The rich have gotten richer but they do not invest their money in productive activities but in leisure and luxury goods; and this in turn increases inequality. PHOTO: Bloomberg by David Paul Morris.

Robert Armstrong

Is it the excess of rich people and not middle-aged people that depresses interest rates?

My expectation that nothing interesting would happen at the Federal Reserve conference in Jackson Hole turned out to be incorrect. Fed Chairman Jay Powell’s speech was boring, sure, but three academics redeemed the proceedings by presenting a document that all investors should read.

They argue that the main force driving interest rates down is not demographic change, but income inequality. This is important to investors, because the demographic trend that has (in theory) put pressure on rates is set to reverse, while the trend toward higher income inequality appears to be endemic.

Atif Mian, Ludwig Straub and Amir Sufi agree with the supporters of the demographic perspective such as the economists Charles Goodhart and Manoj Pradhan (G&P – whom I have spoken about in other articles) and that they posit that a key element for the fall in rates is a major savings. Savings seek returns, so with greater savings and the same number of places to invest them, interest rates should fall.

However, Mian, Straub and Sufi (MS&S) disagree on why the savings increased. It’s not because the great baby boomer generation is getting older and saving more (a trend that will change direction soon, when everyone is retired). Rather, it is because an increasing share of the national income goes to the top decile of wage earners. Because a person can only consume a certain amount, the wealthy few tend to save much of their income rather than spend it. This drives rates down directly, when those savings are invested, driving up asset prices and lowering returns; and indirectly, undermining aggregate demand.

Why doesn’t all the cash that the rich put into markets ultimately become productive investment, either at home or abroad? A complex question. For present purposes, suffice it to note that this is not happening: the savings of wealthy Americans are reappearing instead as debt to the government or to low-income American households. (In another article, MS&S has pointed out that this means that the high share of income going to the rich hurts aggregate demand in two ways: the rich have a lower marginal propensity to consume, and governments and the poorest are forced to use their dollars in debt service instead of consumption. Economically speaking, the high inequality is a real downturn).

MS&S prefer the inequality explanation for two reasons. Using data from the Fed’s Survey of Consumer Finance (SCF) (dating back to 1950), they show that differences in saving rates are much larger within a given age cohort than between age cohorts. That is, savings are accumulating faster because the rich are getting richer, not because the baby boomers are getting old. In fact they present graphs of savings as a proportion of income. In one of them, the 10 percent of households with the highest income save much more than the rest as a whole, and the other shows that this saving is much greater (proportionally) than that of all the people aged 45 to 54 years, the cohort of age who has the most savings.

Another way to visualize the same point is to use a color map that matches savings rates (shown in color) with the income decile on the one hand and the age cohort on the other. As you go from left to right in that table, moving between age cohorts, there is not a great deal of color change. The hues denoting high savings rates are all crammed to the top, among the wealthiest people in each cohort.

This effect is dramatic and it is a really big change. In the last 20 years, the top decile has increased its share of national saving by an additional third, compared to the period before 1980:

We estimate that the top 10 percent saved between 3 and 3.5 percentage points more of national income between 1995 and 2019 compared to the period before the 1980s. This represents between 30 and 40 percent of total private savings in the US economy from 1995 to 2019.

The second reason they think that rising inequality is a better explanation for rising savings is that inequality has risen steadily during the period of falling rates; that is, since about 1980. The share of national income that has flowed into middle-aged people and many savings, by contrast, has risen and fallen as baby boomers have aged and begun to retire. In other words, inequality is much more closely correlated with rates than with demographics. In fact, MS&S argue that the SCF data shows that there is no correlation between overall savings rates and the proportion of income that flows to middle-aged people.

What would Goodhart and Pradhan say in response? I do not pretend to answer for them, but two things stand out to me. One is that MS&S focuses only on US data, and G&P is emphatic that because capital and productive capacity migrate across borders, you have to look at the global picture. Japan, for example, has not experienced a drop in rates or an increase in inflation as its population has aged. It was able to keep prices low by moving production capacity to China. Second, G&P thinks savings are only part of the story; the job offer is also important.

I will let economists better than me resolve the disagreement between supporters of demographics and inequality, but I will say that I find MS & S’s vision compelling. Determining who is more right will undoubtedly be important to investors, because the two views differ on the most likely path of rates going forward.

One last point. I think that if MS&S are right, the political implications are particularly unpleasant. Inequality, in his view, is self-perpetuating, and the feedback loop runs through low rates. The excess saving of the rich depresses rates; low rates drive up asset prices and the rich get even richer. Many governments are adopting monetary policies that, in all likelihood, make this mill turn faster. How long are the people who sit outside of this wealth-generating machine and who are the majority of the voters going to tolerate this? This strikes me even more unpleasant than the intergenerational conflict that one would expect if G&P are right, and in which the old would fight to keep the social safety net healthy while those who work would fight tax increases.

Those of us who have some assets as a result of how well we have done in the last few decades should think about this a bit.

Copyright – The Financial Times Limited 2021

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