What Economist Thomas Piketty Can Learn from an Ice Hockey Legend

‘Since the 1970’s, income inequality has increased significantly in the rich countries, especially the United States, where the concentration of income in the first decade of the 21st century regained — indeed, slightly exceeded — the level attained in the second decade of the previous century.’

  • Thomas Piketty – French economist and Author of ‘Capital in the 21st Century’

I skate to where the puck is going to be.’  

            – Wayne Gretzky, legendary Canadian Ice Hockey player.

Thomas Piketty, an obscure French economics professor, has found fame and fortune in the US — perhaps it’s his ‘15 minutes of fame’.

Piketty’s book on the history of income inequality has struck a chord with Nobel Prize winning economists Paul Krugman and Joseph Stiglitz and won him an audience with Obama’s Council of Economic Advisers.

A search of Google Ngram Viewer shows the rise in books relating to ‘income inequality’, especially since the late 1990s. It’s the buzz term at present and Piketty has cleverly (and, profitably) tapped into the prevailing social mood. At last count he had sold over 46,000 copies of his book.

Google Ngram Viewer shows the rise in books relating to ‘income inequality’
click to enlarge

Piketty’s solution to bridging the gap between capital and income is a progressive wealth and income tax of up to 80%. (What else would you expect from a socialist Frenchman?)

The proverbial ‘tax the rich and give to the poor’ solution is as old as Moses. Yet to those feeling the pinch, it’s exactly the answer they want to hear — irrespective of history showing it doesn’t work.

The mood Picketty has tapped into has been festering for several decades and thanks to the US Federal Reserve’s ‘wealth effect’ strategy it is now reaching a tipping point.

Studies show that since 1970, real US wages (after inflation) have been steadily falling. For over forty years, wage earners have progressively lost buying power. Ever-increasing amounts of credit offset the shortfall in this purchasing power.

The GFC brought an abrupt end to this form of ‘income enhancement’ activity. US wage earners, minus the ability to use their home equity as an ATM for the past five years, have been in a tightening vice.

While the wage earner has been screaming ‘enough already’, the owners of capital have benefitted greatly from the Fed’s so-called ‘wealth effect’ — Quantitative Easing and suppressed interest rate policies that specifically target reflating share and property values. The rich have become richer while the middle and lower class have been forced to tighten their belts.

The intended consequences of the Fed’s ‘wealth effect’ was for the rich to share their restored wealth around and eventually all levels of society would feel the ‘love’.

As usual the policy elites intended consequences turn into unintended ones – the wealth hasn’t trickled down. What the Fed has managed to do is drive a social wedge between the haves and have nots.

The following graph from Piketty’s book shows the top 10% own nearly 50% of the US national income. Using the old 80/20 rule, my guess is you could extend this graph out to the top 20% and you’ll find they own roughly 80% of the income.

This means 80% of the people are fighting over 20% of the income — no prizes for guessing why the social mood is what it is.

Share of top decile in national income
click to enlarge

In looking at the above graph I see a different outcome and solution to the one Piketty proposes.

The clue is in the opening excerpt, and particularly the emphasised section below.

Since the 1970’s, income inequality has increased significantly in the rich countries, especially the United States, where the concentration of income in the first decade of the 21st century regained — indeed, slightly exceeded — the level attained in the second decade of the previous century.

Piketty states the obvious fact from the chart- the current percentage of income owned by the top 10% slightly exceeds the level achieved during the Roaring 20s (prior to The Great Depression).

The Great Depression was a reset button on the economy. Market forces went about restoring the capital v income imbalance. When the debt excesses of the 1920’s where purged from the system, the economy entered a period of genuine productivity (not one based on the financial engineering we’ve had since 1980). Real wages grew. The share of the spoils between capital owners and income earners remained relatively static for thirty plus years.

Since 1980 the developed world economy has prospered due to the financial sector finding ever more creative ways to sell debt product to a more than willing consumer.

The GFC tried to do what The Great Depression did — hit the reset button on a period of excess. However, the Fed moved quickly to remove the market’s finger from the reset button.

Five years after the initial crisis, the US Federal Reserve is still fighting the market’s natural forces with even more effort than they used at the outset of the crisis. Does this seem odd to anyone else but me?

It’s my contention GFC MkII is patiently waiting to hit the reset button. When it does, the Fed will not have the strength to force the market to relinquish its grip on the controls.

When GFC MkII unleashes its pent up fury, the wealthy will not be so wealthy (as the post Great Depression sharp decline in Piketty’s graph shows). Therefore the proposition of an 80% wealth tax will be nothing more than an academic toss. With massive capital losses to account for, the newly named ‘not-so-wealthy’ will be in no position to add to the government’s dwindling tax take.

In Australia a severe market downturn would hit superannuation and account based pension balances pretty hard. This would compound the Government’s budget woes — as more retirees would be eligible for higher pension payments under the Assets Test. Less tax revenues and higher welfare payments — not a recipe for any robust post-GFC MkII economic recovery.

Piketty’s own graph together with what we know from history tell us periods of excess always correct themselves — granted some take longer than others, but they all end in tears.

So with nearly every historical marker flashing red on the US share and credit markets, we have the academics NOW proposing a wealth tax — perhaps Piketty’s 15-minutes of fame and his idiotic 80% tax solution is the ringing of the bell on this period of excess.

Prior to developing his ‘solution’ Piketty should’ve taken a leaf out of Wayne Gretzky’s playbook and ‘skated to where the puck was going’. The puck is going over the edge (sooner or later) yet Piketty is trying to hit it with his 80% tax as if it’s standing still. Nothing in a complex economy ever standstill — you’d think an economics professor would know this.

The one area of wealth that is most likely to withstand the financially devastating impact of GFC MkII is Family Wealth. Old family money tends not to get caught up with momentum investing (following the latest ‘hot’ investment asset class).

The custodians of family wealth are generally more patient in their approach to investing. Due to the mentoring from their forefathers (the creators and previous custodians of the family wealth) they appreciate investing is not about chasing returns but understanding and managing risk.

Knowing what you stand to lose is far more important than dreaming of future riches. If you properly assess risk, the returns usually take care of themselves.

The other key ingredient behind successful family wealth is patience. The easiest two things to do in investing are — buy or sell. The hardest thing to do is — sit and wait. Yet it is the sitting and waiting — being invested in cash and waiting for markets to become under-valued OR buying into a market and waiting for the crowd to drive prices higher — that determines the long term outcome on your capital.

Most investors suffer from ‘ants in the pants’ syndrome and can’t wait for markets to tell their full story. This is why study after study shows the average investor and fund manager consistently underperform (some by a very large margin) the average.

While we can expect to see a fair percentage of the top 10% revert to the ranks of ‘the not-so-wealthy’, the custodians of family wealth will see GFC MkII as a once in a lifetime opportunity to acquire quality assets at a substantial discount.

Finally, it would be interesting to know whether Piketty’s ‘walks the talk’ and offers 80% of his book’s earnings to the taxman. What do you think?


Vern Gowdie+
for Markets and Money

From the Archives…

The Delusion That Fools Unwary Investors
25-04-2014 – Vern Gowdie

Join Markets and Money on Google+

Vern Gowdie has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top five financial planning firms in Australia. He has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

To read more insights by Vern check out the articles below.

Leave a Reply

Your email address will not be published. Required fields are marked *

Markets & Money