The wealthiest 1 percent effect
- October 17th, 2011
In light of what is going on with Occupy Wall Street a renewed focus on the wealthiest (1%) of society is happening. For decades now the wealthiest Americans have garnered an increasing portion of the economic. It logically follows that the behavior of this slice of society should also have a disproportionate effect on the economy as well.
The wealth effect simply states that when we are (or feel) wealthier we spend more. A look back just a few years at the housing bubble shows the wealth effect in full force. House-rich Americans felt comfortable borrowing and spending during the run up in home prices.
In a new research paper Roger Farmer argues “that the stock market crash of 2008, triggered by a collapse in house prices, caused the Great Recession.” In the paper he demonstrates the high correlation between the value of the stock market and the unemployment rate. Further he argues that aggregate demand depends on wealth, not income. So attempts to boost income, absent a commensurate increase in wealth, are not going to permanent boost employment.
The wealthiest 1% are a bit of an abstraction and Robert Frank in his new book The High-Beta Rich: How the Manic Wealthy Will Take Us to the Next Boom, Bubble, and Bust takes a look at the 1%. He writes about the growing importance of the habits of the wealthiest on the eocnomy. From the review in The Economist:
“The High-Beta Rich” is one that deserves to be read, and not just because it provides the rest of us with a cathartic dose of Schadenfreude at the expense of the super-wealthy. Robert Frank makes a new, contrarian argument with important implications for economic policymaking: modern wealth is a far more volatile substance than is commonly believed…
His more novel advice is that policymakers take account of the extreme volatility of modern wealth. Vast fortunes have come and gone throughout the ages, but they have usually taken a while to squander. That is why most societies have some version of the proverb, “from shirtsleeves to shirtsleeves in three generations”. Today it is more like half a generation. Mr Frank calls this volatility “high beta”, borrowing from financial investor lingo for a stock that tends to outperform the market when the market rises, and falls further when it drops. His use of the language of finance is no accident: it is the growing financialisation of wealth, more of which than ever is invested in volatile financial markets, that has made it easier for fortunes to grow and shrink so fast.
Relying more on taxes from the wealthiest 1% is a tricky endeavor. High volatility in income translates into a higher volatility of tax revenue. The state of California is a prime example in how a reliance on a volatile stream of revenue is problematic. Whether you agree with OWS or not the issues surrounding wealth and the 1% are here to stay.
Items mentioned above:
What Occupy Wall Street SHOULD be asking for. (Big Picture)
What do the 1% do for a living? (Rortybomb)
The wealth effect. (Wikipedia)
“The Stock Market Crash of 2008 Caused the Great Recession: Theory and Evidence” by Roger Farmer. (NBER)
Farmer’s mainstream book: How the Economy Works: Confidence, Crashes and Self-Fulfilling Prophecies.*
Rags to riches to rags to riches. (Economist)
Robert Frank’s new book: The High-Beta Rich: How the Manic Wealthy Will Take Us to the Next Boom, Bubble, and Bust.*
State of California tax statistics. (California State Controller)
*Amazon affiliate. You know the drill.
Abnormal Returns is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com. If you click on my Amazon.com links and buy anything, even something other than the product advertised, I earn a small commission, yet you don't pay any extra. Thank you for your support.
The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.
Abnormal Returns has over its seven-year life become a fixture in the financial blogosphere. Over thousands of posts we have striven to bring the best of the financial blogosphere to readers. In that time the idea of a “forecast-free investment blog” remains as useful as it did six years ago. More »
- Thursday links: fair returns
- Wednesday links: a deliberate bet
- Tuesday links: bullish on hedge funds
- Monday links: knowing your time horizon
- In search of growth in a shrinking pool
- Sunday links: lucky or smart
- Top clicks this week on Abnormal Returns
- Saturday links: systems vs. goals
- Friday links: avoiding complexity
- A transitional moment for advisors