Thursday, March 12, 2009

Crisis Causes Inequality To Go Down

The number of millionaires in America is dropping fast, from 9.2 million at the end of 2007 to 6.7 million at the end of 2008, as is the number of "affluent households" (with a net worth between $500,000 and $1million), from 15.7 million to 11.3 million. Those were year-end numbers, and as the stock market has dropped significantly since then, these numbers have likely dropped further too.

In a related news item, the number of billionaires globally is also declining fast, from 1,125 to 793, and those that still are billionaires have in most cases seen their net worth drop significantly. For example, Bill Gates net worth has dropped $18 billion, while Warren Buffet has lost $25 billion. The collective net worth of billionaires dropped from $4.4 trillion to $2.4 trillion, both as a result of the lower numbers of billionaires and the lower average net worth among billionaires.

This illustrates a rarely noted phenomenon: economic downturns tend to be associated with falling inequality, while booms are associated with rising inequality. Inequality reached the highest level ever in U.S. history in 1928, only to shrink dramatically during the Depression. It then reached new highs in 1999, and then later (after having briefly declined in 2001-02) in 2006. In other words, inequality tends to peak during financial bubbles, and then decline after those bubbles burst.

That is hardly a coincidence. Asset owners tend to be wealthier than others, almost by definition, and when asset prices rises relative to goods prices, this will inevitably mean that the rich will become relatively richer. Moreover, during cyclical peaks profits in general and financial sector profits in particular tends to peak as well, something which will enable executives and financial sector employees to receive really fat bonuses, thus increasing inequality in labor income as well.

The background to these cyclical tendencies is of course monetary policy.

The bad news for the majority of non-wealthy people is that the decline in inequality that we are now seeing will entirely be a result of the rich becoming less rich. It won't mean that the poor and the middle class will become richer (indeed, they are likely to suffer too, only less so than the rich).

This decline in inequality is also bad for Obama's official "soaking the rich" budget strategy. If you make government financing dependent on soaking the rich, that means that government finances will depend on a high level of inequality. If inequality goes down, there won't be enough rich people to soak to minimize the deficit to a sustainable level. This in turn means that there will be a need to either restrain spending or to raise taxes on the poor and the middle class.


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