China, Uk only has 310 tons as reserve.(Wikipedia: est. 170,000 tons of gold mined on earth as at 2011).

Most money are created is private sector institutions – banks. This is the most serious fault line in the management of money in our societies today.

If before the crisis banks had exited the riskier types of lending, stopped buying complex derivative instruments they would, in the short term, have earned lower profit. Even understanding the risks, it was safer to follow the crowd.

It is remarkable how equal global banks are in terms of size. Among the twenty biggest banks, the ratio of assets of the largest to the smallest is little more than two to one. These 20 banks accounted for assets of US$42tn in 2014, compared with the world GDP of US$80tn, and for almost 40% of total world-wide bank assets.

Investment banks have been described as inventing new financial instrument that are “socially useless”. With their global reach, their receipt of bailouts from taxpayers, and involvement in seemingly never ending scandals, it is hardly surprising that the banks are unpopular.

Bank grew fast: JP Morgan today accounts for almost the same proportion of US banking as all of the top ten banks put together in 1960. Most of this has taken place in the last 30 years and has been accompanied by increasing concentration. The top ten banks in the US account for 60% of GDP (was 10% in 1960). In the UK, the assets of the top ten banks amount to over 450% of UK GDP, with Barclays and HSBC both having assets in excess of UK GDP.

In less than 50 years, the share of highly liquid assets held by UK banks declined from 33% of their assets to less than 2% today. The turning point came when the balance sheet of the financial sector became divorced from the activities of households and companies. Deregulation and derivatives in 1980 contributed to this divorce. Lending to companies is limited by the amount they wish to borrow. But there is no corresponding limit to the size of transaction in derivatives. The market for derivative in 2014 is just over US$20tn, about ½ of the assets of the largest 20 banks.

Since 1999 in the US, stand-alone investment bank that were previously organized as partnership (ie risk shared between partners – so more controlled) turned themselves into limited liability companies (where only assets are at stake, not borrowings to invest in shady business).

With a growing proportion of bank activity deriving from trading of complex instruments, it was difficult to work out how big the risks actually were. The banks themselves seemed not to understand the risks they were taking. And, if that was the case, there was not much hope for regulators could get to grips with the potential scale of the risk.

Whether selling oversized mortgage to poor people in the US, selling inappropriate pension and other financial product to millions of people in the UK, rigging foreign exchange and other markets, failing to stop subsidiaries  from engaging in money laundering and tax evasion, there seem no ends to the revelations about what bank had been doing. The total fines imposed on banks world wide since the banking crisis ended in 2009 amounted to around $300 billion.

Perhaps the enormous losses banks incurred in the crisis, and the fines levied by regulators around the world, will bring a change of heart in the banking sector.

Many of the substantial bonuses that were paid as a result of trading in derivatives reflected not profit earned in the past year but the capitalized value of a stream of profits projected years into the future. Such accounting proved more destructive than creative.

Someone who invested $1000 in Berkshire Hathaway in 1985 would by the middle of 2015 have an investment worth $161,000. A compound annual rate of return of 17%.

Limited liability  in a bank with only small margin of equity capital means that the owner have incentives to take risks – to gamble for resurrection- because they receive all the profits when gamble pays off, whereas their downside exposure is limited. Those who manage other people’s money are more careless than when managing their own.

Money market funds were created in the US as way to get around the regulation that limited the interest rates banks could offer on their accounts. They were attractive alternative to bank accounts. Such funds were exposed to risk because the value of the securities in which they invested was liable to fluctuate. But the investors were led to believe that the value of their funds was safe. Total liability at the time of the crisis repayable on demand was over $7tn.

All non-bank financial institutions have been describe has shadow banking. Special purpose vehicle issue commercial papers – not dissimilar to bank deposit – and purchase long term securities (such as bundles of mortgages. Edge funds are also part of this shadow banking, although because they do not demand deposit, the comparison with banks is less convincing. Financial engineering allows banks and shadow banks to manufacture additional assets almost without limits, with 2 consequences: first, the new instruments are traded between big financial institutions, more interconnection results and the failure of one firm causes troubles for the others. Second, many of the banks position even out when seen as a whole, balance sheets are not restricted by the scale of the economy. When the crisis started in 2007, no one knew which banks were most exposed to risk.

And in some country the size of the banking sector had increased to a point where it was beyond the ability of the state to provide bailouts without damaging its own financial reputation – Iceland, Ireland – and it proved a near thing in Switzerland and the UK.

Equity, debt and insurance are the basic financial contract underpinning our economy. The total global financial stock of marketable instruments (stocks, bonds) plus loans must be well over $200tn.  Over the last 20 years, a wide range of new and complex instruments has emerged (known as derivatives as elaborate combination of debt, equity and insurance contracts). Derivatives typically involve little up-front payment and are a contract between two parties to exchange a flow of returns or commodities in the future.(Wikipedia : total derivatives market value as at 2014: $1,500tn, 20% more than in 2007) .

Credit Default Swap (CDS): the seller agrees to compensate the buyer in the event of default; Mortgage Backed Securities (MBS): a claim on a payments made on a bundle of hundreds of mortgages; Collateral Debt Obligation (CDO) a claim on cash flows from a set of bonds or other assets that is divided into tranches so that the lower tranches absorb the losses first –with investor able to choose which tranche to invest in. A set of five pairs of socks – like a CDO – is a legitimate tactics by a sharp salesman to sell contracts of different value (there is always a pair of socks you would never wear….).

It was rather like watching two old men playing chess in the sun for a bet of $10, and then realizing that they are watched by a crowd of bankers who are taking bets on the result to the tune of millions of dollars.

Derivative also allowed a stream of expected future profits, which might or might not be realizes, to be capitalized into current values and show up in trading profits, so permitting large bonuses to be paid today out of uncertain future prospect. These trading, with the benefit of hindsight, were little more than zero sum activity generating little or no output.

By adopting accounting convention of valuing the new instrument at the latest observed price (marking to market) and including all changes in asset values as profits, optimism in the future, whether justified or not, created large recorded profits from the trading of these new securities. In effect, anticipated future profits were capitalized and turned into current profits.

Once markets realized that different banks had different risks of failure then the whole concept of single interbank borrowing rate (LIBOR) became meaningless. With few or no transactions taking place, it was difficult and at times impossible for banks to know what rate to quote. It matters because LIBOR is used as a reference rate in drawing up derivative contracts worth trillion dollars. The benchmark interest rate used in those contract had shallow foundations and in a storm it just blew away.

High frequency trading: trader have faster access to the exchange, the computer of such firm can watch the order flow and then send in their own orders microseconds ahead of other traders, so jumping the queue and getting to the market before the price turns against them.

The switch from a fixed rule, such as gold standard, to the use of unfettered discretion led to the failure to control inflation, culminating in the great inflation of the 1970’s. Attention turned to the idea of delegating monetary policy to independent central banks with a clear mandate to achieve price stability.

Monetary policy affects output and employment in the short-run and prices in the long run. There are lags in the adjustment of prices and wages to change in demand.

The method used to create money was to buy government bonds from the private sector in return for money. Those bond purchases were described as unconventional and known as quantitative easing (QE). But open market operations to exchange money for government securities have long been a traditional tool of central banks, and were used regularly in the UK during the 1980s.

The outbreak of the First World War saw the biggest financial crisis in Europe, at least until the events of 2008. Yet even after the assassination of Archduke Franz Ferdinand in Sarajevo on 28 June 1914, there was barely a ripple in the London markets.

Countries like Germany have become large creditors, with a trade surplus in 2015 approaching 8% of GDP, and countries in the southern periphery are substantial debtors. Although much of Germany’s trade surplus is with non-euro area countries, its exchange rate is held down by membership of the euro area, resulting in an unsustainable trade position.

The ECB would, Draghi said, ‘do whatever it takes to preserve the euro. And believe me, it will be enough’. It was clear that ECB would buy Spanish and Italian sovereign debt. 10 year bond yields started to fell. By end of 2014, ten-year yield in Greece had fallen from 25% to 8%. Spain from 6% to below 2%. By end of 2014, Spain was able to borrow more cheaply than the US. Draghi’s commitment had obviously done the trick.

The euro area must pursue one, or some combination of the following four ways forward:

  1. Continue with unemployment in the south until prices and wages have fallen enough to restore the loss of competitiveness.
  2. Create a period of high inflation in Germany, while restraining prices and wages in the south, to eliminate differences in competitiveness.
  3. Abandon the need to restore competitiveness within the euro area and accept the need for transfers from north to south to finance full employment in the periphery. Such tranfers can well exceed 5% of GDP.
  4. Accept a partial or total break up of the euro are

 

Some economist would like to return to the original idea of the monetary union – with a strict implementation of the no bail-out clause (which makes it illegal for one member to assume the debts of another) in the European Treaty. “Economically and politically, relaxing the no bail-out clause would open the door for a massive violation of the principle of no taxation without representation, creating a strong movement toward a transfer union without democratic legitimacy”.

Although the provisions of the European Treaty had the appearance of binding treaty commitments, in times of crisis the treaty was simply ignored or reinterpreted according to political needs of the moment.

Art 125: the no bail out clause which makes it illegal for one member to assume the debt of others.

Swiss dinars in Iraq: the value of the Swiss dinar had everything to do with politics and nothing to do with the economic policies of the government issuing the Swiss dinar, because no such government existed.

The tragedy of the monetary union in Europe is not that it might collapse but that, given the degree of political commitment among the leaders of Europe, it might continue, bringing economic stagnation to the largest currency bloc in the world and holding back recovery of the wider world economy.

The key to ending the alchemy is to ensure that the risks involved in money and banking are correctly identified and borne by those who enjoy the benefits from our financial system.

The toxic nexus between limited liability, deposit insurance and lender of last resort means that there is a massive implicit subsidy to risk-taking by banks.

Since the crisis, the minimum amount of equity a bank must use to finance itself – capital requirement – has been raised and banks must also hold a minimum level of liquid assets related to deposits (and other financing that could run from the bank within 30 days). Regulators also look at the shadow banking sector and conduct stress test. Countries such as UK and US have introduced legislation to separate, or ring-fence, basic banking operations from the more complex trading activities of investment banking. And most countries have introduced special bankruptcy arrangements (to protect depositors). Regulators have pursued cases of misconduct by bank employees and the banking system has changed a great deal:  Goldman Sachs balance sheet is 25% smaller in 2015 than in 2007. Many banks have turn to more traditional banking. Is all this enough? I fear not. More radical reforms are needed.

Since the bank bail outs in most advanced economies were huge, it is surprising that more has not been done since the crisis to address fundamental problem.

Irving Fisher : We could leave the banks free… to lend money as they please, provided we no longer allowed them to manufacture the money which they lend. In short nationalize money but do not nationalize the banks.

The prohibition on the creation of money by private banks is not likely to be sufficient to eliminate alchemy in our financial system.

It is time to replace the lender of last resort by the pawn broker for all seasons.  First ensure that all deposits are backed by either actual cash or a guaranteed contingent claim on reserves at the central banks. Second ensure the provision of liquidity insurance is mandatory and paid upfront. Third, design a system which imposes a tax on the degree of alchemy in our financial system – private financial intermediaries should bear the social cost of alchemy.

 

Keynes argued that when short term and long term interest rates had reached their respective lower bounds, further increases in the money supply would not lead to lower interest rates and higher spending. Once caught in this liquidity trap, the economy could persist in a depressed state indefinitely.

But the flaw with the great stability was that many people confused stability with sustainability. From the perspective of conventional macroeconomics, the situation looked sustainable. But the composition of demand was not, with disequilibrium resulting from China and Germany encouraging exports and trade surpluses. The consequence of those surpluses was significant lending to the rest of the world, with more savings invested in the world capital market. Long term interest rates started to fall (from 4% to 2% a year in 2008) and as a result asset prices (stocks, bonds, houses) rose (as future spending are discounted at a low long term rate). Household brought forward consumption and investment spending from the future to the present. GDP was evolving on a right path but the stability brought about was not sustainable: the demand was just unsustainably too high.

In 2014, Jaime Caruana, the General Manager of the Bank for International Settlements said ‘there is simply too much debt in the world today’. And Adair Turner, former chairman of Financial Service Authority, asserted that ‘ the most fundamental reason why the 2008 financial crisis has been followed by such a deep and long lasting recession is the growth of real economy leverage across advanced economies over the previous half-century’. Although such statements point to the great fragility resulting from high debt levels, debt was a consequence, not a cause of the problems that led to the crisis. Debt resulted from the need to finance higher value of stock of property. In turn, those higher values were a reflection of the lower level of long term real interest rates. The real causes of the rise of debt were the ‘saving glut’ and the response to it by western central banks that led to the fall of real interest rates.

Short term Keynesian stimulus boosts consumption, reduces saving, and encourages households to borrow more. But in the long term, US and UK need to shift away from domestic spending toward exports, to reduce trade deficit, to raise the rate of national saving and investment. The irony is that those countries most in need of the long term adjustment, the US and UK, have been most active in pursuing the short term stimulus.

By 2015, corporate debt defaults in the industrial and emerging markets economies were rising. Disruptive though a wave of defaults would be in the short run, it might enable a reboot of the economy so that it could grow in a more sustainable and balanced way. More difficult is external debt…Sovereign debts are likely to be a major headache for the world in years to come. Should these debt be forgiven? Greece encapsulates the problems. When debt was restructured in 2012, private sector creditors were bailed out. Most Greek debt is now owed to public sector institutions (ECB, IMF). There is little chance that Greece will be able to repay its debt (austerity in Greece cannot work because exchange rate cannot fall to stimulate trade).

In 1931, a crisis of the Austrian and German banking system led to the suspension of reparations. They were largely cancelled altogether at the Lausanne conference in 1932. In all Germany paid less than 21 billion marks (out of 132 billion original figure of the Reparations Commission), much of which was financed by overseas borrowing on which Germany subsequently defaulted. ‘ A debtor country can pay only when it has earned a surplus on its balance of trade, and …the attack on German exports by means of tariffs, quotas, boycotts etc. achieves the opposite result’ (Schaft, 1934)

One way of easy the financing problems of the periphery countries would be to postpone repayment of external debt to other member of the Euro area until the debtor country had achieved export surplus.

Debt forgiveness, inevitable though it may be, is not a sufficient answer to all our problems. In the short run, it could even have the perverse effect of slowing growth.

Resentment towards the conditions imposed by the IMF (or the US) in return for financial support has also led to the creation of new institutions in Asia, ranging from Chiang Mai Initiative, a network of bilateral swap arrangments between China, Japan, Korea and ASEAN, to the Chinese led Asian Infrastructure Investment Bank created in 2015.

Because the underlying disequilibrium has not been corrected, it is rational to be pessimistic about future demand. That is a significant deterrent to investment today. To solve this our approach must be twofold: to boost expected income through raising productivity and encourage relative prices, especially exchange rate, to move in a direction that support a more sustainable pattern of demand and production. The second element can be achieved through promotion of trade and restoration of floating exchange rates.

After the crisis, demand for Chinese exports fell away, and chines authority allowed credit to expand in order to boost construction spending. But before the crisis there was already excessive investment in commercial property. As a result, empty blocks of apartment and offices are a commonplace sight in new Chinese cities.

Chine now faces serious risks from its financial sector.  A policy of investing one half of its national income at low rates of return financed by debt is leading to an upward spiral of debt in relation to national income.

Germany will find that it is accumulating more and more claims on other countries, with the risk that those claims turn out to be little more than worthless paper. That is already true of some of the claims of the euro area as a whole on Greece.

 

Capital in the Twenty-First Century – Thomas Piketty (2014)

 

piketty

 

When the rate of return on capital exceeds the rate of growth of output and income, as it did in the nineteenth century and seems quite likely to do again in the twenty-first, capitalism automatically generates arbitrary and unsustainable inequalities that radically undermine the meritocratic values on which democratic societies are based.  There are nevertheless ways democracy can regain control over capitalism and ensure that the general interest take precedence over private interests…

Whenever one speaks about distribution of wealth, politics is never very far behind.

In 1798, Malthus, like his compatriots, was very afraid of new political ideas emanating from France, and to reassure himself that there would be no comparable upheaval in Great Britain he argued that all welfare assistance to the poor must be halted and that reproduction by the poor should be severely scrutinized. It is impossible to understand Malthus’s exaggeratedly somber predictions without recognizing the way fear gripped much of European elite in the 1790s.

Kuznets (1953) noted a sharp reduction in income inequality in the US between 1913 and 1948. In 1913, the upper decile of the income distribution (the top 10% of US earners) claimed 45-50% of annual national income. By 1948, the share had decrease to 30-35%. This was considerable and equivalent to the share of the poorest 50% of Americans. Inequality was shrinking. According to the “Kusnets curve” inequality can be expected to follow a “bell curve”. It should first increase and then decrease over the course of industrialization and economic development, as a larger and larger fraction of the population partakes of the fruits of economic growth. The data and the theory became a powerful political weapon in the context of the cold war: the intent of his optimistic predictions was quite simply to maintain the underdeveloped countries within “the orbit of the free world”.  The Kuznets’s curve theory was formulated in large part for the wrong reasons. The sharp reduction in inequality was due above all to the world wars and violent economic shocks they entailed. It had little to do with the tranquil process of intersectoral mobility described by Kuznets.

WTIP : world top income database

Just as income tax returns allow us to study changes in income inequality, estate tax returns enable us to study changes in the inequality of wealth.

First conclusion: one should be wary of any economic determinism in regard to equalities and wealth and income. The history of distribution of wealth has always been deeply political, and it cannot be reduced to purely economic mechanisms.  The reduction of inequality between 1910 and 1950 was due to wars and policies to deal with shocks. The resurgence of inequality after the 1980 was largely due to the political shifts in regard to taxation and finance.

Second conclusion: the dynamics of wealth distribution reveal powerful mechanisms pushing alternately toward convergence and divergence. Furthermore, there is no natural, spontaneous process to prevent destabilizing, inegalitarian forces from prevailing permanently.

The main forces for convergence are the diffusion of knowledge and investment in training and skills. The emergent economies are now in the process of catching up with the advanced ones by adopting modes of production of the rich countries and acquiring skills comparable to those found elsewhere.

The forces of divergence? First, top earners can quickly separate themselves from the rest by a wide margin. More importantly there is a set of forces of divergence associated with the process of accumulation and concentration of wealth when growth is weak and the return on capital high. This is the principal threat to an equal distribution of wealth over the long run.  It is not out of question that those two forces of divergence come together in the 21st century. This has already happen to some extent and may yet become a global phenomenon, which could lead to level of inequality never seen before. The top decile in the US claimed 45-50% of the national income in 1910-20; 30-35%  from the 1940s to 1970s and rapidly rose from 1980 to 45-50% in 2000s.  This spectacular increase in inequality reflects an unprecedented explosion of very elevated incomes from labor, a veritable separation of the top managers of large firms from the rest of the population. These top manager by and large have the power to set their own remuneration, sometimes without limits and in any case without any clear relation to their individual productivity.

In slow growing economies, past wealth naturally takes on disproportionate importance, because it takes only a small flow of new savings the stock of wealth steadily and substantially. When the rate of return on capital significantly exceeds the growth rate of the economy, then it logically follows that inherited wealth grows faster than output and income. It is almost inevitable that inherited wealth will dominate wealth amassed in a lifetime’s labor and the concentration of capital will attain extremely high levels potentially incompatible with principles of social justice. It is possible to imagine public institutions and policies that would counter the effects of this logic: for instance a progressive global tax on capital.

It was not until the coming of the 21st century that the wealthy countries regained the same level of stock market capitalization relative to GDP that Paris and London achieved in the early 1900s.

It has been the demographic growth of the New World that has ensured that inherited wealth has always played a smaller role in the US than in Europe. This explain why the structure of inequality has always been so peculiar.[ US went from 3M at the time of independence to 300M today, France went from 30 million to 60 million in the same period. US is not the same country anymore. France example is more typical and pertinent for understanding the future. ]

Many commentators continue to believe that ever more fully guaranteed property rights, ever freer markets and ever purer and more perfect competition are enough to ensure a just, prosperous and harmonious society. Unfortunately, the task is more complex.

Capital/Labor split: at historically low level in the 1950’s, the growth of capital share accelerated with the victories of Margaret Thatcher in England in 1979 and Ronald Reagan in the US in 1980, followed by financial globalization and deregulation in the 1990’s. By 2010, despite the crises in 2007-2008, capital was prospering has it had not done since 1913.

National income: subtract from GDP the depreciation of capital that made the production possible (10% of GDP in most country) and add the net income received from abroad. A country that own a large portion of the capital of other countries may enjoy a national income higher than its domestic product.

In most rich countries the residents own as much in foreign real estate and financial instruments as foreigners own of theirs. France is not owned by Californian pension funds of the Bank of China. US does not belong to Japanese of German investors. The reality is that inequality with respect to capital is a far greater domestic issue than it is an international one.

Public wealth in most developed countries in currently insignificant: private wealth accounts for nearly all wealth almost everywhere.

Since the 1980s many countries have more or less balanced net asset positions, but those positions are quite large in absolute terms. Many countries have large capital stakes in other countries and those other countries also have stakes in the country in question, and the two positions are more or less equal, so net foreign capital is close to zero. Net income from abroad is just slightly positive in Japan, France, US, Britain, with 1-2% of GDP. Japan and Germany, whose trade surpluses have enabled them to accumulate over the past decades substantial reserves, have a net income from abroad at 2-3% of GDP. All continental blocs are close to equilibrium but for Africa where income is roughly 5% less than the continent output ( and 10% in some countries): this means that some 20% of African capital is owned by foreigners.

In developed countries today, the capital/income ratio generally varies between 5 and 6, and the capital stock consist almost entirely of private capital.

The population of the planet is close to 7 billion in 2012, and global output is slightly greater than 70 trillion euros, so that global output per capita is 10,000 euros. If we subtract 10% for capital depreciation and divide by 12, this yield an average per capita monthly income of 760euro. If the output was equally distributed each individual would have an income of 760 euros per month.

Sub Saharan Africa, with a population of 900 million and annual output of 1.8 trillion (less than the French GDP if 2 trillion) result in a per capita output of 2000 euro/year, the poorest economic region. China has 8000 euro/year.

The world clearly seems to have entered a phase in which rich and poor countries are converging.

The fact that rich countries own part of the capital of poor countries can have a virtuous effect by promoting convergence. Wealthy country residents will obtain better return on their investment by investing abroad, the poor country will produce more and close the gap between them and the rich countries. However this mechanism does not guarantee convergence of per capita income.  Then after the wealthy countries have invested in their poorer neighbors, they may continue to own them indefinitely: poor countries must continue to pay to foreigners substantial share of what their citizens produce (as African countries have done for decades).

None of the Asian countries that have moved closer to the developed countries of the West in recent years has benefited from large foreign investments (Japan, South Korea, Taiwan, China).

Many studies show that gains from free trade come mainly from the diffusion of knowledge and from the productivity gains made necessary by open borders, not from static gains associated with specialization.

The poor catch up with the rich to the extent that they achieve the same level of technological know-how, skill and education, not by becoming the property of the wealthy.

Growth: illusions and realities

The 21st century may see a return to a low growth regime.

According to the best available estimates, global output grew to an average annual rate of 1.6% between 1700 and 2012, 0.8% of which reflects population growth, while another 0.8% came from growth in output per head.

According to the UN forecast, the demographic growth rate should fall to 0.4% by the 2030s and around 0.1% in 2070, a rate similar to the low growth regime before 1700 and far from the spectacular peak of 2% of the 1950-1990.

 

A 2% growth rate is equivalent to a cumulative generational growth (over 30 year) of 81%. After 100 year, the wealth is multiplied by 7.

A stagnant or, worse, decreasing population increases the influence of capital accumulated in previous generations. The same is true for economic stagnation. Inherited wealth will make a comeback. On the contrary growth can increase social mobility for individuals whose parents did not belong to the elite generation. This phenomenon not only decrease income inequality but also limit the reproduction of inequality of wealth.

The end of growth: the key point is that there is no historical example of a country at the world technological frontier whose growth in per capita output exceeded 1.5% over a lengthy period of time. A growth of 3-4% per year is illusory.

It was essentially inflation that allowed the wealthy countries to get rid of the public debt they owed at the end of World War II. Conversely, the wealth-based society that flourished in the 18th and 19th centuries was inextricably linked to the very stable monetary conditions that persisted over this very long period. Despite slight adjustments, the conversion rate between French and Britain currencies remained quite stable for two centuries (parities with gold and growth was slow so the amounts of money changed only very gradually over time). Until World War I money had meaning.

Today’s public debt is nowhere near the astronomical levels attained at the beginning of the 19th century, but it is at historical levels in France and some other countries and is probably the source of much confusion. Britain’s public debt attained extremely high levels, around 200% of GDP in only two occasion: after WWII and after the Napoleonic wars. While the French defaulted on 2/3 of its debt (in the 1800s) Britons who had the necessary means lent what the state demanded without appreciably reducing private investment: the debt was largely financed by increased private savings. It is quite clear that the very high level of public debt served the interest of the lenders- investing in government bond was good business for wealthy people. For over 100 years, British government did not repay the principal and only paid the annual interest due on the debt. The British budget was always in substantial primary surplus: tax exceeded expenditures by several % of GDP. It was only growth of GDP and income from 1815 to 1914 that ultimately allowed Britain to reduce its public debt (and never defaulted). After WWI, the inflation of the 1950s (4% a year) and of the 1970s (15% a year) help reduce the debt from 200% to a 50% of GDP ratio.

To simplify the total value of public debt increased over the long run to roughly 100% at the end of 20th century. This increase reflects the expansion of the economic role of the state, the development of ever more extensive public services (health, education) and infrastructures. The total value of public assets in France is 150% of national income.

In the 1980s started a wave of liberalization and deregulation. The memory of the Great Depression had faded. The stagflation of the 1970s demonstrated the limit of post war Keynesian consensus. With the end of the reconstruction and the Trente Glorieuse it was only natural to question the indefinitely expending role of the state and its increasing claims on national output. Privatisation, deregulation followed. Public wealth fell to very low levels and private wealth slowly returned to levels of the early 20th century. France totally transformed its national capital structure.

Capital in the US took some specific forms first because land was abundant and did not cost very much, second because of the existence of slavery and finally because of the [strong] demographic growth (accumulating smaller amount of capital).

In the 1850s, the low capital/income ratio in America (3 years of national income as opposed to 6-7 in Europe) signified in a very concrete way that the influence of landlords and accumulated wealth was less important in the New World. With a few years of work, the new arrival were able to close the initial wealth gap (more rapidly than in Europe).

The United States is more than 95% American owned and less than 5% foreign owned.

In 1770-1810, If one adds the market value of slaves to other component of wealth, the value of southern capital exceeds 6 years of southern states’ income, or nearly as much as the total value of capital in Britain and France. Conversely in the North, with no slaves, total wealth was quite small: 3 years of income (as much as in the south of Europe).

Note that the phenomenon of international cross-investments is much more prevalent in European countries (France, Britain, Germany) where financial assets held by other countries represent between ¼ and ½ of the total domestic financial assets (which is considerable), than in larger economies such as US or Japan (around 1/10). This increases the feeling of dispossession. People forget that while domestic companies and government debt are largely own by the rest of the world, residents hold equivalent assets abroad.

Return on capital, from the 18th to the 21st century oscillated around a central value of 4-5% a year whereas in the early 21st century only it seems to be approaching 3-4%.

Too much capital kills the return on capital: it is natural to expect that the marginal productivity of capital decreases as the stock of capital increases.

Numerous studies mention a significant increase in the share of national income in the rich countries going to profit and capital after the 1970s, along with a concomitant decrease in the share going to wages and labor (linked to new and useful things to do for capital, mobility of capital, competition between states to attract investment, opportunities to substitute capital to labor)

The only thing that appear relatively well established is that the tendency for the capital/income ratio to rise, as observed in rich country and might spread to other countries around the world if growth (especially demographic growth) slows in the 21st century, may well be accompanied by a durable increase in capital’s share of national income and a decrease in return on capital.

In 1900-1910 in France, Britain, Sweden, the richest 10% owned 90% of the nation’s wealth.The wealthiest 1% owned 50% of the wealth. In other words, there was no middle class. The emergence of a patrimonial middle class was an important, if fragile, historical innovation. To be sure, wealth is still extremely concentrated today: the upper 10% own 60% of Europe’s wealth (more than 70 in the US). And the poorer half of the population owns 5% of wealth (as in 1900-1910). Basically all the middle class managed to get its hands on few crumbs : scarcely 1/3 of Europe wealth and ¼ in the US. The rise of a propertied middle class was accompanied by a very sharp decrease of the wealth of the upper 1% (from 50% in Europe in 1910 to 20-25% in 2010).

Since 1980, income inequality has exploded in the US. The upper decile’s share increased from 30-35% in 1970s to 45-50% in 2000s. Early data from 2011-2012 suggest the increase is still continuing. Financial crisis as such cannot be counted on to put an end to the structural increase of inequality in the US.

The US : a record level of inequalities of income from labor (probably higher than in any other society at any time) together with a level of inequality of wealth less extreme than in Europe in 1900-1910. If both logic continue and combine their effects, the future could hold in store a new world of inequality more extreme than any that preceded it.

In practice the Gini coefficient varies from 0.2 to 0.4 in distribution of labor income in actual societies;  from 0.6 to 0.9 for distribution of capital ownership; from 0.3 to 0.5 for total income inequality. Scandinavia in the 70/80s of labor income was 0.19. Conversely, Belle époque Europe had a Gini Coefficient of 0.85, not for from absolute inequality. Coefficients, synthetic indices are inevitably misleading. It seems to me far better to analyze inequalities in terms of distribution tables indicating the shares of various deciles and centiles in total income and total wealth.

To sum up: the reduction of inequality in France during the twentieth century is largely explained by the fall of the rentier and the collapse of very high incomes from capital. No generalized process of inequality compression seems to have operated over the long run, contrary to the optimistic predictions of Kuznets’s theory.

There is no doubt that the increase inequality in the US contributed to the nation’s financial instability. One consequence of increasing inequality was the virtual stagnation of the purchasing power of the lower and middle classes, which made it more likely for modest household to take on debt. Banks, freed from regulation and eager to earn good yields on enormous savings injected into the system by the well-to-do, offered credit on increasingly generous terms.

It is important to note the considerable transfer of US national income (some 15%) from the poorest 90% to the richest 10% since 1980. This internal transfer between social groups is nearly 4 times larger than the impressive deficit the US ran in the 2000s (on the order of 4 point of national income). The trade deficit, which has its counterpart in China, Japan and Germany trade surpluses, is often describe as one of the key contributor to global imbalances that destabilized the US and global financial system. That is quite possible, but the internal imbalances are four times larger than the global imbalances. The place to look for solutions may be more within the US than in China or other countries.

The top thousandth in the US increased their share from 2% to 10% over the past decades. A share of 2% means people enjoy an income 20 times the average – 10% means people enjoy an income a 100 times the average. In France and Japan, the top thousandth share rose barely from 1.5% to 2.5% from 1980 to 2010. From a macroeconomic point of view, the explosion has thus far been of limited importance in continental Europe and japan. The rise is impressive but too few people have been affected to have had an impact as powerful as in the US where transfer of income to the 1% involve 10-15 points of national income.

In emerging and poor countries, tax data reveal much higher – and more realistic – top income levels than do household surveys. The highest incomes declared in household surveys are generally only 4-5 times higher than the average income.  The top centile share would be less than 5% of wealth. This is not very credible. Clearly household surveys, which are often the only source used by international organisations (WB) and government for gauging inequality, give a biased and misleading complacent view of the distribution of wealth.

Financial globalization seems to be increasing the correlation between the return on capital and the initial size of the investment portfolio, creating an inequality of returns that acts as an additional force for divergence in the global wealth distribution.

It is an illusion to think that something about the nature of modern growth or the laws of the market economy ensures that inequality of wealth will decrease and harmonious stability will be achieved.

 

According to Forbes, the planet boasted 140 billionaires in 1987  but counts more than 1,400 in 2013. They owned 0.4% of private wealth in 1987 and 1.5% in 2013 ($5.4 trillion). The average wealth of the group has increased from just over US$1.5bn in 1987  to US$15 bn in 2013n (6.4% a year, above inflation). For the sake of comparison; average global wealth per capita increased by 2.1% a year and world GDP by 3.3% (all after deduction of inflation). The amounts remain small but the rate of divergence is spectacular. If this continues, the share of these tiny groups (billionaires and 1/100 million fractile) could reach substantial levels by the end of 21st century. Only a progressive tax on capital can effectively impede such dynamic.

Approximate conclusions: Global inequality of wealth in the early 2010 appears to be comparable in magnitude to that observed in Europe in 1900-1910. The top thousandth seems to own nearly 20% of total global wealth, the top centile 50% and the top decile somewhere between 80 and 90%. The bottom half owns less than 5% of total global wealth. These estimates are highly uncertain.

The rate of inflation in the wealthy countries has been stable at around 2% since 1980. This is much lower than the peak inflation in the 20th century and much higher than the prevailing rate up to WWI.

Although the effect on inflation are complex, evidence suggests that the redistribution induced by inflation is mainly to the detriment of the least wealthy and to the benefit of the wealthiest.

Sovereign funds (imperfect estimates) from China; Hong Kong, Singapore, Dubai, Lybia, Iran, Azerbaijan etc. today own 1.5% of the world private wealth (same as the billionaires). The annual rent derived from exploitation of natural resources has been about 5% of GDP since 2000 (half of which is petroleum, the rest being gas, coal, minerals, wood…) compared with 2% in the 1990 and 1% in 1970s. If rate continue to increase – with the barril as high as $200 by 2020-2030, sovereign wealth funds could own 10-20% of global capital by 2030-40. No economic law rules this out but sooner or later this would trigger political reactions (restriction on purchase of real estate, industrial assets etc.). Petroleum rents might well enable the oil states to buy the rest of the planet (or much of it) and to live on the rents of their accumulated capital. China, India are different: they have a large populations whose needs remain far from satisfied.

In the future, the threat of gradual acquisition of rich countries by China seems less credible and dangerous than a process in which the rich countries would come to be owned by their own billionaires. The rich countries are not about to be taken over by the poor countries, which would have to get much richer and that would take many more decades.

Are the rich countries really poor? The net asset position of the rich countries relative to the rest of the world is in fact positive (rich countries own on average more than the poor countries) but is masked by the fact that the wealthiest residents of the rich countries are hiding some of their assets in tax havens (which can account for up to 10% of GDP, or 2-3 times more according to NGOs). [If one adds up financial statistics, poor and rich countries have a negative position : it seems that Earth must be owned by Mars]

The inequality r>g (return on capital>growth of income) implies that wealth accumulated in the past grows more rapidly than output and wages. This inequality expresses a fundamental logical contradiction. The entrepreneur inevitably tend to become a rentier, more and more dominant over those who own nothing but their labor. Once constituted, capital reproduce itself faster than output increases. The past devours the future. The long term consequences are potentially terrifying, especially when one adds that the return on capital varies directly with the size of the initial stake (the higher the stake, the higher the return) and that divergence are occurring on a global scale.

There is ample reason to believe that growth rate will not exceed 1-1.5% in the long run. Growth can be encourage by investing in education, knowledge and nonpolluting technology. But none of these will raise the growth rate to 4-5%. With a average return on capital at 4-5%, it is therefore likely that r>g will again be the norm for the 21st century, as it was until WWI. It took two world wars to reduce the return on capital, thereby creating the illusion that the structural contradiction of capitalism had been overcome.

If we are to regain control of capitalism, we must bet on democracy – and in Europe, democracy on the European scale. In small countries of Europe which will soon look very small indeed in relation to the global economy, national withdrawal can only lead to even worse frustration and disappointment than currently exist with the European Union. Nation state is the right level to modernize social and fiscal policies but only regional political integration can lead to effective regulation of the globalized pratimonial capitalism of the 21st century.