Thursday, March 27, 2014

The Insights of the New Inequality Reports Relevant to Personal Finance

Those of you who have skimmed my bio will have noted that a good while ago I wrote a (unpublished) book on personal finance.  In the book, I came to certain counterintuitive conclusions about the best way to manage your money; in the last few years, I have conjectured that my take on personal finance can be used to analyze wealth management and investment patterns at the macro level, i.e., at the country or global level.  However, up to now, the only evidence I had for the correctness of my views was anecdotal.
In recent publications, the acknowledged experts on income inequality – Piketty and Saez – turn their attention (and that of their co-authors) – to wealth.  In the process, they derive some insights which place on a solid statistical foundation most of my conjectures.  In this post, I summarize some of the insights of the reports that may seem counter-intuitive to many readers, but together form a picture that places wealth – not income – squarely at the forefront of personal finance and many aspects of today’s economics.
In no particular order, here are the insights, in grossly generalized form:
1.        Over the last 200 years, except for a period around the Great Depression, “capital” (really, stocks and bonds) has consistently performed better in terms of growth of wealth than income from “labor” (ranging from salaries to CEO “incentive pay”).

2.       As a result, again consistently, there is a line somewhere around $2-$4 million in invested (stocks and bonds, not real estate or venture capital-type investments) wealth below which the wealth of the individual does not grow significantly over time, and above which his or her wealth grows at about a 7% (in real terms) rate per year.

3.       Again consistently, 50% of the population has zero or negative wealth, 40% has minimal investment wealth, and for 8-9% much of the investment wealth comes from a pension or 401(k) whose yield income is typically less than that person’s labor income.  Only the top 1-2 percent have investment income greater than labor income.

4.       The very rich (top 1-0.1%, $20 million to $100 million in wealth, plus the top 0.1%, $100 million and above in wealth) are no better investors than the other 99% (actually, the other 49%, since 50% have zero or negative wealth) – despite sometimes having certain advantages in the treatment of capital income, and in connections to investment “opportunities”.  

5.       It appears that high estate taxes, fairly high income-tax rates, fairly high capital-gains rates, and fairly high dividend-taxation rates have had little effect on this “shift to capital income”, while the main reversal of trend (the Great Depression) may have occurred because the loss of stock value was so severe (perhaps 70% from peak to trough) that many of the 1% found themselves below $2-4 million in invested wealth, with habits of high spending that were difficult to break.  Also, the Great Depression effect may have lasted for 40-odd years because high marginal income tax rates and smaller markets and pay norms did not prevent those with more than $4 million from growing at 7% per year, but did prevent most would-be entrants (typically CEOs) from reaching the magic level over the course of a career.  Reductions in tax rates, globalization of markets that allowed more scope for high CEO salaries, and new norms of compensation that piled direct-to-investment stock options on top of large increases in salaries in the 1979-1990 time period probably broke the Great Depression mold.
Here are the initial conclusions I draw – or, more properly, move from “anecdotal evidence” to “firmly based in statistics”:

1.        The aim of personal finance should be to achieve $2-3 million in low-expense-ratio S&P 500 (or Russell 2000) index funds.   Note that Vanguard typically has a 0.1-0.2% expense ratio over time.  The tendency of the rich to invest instead in high-expense-ratio actively-managed funds, in bonds, in derivatives, in hedge funds, in real estate, in venture capital firms (assuming that the aim isn’t philanthropic), in listening to con men, in conspicuous consumption, and in political maneuvering to protect labor income from miniscule threats, explains why the average rich person is no better at investing than the less-well-off 401(k) owner who is forced to deal with lack of available index funds and 2% fees in the 401(k), as well as less opportunity to use capital-gains, dividend, and interest tax advantages.

2.       Overall, these wrong investing decisions cost the top 50% about 1.5% per year (based on a study that showed that in real terms, a Vanguard S&P 500 index fund or the like grows about 8.5% per year).  They also suggest that unless there is less than 15 years to go until retirement or one’s employer is also contributing significantly, investing directly in such an index fund may be better than putting that money in a high-expense-ratio 401(k) or IRA.

3.       It also follows that once one reaches the “safe rich” category as defined above, there is far less urgency about piling up more and more than is assumed.  What the rich buy in terms of power to protect their money with the extra cash is unneeded in the first place.  Economics, as many have said, is not a morality play; but if one reaches the “safe rich” category, it is perfectly reasonable to do the moral thing and not stretch desperately after more and more and more, and the person who does so will typically not suffer any real penalty.

4.       The first macro implication of these insights is that income tax and estate tax tweaking is strictly limited in its effect on this “investment rich get richer” trend.  It now appears unlikely that we can reverse the trend by limiting entry into the “$4 million and up” investment club – although we can prevent its spread to many of today’s CEO wannabes.  No, by far the most powerful tactic for preventing rapid wealth/income rich-share expansion (and, by the way, the top 1% now have 40% of the wealth and the top 0.1% 20-22% of it) is an investment-wealth tax.  France, I note, has a general-wealth tax of 2%, which has helped somewhat – one might consider putting it at 3.5%, to counter the effects of 2.5% inflation.  Note that this will simply take the rich’s yield down to 3.5%, still enough to ensure some wealth increase, but one-half the increase of the 49%.  I limit it to investment wealth, because the data suggest that if the super-rich shift to other forms of investment, not only will their own income suffer (stock options), but their own investment yields as well.  However, other distortionary economic effects may mean that one should echo France.

5.       The second macro implication, I believe, is that inequality and its follow-on economic effects is not primarily a problem of income inequality, or as Krugman conjectures in recent blog posts, a matter of inherited wealth – the Rockefellers and Vanderbilts are still doing quite well through stringent estate taxes and loosened ones.  It is, rather, a matter of regulating both entry into the “safe wealthy” category and the amount of wealth growth once one has reached that stage.  To have a hope of long-term success, in other words, inequality policy must deal with investment wealth above a certain level.

Saturday, March 22, 2014

The 2013 Global (Climate) Insanity Awards

In returning from a posting hiatus, I thought I’d clean up a few odds and ends before beginning this year’s posts.  This one concerns countries the net effect of whose policies and business and personal efforts has given the strongest impetus to oncoming climate disaster (as laid out in previous posts, and specifically referring to the “worst consequences” outcome described in Hansen’s recent paper and summarized here).  It goes without saying that in order to act as they have, these countries are deserving of the psychological label “insane” if anyone is.

Let’s start right in.

#1:  Canada

I have attempted in several posts to lay out the reasoning behind James Hansen’s scientific assessment that use of tar sands and oil shale will mean “game over for the environment”, in the sense that together with even minimal use of oil, coal, and natural gas from now on, they will lead to “worst consequences.”  For several years, Canada under its latest prime minister has been going full steam ahead in attempting to mine the Athabasca tar sands, which contain a major fraction of the world’s known tar sands.  In order to successfully sell this “product”, a major modification of infrastructure must be accomplished, and Canada is now – according to credible reports -- going all out to create this infrastructure, including muzzling its own scientists, distorting the facts about the actual carbon emissions, and allying with the Koch brothers (US businessmen deeply invested in all forms of carbon-polluting energy) to lobby foreign governments to allow Canada to create the infrastructure to export the resulting “dirty” oil. 

If Canada were not pushing tar sands oil in 2013, including but not limited to the “gateway drug” Keystone XL export pipeline, it is very unlikely that there would be even a possibility of this “worst of all outcomes”.  I need only mention that the prime minister is also under the delusion that sea ice in the central Arctic won’t melt for a good long time, so that Canada can make profits from its Northwest Passage, and the picture of insanity is complete. But that’s really a side show; the introduction of tar sands oil and attempts to make it viable earn Canada 2013’s Number 1 spot.

#2:  The United States

It was a tough choice here between the US and China.  The US won because its policies, politics, and business interests combined in 2013 (and previous years) to slow world attempts to cut back on carbon pollution in ways that made it more and more difficult for the world to respond.  The failure over the last few years to squelch the Keystone XL pipeline is merely the icing on the cake.

The failure primarily of Republican office-holders to recognize that politics ends at climate disaster’s edge – and, in particular, failure to understand that accepting oil lobby money for votes should be a matter of how to engineer a soft landing for these companies during changeover to solar/wind, not how to double down on carbon pollution and its infrastructure using the chimera of “energy independence” – combined with the willful “stick my head in the sand” voting of almost half the population, as well as the delusion of most businesses that their “green” efforts are anywhere near what’s needed and business’ failure to recognize that outsourcing is effectively increasing carbon pollution – produce a worldwide result in which overall carbon emissions increases become ever more entrenched in the system.  As Hansen notes, the facts speak for themselves:  whatever minor decreases appear to be occurring in US carbon pollution, the worldwide level continues to rise at the same rate – which would not happen if the country that produces more carbon pollution than any other were exercising any countervailing force. 

#3:  China

As it turns out, despite the solar fluff sold to foreigners, China is rapidly ramping up its coal emissions, and has committed to coal gasification plants that have repeatedly proved that they cannot effectively capture and sequester a significant part of the resulting emissions.  What makes China better than the US, given that its carbon pollution is increasing faster in percentage and absolute terms?  Only that the ability of America to retard the rest of the world’s reaction to the problem, and its contribution to carbon pollution, is still greater than China’s.

#4:  Australia

Despite the efforts of the former prime minister to administer even a modest check on internal pollution, Australia under its next prime minister is now going back to “business as usual” while massively mining coal to sell to foreign countries.  Since Australia is one of the first countries in which the weather consequences – from unprecedented catastrophic rains to catastrophic droughts – is becoming blatantly obvious, it takes a special kind of insane blindness to do this.  However, even the massive amounts of Australian fossil-fuel reserves don’t have the same effect as US and Chinese actions; so #4 it is.

#5:  India

India has been ramping up carbon emissions – from a smaller base – almost as fast as China, and I understand it has been tapping coal as well.  I also understand that they’re using the same excuse as China:  hey, we need it to develop.  I’m sure that will be a great consolation as they deal with the flooding of Bangladesh and increases in heat and storm violence that render the “agricultural miracle” of the 1960s null and void.

And what’s up for this year?  Why, it looks just like 2013 so far!