Sorry Piketty, Wealth Isn't What's Driving Inequality

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Modern central banks are afforded a level of consistency with capitalism that is just plain undeserved. You see this with often blind support of people and institutions that are erstwhile unquestioned supporters of free enterprise and markets. When they follow the traditional course of monetarism, they believe, with more than a little history, that they are being perfectly consistent with the capitalist tradition.

The prime example is Milton Friedman himself, celebrated not just as a free-market economist but a full-on libertarian one. Yet the diagnoses and prescriptions that follow from his work, going back all the way to his seminal book A Monetary History, share a curious imperfection with what is supposed to be his exact opposite number.

It was only a little while back where the mainstream was totally captured by Thomas Piketty. There has always been an academic infatuation with Marxism, if not fully economic than at least culturally. Piketty's book, Capital in the Twenty-First Century, is a full nod to Marx acknowledged by the title itself. For academic purposes, and maybe more than that, Piketty is not a full-blown Marxist, however, as he doesn't, at least in this work, follow all the way down Marx's "inevitable" implosion of capitalism into total, global socialist revolution.

Instead, Piketty takes Marx's critique of capitalism and applies his own "solution" - draconian taxation on the rich in the name of "equality." While I doubt he would admit as much, the reason for eschewing full revolution is simple status quo - Marx was outside the power structure, as was his disciple Lenin; Piketty is very much a part of it. In other words, Piketty has already reached the new elite aristocracy, he just wants that aristocracy (the theocracy, essentially, of exclusive credentials) to gain more power at the expense of other people who don't know as much as he claims he does about running everything.

The basis for the shifting even further toward top-down statism comes down to a single concept, one that drives both his view of the world and, as I will contend, the reason the global economy is once more purged upon the precipice of further economic ruin.

Piketty writes,

"...capitalism automatically generates arbitrary and unsustainable inequalities that radically undermine the meritocratic values on which democratic societies are based."

It is the word "arbitrary" that so offends basic capitalist sensibilities. Piketty surely would, being so bold as to offer his own opinion for him, care little about capitalist feelings; that is precisely his point. But how can he, or any Marxist or branch of Marxism, establish that inequality in the capitalist tradition is "arbitrary?"

Henry Ford's rise to fame and fortune was the exact opposite of "arbitrary." So too were the great industrialists of the Gilded Age, which so offended the predecessor economic thought to Piketty's revivalism. You can add the list (some, anyway, in this financialism) of the great wealthy of the current age, as Steve Jobs (more like Steve Wozniak) was not "arbitrary" in his ascent, nor was Sam Walton or Larry Page. Their efforts were not simple activities for the sake of nothing but "money", but rather the capitalist tradition of advancing society well-being and getting paid to do it. The two are inseparable, which is entirely the point of contention though the argument is so easily settled in the world that exists outside the rigid nature of academic thought systems.

The poorest members of our society right now live better than the richest members of the "unequal" society of the middle to late 19th century - and it isn't even close, so much so that what I just wrote isn't in any way insightful or the least bit controversial. Poverty in America today does not even countenance starvation as it once did, and not all that long ago (food "insecurity" is the new "destitution"), as those classified as "poor" have everything everyone else does only in lower quantity. The "poorest" households have access to cable TV (and usually to more than one of them), cellphones and at least one automobile. That is the essential element of capitalist tradition; again everyone gains.

Piketty would have it that it matters more that everyone gains at the exact same rate, which is so utter nonsense as to be axiomatic. Who would invent the transistor under "to each according to his needs, from each according to his abilities?" Innovation is not the spontaneous assumption of unrivaled intelligence; it is almost exclusively a process of trial and error, with the vast enumeration of "error" taken under the umbrella of nothing but risk-taking in the name of future potential profitability.

And it is there that Piketty gains entrance into plausibility by asserting "wealth" as the same as paper wealth. Indeed, that is a sentiment that has predominated since money ceased to exist in the US. There is no risk-taking in inheriting a vast sum of currency or financial assets, nor is there much, especially in the age of interest rate targeting, in becoming "wealthy" via finance alone. Those two classes are, more than anything, rife with "arbitrary" inequality stripped of all risk.

That was always the most curious aspect of his idea of "rising inequality", especially of the last forty years (coincident to date to the onset of the 1970's, as if something happened then?). The largest source of "capital" for his formulation is nothing like capital in a true capitalist system. He includes, as does all orthodox economics, housing stock as both wealth and capital.

To the devoted, housing stock is like capital in the sense of imputed owner's rental equivalence. This is another facet of economic thought that has a plausible beginning and rationale but has been extended far beyond any proper sense. Henry Ford's capital was not his portfolio of t-bills or Central Pacific bonds (assuming he held either), but rather Ford Motor Company as a viable business that profitably manufactured goods that society demanded. Equating his house, which was probably magnificent and expensive (again, for all I know or care), to his business is tantamount to disqualifying flaw - there are immense differences between the two that are of function and true nature rather than just semantics or economic theory.

The only sense whereby real estate becomes capital is when it is used in the sense of a business to provide the "good" of shelter. An apartment complex might be fairly called "capital" in that it does all the same as Ford Motor Company, but it is stretching all sense of economy to say that your house that you own and live in is a business whereby you rent the good "shelter" to yourself at some rate which the Bureau of Economic Analysis will infer or impute and include in GDP (to the tune of $1.3 trillion).

To this grossly distorted view, the Fed took to "stimulating" the economy these past three decades under interest rate targeting via housing and mortgages. The primary channel of all such monetary measures has traditionally been exactly that, housing via mortgage credit production. In essence, to the Fed and to Thomas Piketty, the engagement of the housing bubble looked very much like an increase in capital in the US system. Yet for all that supposed capital, wages have lagged, depressed and downright declined at the very same time.

That is because housing is not capital, try as they might to define it philosophically as such and count it numerically as one and the same; again, there is a vast functional difference. Wages are the byproduct of true capital, as in a capital owner like Henry Ford increasing actual production by combining his stock of true capital with your toil and effort. The more successful his combination skills and reach, the more you and neighbors get paid in return. It really is that simple (cue the outrage from Upton Sinclair or William Jennings Bryan fans that ignore the enormous rise in living standards from a subsistence agriculture basis to industrial to now information or whatever we want to call the ridiculously high living standards right now). Capitalism actually works, but is messy, and even violently so. But taking out the mess takes out the vitality, as all these arbitrary assignments actually try to do.

To increase the housing stock, and even just the paper value of it in the name of "smoothing out the business cycle", of course is not going to have any real impact on wages because it is not capital. Worse than that, it attracts resource utilization in a highly inefficient and ultimately arbitrary means, directing good resources away from what would otherwise produce profitable and sustainable capital growth (and thus real wage growth).

On a granular level, you can see this almost anywhere today. Right near my office here in West Palm Beach there is a cluster of apartment complexes, maybe ten or so totaling a thousand or more units. Starting around 2005, the lure of "easy money" and the rapid ascent in real estate "prices" spurred a radical shift in their existence. Almost all of them decided to exit the apartment business and sell themselves piecemeal as condos. Of course, that was not a direct process, as refurbishments were necessary to hit the resale market.

Over about a year and a half, each of these facilities wound down their whole pool of tenants to undertake condo conversion. That meant a great number of empty units sitting idle, and unprofitably in cash flow terms, for an extended period. To the Fed and orthodox economists, this was terrific as it represented a burst of "activity" as construction jobs were "created" to gain this conversion. The devotion to aggregate demand is exactly that - arbitrary activity for the sake of activity.

To the part that economists ignore, restaurants and shops in the immediate vicinity were essentially decimated as there was no one left to shop there (shopping instead wherever they all moved). And of course, given the timing of this "market-based" euphoria, the property owners suffered the wrath of such artificial prices when they inevitably collapsed only partway into the conversion process.

So sitting drastically idle for several years, the property "market" has sprung back to life, in some sense, in that almost all of these places have taken "market signals" under QE3 to convert back into apartments since that is where all the "easy money" now resides. In fact, as of late 2014, I count nearly all of them having regained their apartment business (though a few are still selling condos at huge discounts to 2006 pricing, undoubtedly as new owners have taken over after bankruptcy and foreclosure). In other words, these pieces of "capital" are right back where they started almost a decade ago, but are not neutral for having done all this arbitrary, finance-driven activity. The Fed sees a bunch of activity for the sake of activity, "gaining" about some positive GDP and such, but businesses and even true capital stock are much lower and reduced for having participated in all this "stimulus."

That is the true essence of counting on "inflation" as a means of "pump priming." The Keynesian tradition cares nothing for the long-term, as long as something, anything, happens today that otherwise would not have. And it is exactly that moment where the economy grows poorer, because "would not have" is based on profit considerations, and "aggregate demand" is just pure arbitrary allocation.

So how much in resources, including labor and innovative potential, has been drawn into this arbitrary black hole of artificial "capital?" There will never be any way to show for sure the level of waste apart from the utter deficiency of our current circumstance. The lack of wage growth is the full part of that, and that traces back to the growth of all this redistribution and the creation of artificial "capital" at the direct expense of true capital. Inequality in this formulation is simple imbalanced finance as totally separate from capitalism.

When the accumulation of so much artificial and unprofitable "capital" reaches a breaking point, the damage and carnage is not limited to those undertaking the "wrong" path of central bank incentivizing. Instead, everyone gets the short end, but not everyone gets the bailout. Prices decline and "regular" folks take their losses, but financial firms are given the full measure of aid and left standing to take full advantage, as a tool of redistribution, of the rebound. That is about as arbitrary an assessment and mechanism as exists in any economic setup, as the only reason for it is the supremacy of redistribution as a further economic means.

So the cycle will continually repeat, because this arbitrary distinction in favor of financialism leads only to more artificial and arbitrarily-assigned economic growth, or what most people call now serial asset bubbles.

The beneficiaries of all this financialism are of course the closest financial participants. The more the real economy undertakes the stress of arbitrary assignment, the greater the financial imbalance grows so that the new stream of "wealthy" are the financiers themselves, with a conspicuous disproportion against the class that used to be dominated almost exclusively by industrialists. The capitalists, who owned their own productive businesses, have been moved out in favor of the banks and those that "manage" the redistribution. That is what Piketty is partially arguing, as it offends the senses of meritocracy as he contends; it is hard to argue in this sense for too big to fail, especially as a component of "merit."

One of the most underappreciated (if not totally ignored) aspects of all this is how interest rate repression in the name of redistribution is essentially, in the inverse, an increase in the cost of "capital" (at least as the distinction of what counts for it in the modern, shadow system). The heavier the degree of repression, the higher the cost of capital, moving not linearly but in what looks like discrete boundaries or jumps whereby what might have been stable at one point is entirely disrupted at the next. In other words, a bank may exhibit totally "normal" behavior at, say, a 2% benchmark rate, but act entirely different at 1%; and might even be unrecognizable to the first iteration at that notorious zero lower bound.

No less than Karl Marx himself anticipated something very much like this in his own "theory of money."

"A devaluation of credit money (not to speak of loss of its monetary character, which is in any case imaginary) would destroy all the existing relationships. The value of commodities is thus sacrificed in order to ensure the fantastic and autonomous existence of this value in money. In any event, a money value is only guaranteed as long as money itself is guaranteed. This is why many millions' worth of commodities have to be sacrificed for a few millions in money. This is unavoidable in capitalist production, and forms one of its particular charms. In former modes of production, this does not happen, because given the narrow basis on which these move, neither credit nor credit money is able to develop. As long as the social character of labour appears as the monetary existence of the commodity and hence as a thing outside actual production, monetary crises, independent of real crises or as an intensification of them, are unavoidable. It is evident on the other hand that, as long as a bank's credit is not undermined, it can alleviate the panic in such cases by increasing its credit money, whereas it increases this panic by contracting credit."

This is why neo-Marxism gains such currency (pun very much intended) in the current age because he sounds downright prescient. But he makes the same mistake that Piketty has made, that the Fed continues to make and is spread all over the globe by central banks adhering to principles of arbitrary monetary assignment. In that connective sense, this is as much Georg Knapp's taxes-drive-money theory of chartalism. Everything is arbitrary in finance derived solely by government action.

Does the "social character of labour" appear as "the monetary existence of the commodity" as Marx proclaims of capitalism? In other words, are wages purely monetary or inseparable pieces of production in combination with capital? In the modern tradition of monetarism combined with Keynesianism, an outgrowth of ancient chartalism combined with underconsumption, the view is exactly as that Marxist formulation. Wages are nothing but monetary constructs and thus should be attainable as monetary constructs - thus QE and ZIRP and even negative nominal interest rates are expected by orthodox economists to produce a healthy economy. Yet, they do nothing of the sort, running so long now in such "unexpected" disarray as to have produced an academic response to try to gain intellectual hold of that reality (what they are now calling "secular stagnation", or how it relates to the supposed negative natural rate of interest).

If the economic system is set arbitrarily, what happens to wages in the long run (despite underconsumptionist Keynes' ridiculous assertion that all that matters is the here and now)? All the workers that contributed to the condo conversions here in West Palm Beach were paid and likely paid well for the artificial profits the landowners were expecting as exceedingly large (a reasonable assumption on my part, though I have no direct knowledge of exactly what figures or suppositions were used). That is what orthodox economists expect, but they do not see the next stages. In reality, the workers in that conversion are contributing not to an increase in actual capital stock, but instead to its further demise and erosion. In that very real sense, as opposed to the theoretical one driving the Fed's models, wages actually will fall over the long run because the economy set arbitrarily destroys itself as the central bank lives up to the Marxist definition of monetary wage rates.

Marx was incorrect, as is the Fed, in that wages are separable from true capital. Further, by increasing this stock of arbitrary false capital, that does nothing but contribute to the decline in wages (if not outright decline than at least a downward bend in the trajectory; the former appearing more recently in the 2000's with the latter taking place for just about the whole of the Great "Moderation"). The global economy is not suffering from a dearth of money but a dearth of true wealth. An increase in actual wealth would produce actual wages, becoming the self-reinforcing trend we used to call the economy.

Piketty's assertions, then, wrongly decry this disparity, for it is not wealth that is driving inequality but the same idea as Marx had of capitalism in the 19th century that was never truly capitalism. In that sense, the modern central bank adhering to redistribution has fulfilled the Marxist fantasy by essentially animating these Marxist traditions. The chartalists won the long war of academic proselytizing, and in doing so introduced the very means of arbitrary assignment (they believe as the primary feature rather than a bug) Marx saw of capitalism then, and what Piketty sees of it now. How wrong they all are, as the depressingly and depressive dark clouds gather once more to prove it.


Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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