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The Prince
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This article is about the book by Niccolò Machiavelli . For other uses, see Prince (disambiguation).
The Prince
Machiavelli Principe Cover Page.jpg
The Prince Title Page
Author Niccolò Machiavelli
Original title De Principatibus / Il Principe
Country Florence
Language Italian
Subject(s) Political Science
Genre(s) Non-fiction
Publisher Antonio Blado d'Asola.
Publication date 1532
Preceded by Discorsi sopra la prima deca di Tito Livio
Followed by Andria
The Prince (Italian: Il Principe) is a political treatise by the Italian public servant and political theorist Niccolò Machiavelli. Originally called De Principatibus (About Principalities), it was originally written in 1513, but not published until 1532, five years after Machiavelli's death. The Prince was one of the first works of modern philosophy, in which pragmatic ends, as opposed to teleological concepts, are the purpose. The treatise is the most remembered of his works and the one responsible for bringing 'Machiavellian' into wide usage as a pejorative term.
Contents
[hide]
* 1 Analysis
* 2 Summary
o 2.1 Introduction
o 2.2 Defense and military
o 2.3 Self-reliance
o 2.4 Reform and revolution
o 2.5 Reputation of a prince
o 2.6 Generosity vs. parsimony
o 2.7 Cruelty vs. mercy
o 2.8 In what way princes should keep their word
o 2.9 Avoiding contempt and hatred
o 2.10 Gaining honors
o 2.11 Nobles and staff
o 2.12 Avoiding flatterers
o 2.13 Fortune
* 3 Influence on politics
* 4 Interpretation of The Prince as political satire
* 5 Further reading
* 6 See also
o 6.1 Other works by Machiavelli
* 7 Notes
* 8 External links
[edit] Analysis
The views expounded by Machiavelli in The Prince may seem extreme even for the time period in which they were written. However, his whole life was spent in Florence at a time of continuous political conflict. Accordingly, Machiavelli emphasizes the need for stability in a prince’s principality; at stake is its preservation.
The theories expressed in The Prince describe methods that an aspiring prince can use to acquire the throne, or an existing prince can use to maintain his reign. According to Machiavelli, the greatest moral good is a virtuous and stable state, and actions to protect the country are therefore justified even if they are cruel.[citation needed] Machiavelli strongly suggests, however, that the prince must not be hated. He states, '...a wise prince should establish himself on that which is his own control and not in that of others; he must endeavor to avoid hatred, as is noted.'[1]
The opening discourse of The Prince defines effective methods of governing in several types of principalities (for example, newly acquired vs. hereditary). Machiavelli explains to the reader, the 'Magnificent Lorenzo de' Medici',[2] member of the Florentine Medici family, the best ways to acquire, maintain, and protect a state. The methods described therein have the general theme of acquiring necessary ends by any means.[citation needed]
[edit] Summary
[edit] Introduction
The Prince examines the acquisition, perpetuation, and use of political power in the western world. Machiavelli wrote The Prince to prove his proficiency in the art of the state, offering advice on how a prince might gain and keep power.
Machiavelli justified rule by force rather than by law. Accordingly, The Prince seems to justify a number of actions done solely to perpetuate power. It is a classic study of power—its acquisition, expansion, and effective use.
[edit] Defense and military
Having discussed the various types of principalities, Machiavelli turns to the ways a state can attack other territories or defend itself. The two most essential foundations for any state, whether old or new, are sound laws and strong military forces. A self-sufficient prince is one who can meet any enemy on the battlefield. However, a prince that relies solely on fortifications or on the help of others and stands on the defensive is not self-sufficient. If he cannot raise a formidable army, but must rely on defense, he must fortify his city. A well-fortified city is unlikely to be attacked, and if it is, most armies cannot endure an extended siege. However, during a siege a virtuous prince will keep the morale of his subjects high while removing all dissenters. Thus, as long as the city is properly defended and has enough supplies, a wise prince can withstand any siege.
Machiavelli stands strongly against the use of mercenaries. He believes them useless to a ruler because they are undisciplined, cowardly, and without any loyalty, being motivated only by money. Machiavelli attributes the Italian city states’ weakness to their reliance on mercenary armies.
Machiavelli also warns against using auxiliary forces, troops borrowed from an ally, because if they win, the employer is under their favor and if they lose, he is ruined. Auxiliary forces are more dangerous than mercenary forces because they are united and controlled by capable leaders who may turn against the employer.
The main concern for a prince should be war, or the preparation thereof. Through war a hereditary prince maintains his power or a private citizen rises to power. Machiavelli advises that a prince must frequently hunt in order to keep his body fit and learn the landscape surrounding his kingdom. Through this, he can best learn how to protect his territory and advance upon others similar. For intellectual strength, he is advised to study great military men so he may imitate their successes and avoid their mistakes. A prince who is diligent in times of peace will be ready in times of adversity. Machiavelli writes, “thus, when fortune turns against him he will be prepared to resist it.”
[edit] Self-reliance
When a prince comes to power through luck or the blessings of powerful figures within the regime, he has an easy time gaining power but a hard time keeping it thereafter, because his power is dependent on his benefactors' goodwill - a fickle thing at best. He does not command the loyalty of the armies and officials that maintain his authority, and these can be withdrawn from him at a whim. Having risen the easy way, it is not even certain such a prince has the skill and strength to stand on his own feet.
Conversely, a prince who rises by overthrowing the existing order has a hard time rising but rules with ease afterwards. He clears away his enemies, forges alliances on his own terms and earns more respect.
[edit] Reform and revolution
Reforming an existing order is one of the most dangerous and difficult things a prince can do. Part of the reason this is so is that people are naturally resistant to change and reform. Those who benefited under the old regime will resist him fervently, whilst those who stand to benefit from his new order will help him only half-heartedly. This is mainly because the reformers lack legitimacy, and because it is hard for people to believe in a proposed system that they haven't experienced for themselves. Moreover, it is impossible for the prince to live up to everybody's rosy expectations; inevitably, he will disappoint some of his followers. To counter this, a prince must have the means to force his supporters to keep supporting him even when they start having second thoughts. Only armed prophets succeed in bringing lasting change.
[edit] Reputation of a prince
Concerning the behavior of a prince toward his subjects, Machiavelli writes: 'Men have imagined republics and principalities that never really existed at all. Yet the way men live is so far removed from the way they ought to live that anyone who abandons what is for what should be pursues his downfall rather than his preservation; for a man who strives after goodness in all his acts is sure to come to ruin, since there are so many men who are not good.' Since there are many possible qualities that a prince can be said to possess, he must not be overly concerned about having all the good ones. Also, a prince may be perceived to be merciful, faithful, humane, frank, and religious, but he must only seem to have these qualities. A prince cannot truly have these qualities because at times it is necessary to act against them. Although a bad reputation should be avoided, this is not crucial in maintaining power. The only ethic that matters is one that is beneficial to the prince in dealing with the concerns of his state.
[edit] Generosity vs. parsimony
If a prince is overly generous to his subjects, Machiavelli asserts he will lose appreciation and will only cause greed for more. Additionally, being overly generous is not economical, because eventually all resources will be exhausted. This results in higher taxes and will bring grief upon the prince. Then, if he decides to discontinue or limit his generosity, he will be labeled as a miser. Thus, Machiavelli summarizes that guarding against the people’s hatred is more important than building up a reputation for generosity. A wise prince should be willing to be more reputed a miser than be hated for trying to be too generous.
[edit] Cruelty vs. mercy
In addressing the question of whether it is better to be loved than feared, Machiavelli writes, “The answer is that one would like to be both the one and the other; but because it is difficult to combine them, it is far safer to be feared than loved if you cannot be both.” As Machiavelli asserts, commitments made in peace are not always kept in adversity; however, commitments made in fear are kept out of fear. Yet, a prince must ensure that he is not feared to the point of hatred, which is very possible. Above all, Machiavelli argues, do not interfere with the property of the subjects, their women, or the life of somebody without proper justification. Regarding the troops of the prince, fear is absolutely necessary to keep a large garrison united and a prince should not mind the thought of cruelty in that regard. For a prince who leads his own army, it is imperative for him to observe cruelty because that is the only way he can command his soldiers' absolute respect. Machiavelli compares two great military leaders: Hannibal and Scipio Africanus. Although Hannibal's army consisted of men of various races, they were never rebellious because they feared their leader. Scipio's men, on the other hand, were known for their mutiny and dissension.
[edit] In what way princes should keep their word
Machiavelli notes that a prince is praised for keeping his word. However, he also notes that a prince is also praised for the illusion of being reliable in keeping his word. A prince, therefore, should only keep his word when it suits his purposes, but do his utmost to maintain the illusion that he does keep his word and that he is reliable in that regard. Therefore, a prince should not break his word unnecessarily.
[edit] Avoiding contempt and hatred
Machiavelli observes that most men are content as long as they are not deprived of their property and women. A prince should command respect through his conduct, because a prince that is highly respected by his people is unlikely to face internal struggles. Additionally, a prince who does not raise the contempt of the nobles and keeps the people satisfied, Machiavelli assures, should have no fear of conspirators.
[edit] Gaining honors
A prince truly earns honor by completing great feats. King Ferdinand of Spain is cited by Machiavelli as an example of a monarch who gained esteem by showing his ability through great feats and who, in the name of religion, conquered many territories and kept his subjects occupied so that they had no chance to rebel. Regarding two warring states, Machiavelli asserts it is always wiser to choose a side, rather than to be neutral. Machiavelli then provides the following reasons why:
* If your allies win, you benefit whether or not you have more power than they have.
* If you are more powerful, then your allies are under your command; if your allies are stronger, they will always feel a certain obligation to you for your help.
* If your side loses, you still have an ally in the loser.
Machiavelli also notes that it is wise for a prince not to ally with a stronger force unless compelled to do so. In conclusion, the most important virtue is having the wisdom to discern what ventures will come with the most reward and then pursuing it courageously.
[edit] Nobles and staff
The selection of quality servants is reflected directly upon the prince’s intelligence, so if they are loyal, the prince is considered wise; however, when they are otherwise, the prince is open to adverse criticism. Machiavelli asserts that there are three types of intelligence:
* The kind that understands things for itself—which is great to have.
* The kind that understands what others can understand—which is good to have.
* The kind that does not understand for itself, nor through others—which is useless to have.
If the prince does not have the first type of intelligence, he should at the very least have the second type. For, as Machiavelli states, “A prince must have the discernment to recognize the good or bad in what another says or does even though he has no acumen himself'.
[edit] Avoiding flatterers
A prudent prince should have a select group of wise counselors to advise him truthfully on matters all the time. All their opinions should be taken into account. Ultimately, the decision should be made by the counselors and carried out absolutely. If a prince is given to changing his mind, his reputation will suffer. A prince must have the wisdom to recognize good advice from bad. Machiavelli gives a negative example in Emperor Maximilian I; Maximilian, who was secretive, never consulted others, but once he ordered his plans and met dissent, he immediately changed them.
[edit] Fortune
Machiavelli argues that fortune is only the judge of half of our actions and that we have control over the other half. He expresses a high opinion of Cesare Borgia, but says he lost power because of unexpected illness. Machiavelli compares fortune to a torrential river that cannot be easily controlled during flooding season. In periods of calm, however, people can erect dams and levees in order to minimize its impact. Fortune, Machiavelli argues, seems to strike at the places where no resistance is offered, as is the case in Italy. Additionally, a prince’s rule must be suited and adjusted for the times.
In a more controversial metaphor, Machiavelli writes that 'it is better to be impetuous than cautious, because fortune is a woman; and it is necessary, if one wants to hold her down, to beat her and strike her down.'[3] Some translations use the word 'rape,' although it is disputed. However, the attitude encapsulates Machiavelli's view of power and his understanding of the lust which follows it. A prince should imitate the actions of great men before him but only to a certain extent, adjusting certain aspects of his predecessors' ideas.
Machiavelli also holds that the greatest princes in history tend to be ones who rise to power through their own effort and cunning rather than depending on luck. The only thing they owe to luck is the initial opportunity that allowed them to begin their rise.
[edit] Influence on politics
This section is missing citations or needs footnotes. Please help add inline citations to guard against copyright violations and factual inaccuracies. (November 2007)
Machiavelli's ideals on ruling a country have had a profound impact on political leaders throughout the modern west. Machiavelli is featured as a character in the prologue of Christopher Marlowe's The Jew of Malta.
Frederick the Great of Prussia criticised Machiavelli's conclusions in his 'Anti-Machiavel', published in 1740.
At different stages in his life, Napoleon I of France wrote extensive comments to The Prince. After his defeat in Waterloo, these comments were found in the emperor's coach and taken by Prussian military.[4]
Italian dictator Benito Mussolini wrote a discourse on The Prince.
Soviet dictator Joseph Stalin was said to be deeply influenced by The Prince, and kept a copy of it on his nightstand.[citation needed]
[edit] Interpretation of The Prince as political satire
There is 'a widely held ... view of The Prince, namely, that the book is, first and foremost, a satire, so that many of the things we find in it which are morally absurd, specious, and contradictory, are there quite deliberately in order to ridicule ... the very notion of tyrannical rule ... (hence, the satire has a firm moral purpose -- to expose tyranny and promote republican government).'[5] According to Hans Baron (1961, p. 299)[6], Machiavelli's motive in writing The Prince was 'to entice Lorenzo de Medici to commit the suggested crimes so as to reap the Florentines' harsh judgement sooner.' 'Mary Deitz (1986)[7] writes that Machiavelli's agenda was ... offering carefully crafted advice (such as arming the people) designed to undo the ruler if taken seriously and followed.'
In The Social Contract, the French philosopher Jean-Jacques Rousseau said: 'Machiavelli was a proper man and a good citizen; but, being attached to the court of the Medici, he could not help veiling his love of liberty in the midst of his country's oppression. The choice of his detestable hero, Caesar Borgia, clearly enough shows his hidden aim; and the contradiction between the teaching of the Prince and that of the Discourses on Livy and the History of Florence shows that this profound political thinker has so far been studied only by superficial or corrupt readers. The Court of Rome sternly prohibited his book. I can well believe it; for it is that Court it most clearly portrays.'[8]
Diderot also thought it was a satire. In fact it appears to have been the mainstream view (perhaps adopted from Spinoza) of the Enlightenment philosophes.
[edit] Further reading
* Machiavelli, Niccolò (2004). The Prince. London: Penguin. ISBN 978-0-140449-15-0.
[edit] See also
* Mirrors for princes, the genre
* Arthashastra, an ancient Indian text with many similarities.
[edit] Other works by Machiavelli
* Discourses on Livy
* The Art of War
[edit] Notes
1. ^ 'Machiavelli: The Prince: Chapter XVII'. Constitution.org. http://www.constitution.org/mac/prince17.htm. Retrieved 2009-04-08.
2. ^ http://books.google.com/books?id=VIAgG12gh_EC&printsec=frontcover&dq=The+Prince&sig=ACfU3U2fm8rvB3Q6zdp8R8SXCKPhsy9CXw#PPA19,M1
3. ^ Prince, ch. 25.
4. ^ Massa-Carrara, Marina (2006). El Principe/The Prince: Comentado Por Napoleon Bonaparte / Commentaries by Napoleon Buonaparte, Mestas Ediciones.
5. ^ 'Lecture on Machiavelli's The Prince'. See also 'Machiavelli's Prince : Political Science or Political Satire?'In :- PROBLEMS IN EUROPEAN CIVILIZATION. De Lamar Jensen (ed.) : Machiavelli : Cynic, Patriot, or Political Scientist? D. C. Heath & Co., 1960. Reprinted from AMERICAN SCHOLAR 27 (1958)
6. ^ 'Machiavelli : the Republican Citizen and Author of The Prince'. THE ENGLISH HISTORICAL REVIEW 76:218sq
7. ^ 'Trapping the Prince'. In :- AMERICAN POLITICAL SCIENCE REVIEW 80:777-799
8. ^ Social Contract, Book 3, n. 23
* Opening paragraph adapted from Outline of Great Books, Vol. I, published 1937.
[edit] External links
Search Wikisource Wikisource has original text related to this article:
The Prince
Search Wikiquote Wikiquote has a collection of quotations related to: The Prince
* Il Principe at MetaLibri Digital Library.
* Adelaide's full text of The Prince (includes footnotes)
* The Prince at Project Gutenberg
* The Prince, online text and audio
* The Prince, full text in HTML, indexed by chapter. English translation by W.K. Marriot
* Concordances and Frequency List based on the Italian text.
* Shakespeare reference Reference to Machiavelli's influence on Shakespeare.
* Commentary on The Prince
* Machiavelli in 'The History Guide'
* Stanford Encyclopedia of Philosophy on Machiavelli
* The Prince suitable for ereaders
* Podcast of Nigel Warburton on Machiavelli's The Prince
* A Monologue by Prof. Robert Harrison on The Prince
* Interview with Quentin Skinner on The Prince
[hide]
v • d • e
Works by Niccolò Machiavelli
Discourse on Pisa • On the method of dealing with the Rebellious Peoples of Valdichiana • A Description of the Method Used by Duke Valentino in Killing Vitellozzo Vitelli, Oliverotto da Fermo, and Others • A discourse about the provision of money • Decennale primo • Ritratti delle cose dell’Alemagna • Decennale secondo • Ritratti delle cose di Francia • Andria • The Mandrake • Della lingua • Clizia • Belfagor arcidiavolo • The Golden Ass • The Art of War • Discorso sopra il riformare lo stato di Firenze • Sommario delle cose della città di Lucca • The Life of Castruccio Castracani of Lucca • Florentine Histories • Frammenti storici • The Art of War • The Prince • Discourses on Livy
Retrieved from 'http://en.wikipedia.org/wiki/The_Prince'
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Monday, May 31, 2010
Project Abundance: Energy: How much do we need and how much can we make? | Resource Based Living
Project Abundance: Energy: How much do we need and how much can we make? | Resource Based Living: "Project Abundance: Energy: How much do we need and how much can we make?
May 28th, 2010 by Stuart Leave a reply »
In 2008, total worldwide energy consumption was 474 exajoules (474×10^18 J) with 80 to 90 percent derived from the combustion of fossil fuels. This is equivalent to an average power consumption rate of 15 terawatts (1.504×10^13 W).
Exajoule? Terawatt? WTF? Ok hang on.
Here is a reference table. I think we’re going to need it for this article.
Multiplication factor
Prefix
Symbol
1,000,000,000,000,000,000,000,000 = 1024 yotta Y
1,000,000,000,000,000,000,000 = 1021 zetta Z
1,000,000,000,000,000,000 = 1018 exa E
1,000,000,000,000,000 = 1015 peta P
1,000,000,000,000 = 1012 tera T
1,000,000,000 = 109 giga G
1,000,000 = 106 mega M
1,000 = 103 kilo k
100 = 102 hecto h
10 = 10 deka da
0.1 = 10-1 deci d
0.01 = 10-2 centi c
0.001 = 10-3 milli m
0.000 001 = 10-6 micro m
0.000,000,001 = 10-9 nano n
0.000,000,000,001 = 10-12 pico p
0.000,000,000,000,001 = 10-15 femto f
0.000,000,000,000,000,001 = 10-18 atto a
0.000,000,000,000,000,000,001 = 10-21 zepto z
0.000,000,000,000,000,000,000,001 = 10-24 yocto y
http://www.educypedia.be/electronics/metrixprefix.htm
“Industrial users (agriculture, mining, manufacturing, and construction) consume about 37% of the total 15 TW. Personal and commercial transportation consumes 20%; residential heating, lighting, and appliances use 11%; and commercial uses (lighting, heating and cooling of commercial buildings, and provision of water and sewer services) amount to 5% of the total.
The other 27% of the world’s energy is lost in energy transmission and generation.”
The average residential usage of each American is 11.4kW,
So now let’s see whether or not we can generate this vast amount of energy.
Solar
The available solar energy resources are 3.8 YJ/yr (120,000 TW).
To put it another way, we use less than half a zetajoule a year, while the sun provides 3800 ZJ a year.
Oh. Well there we have it. 8000 times the energy we need right now, just from the sun.
Thanks for reading, and good night.
Ok let’s not get carried away. Obviously there is the difficulty of harnessing this energy, but this just shows the sheer volume of abundant energy that we can utilise.
Wind
Currently has the capacity for a poultry 159.2GW. Still, that’s enough for 131 DeLoreans to travel through time.
Wave and Tidal
The power of waves is about 3TW, and the available tidal energy is 0.8TW. Note that this is close to the 5.5TW (37% of 15TW) currently needed for ALL industrial, agricultural, mining, and construction needs.
There is some talk on Wikipedia about “Celestial dynamics” – ie screwing up our orbit if we harness too much of it, so it’s probably best we don’t delve too deep into this… Luckily, we don’t need to.
Geothermal
In 2004, 200PJ (57 TWh) of electricity was generated from geothermal resources, and an additional 270 PJ of geothermal energy was used directly, mostly for space heating.
According to Wikipedia, in 2007, the world had a global capacity for 10 GW of electricity generation and an additional 28 GW of direct heating. (about 0.3% of our needs).
However, the much cited MIT report (mentioned in Zeitgeist Addendum) estimated that 13.3YJ (13,300ZJ) of energy is stored in rocks in the USA. (source – 14.06mb – see page 18). Yes, that’s enough for 26,000 years, although it is constantly renewing itself.
Localisation
All these energy sources are based on the idea of a centralised collection supplying the population. In reality, what we may see is far more localised harnessing to supply smaller systems. Take home solar panels and other off-grid technologies.
In 2005, the average monthly residential electricity consumption in American was 938 kilowatt hours (kWh), according to the Energy Information Administration. That’s 30.84kWh/day per household.
“At high noon on a cloudless day at the equator, the power of the sun is about 1 kW/m². Accounting for clouds, and the fact that most of the world is not on the equator, and that the sun sets in the evening, the correct measure of solar power is insolation – the average number of kilowatt-hours per square meter per day. For the weather and latitudes of the United States and Europe, typical insolation ranges from 4kWh/m²/day in northern climes to 6.5 kWh/m²/day in the sunniest regions.”
So in theory, if you have 8m² of 100% efficient solar panels, that should be enough to completely supply the average home. There are lots of factors involved, of course, the sun wouldn’t be direct for most of the time, there could be clouds, there could be inefficiencies in the system etc, but that’s a rough guide.
Combine this with wind turbines on each house, or a small hydro-electric generator in the stream near your house, or several other localised solutions, and it seems that most residential needs can be met relatively easily. If anyone has more practical experience in this area I would like to hear your thoughts.
With batteries, you can store the energy you don’t use immediately and make the energy you collect last much longer, without having to sell it back to the grid.
Search “Off grid” on YouTube for thousands of examples of completely self sufficient systems.
Efficiency
Of course, residential needs only count for 11% of the energy we consume.
Although the sun and our geothermal potential gives us thousands of times the energy we need, so any more discussion is pointless, an important thing to mention when discussing energy needs is the efficiency of our current systems. Currently there is so much inefficiency in transport, distribution, and industry that we’re probably using a lot more than we really need to.
Take LEDs as a simple example, which for most purposes are 10x more efficient than incandescent lights.
Now imagine that instead of driving hundreds of trucks across the continent, we install a conveyor belt (or more likely, a network of continual belts). The only energy needed would be that needed to drive the wheel at one end of each belt, in order to move the belt. Even if there were problems along the way, a remote controlled (or eventually automated) robotic probe could be sent to perform maintenance at very little energy cost.
All we need to do is think a little more logically about how we do things, and how we are wasting so much energy, and there can be huge savings made. Technology will increase efficiency, but so will basic human ingenuity, if applied.
Do we have the resources?
It seems that we do. Geothermal and solar appear to have the potential to supply us many times over.
Solar is the fastest growing technology and seems to be the one that will take over from fossil fuels. Its major drawback is the cost of solar cells, also there is the problem of utilising it in high northern and southern latitude countries where there is less sunlight in the winter. However, these countries often have the space or surrounding sea to utilise wind, wave, and tidal power.
The problem is not lack of energy, or even the technology to harness it, it’s the willingness. It’s the heel dragging in setting up the projects, the incredible persistence of the governments in pushing non-renewable sources, and the lack of awareness in the general public.
The cost of solar panels is undoubtedly a major factor. However, the technology is already at a level where large farms are completely feasible. It’s also highly innovative. Take Sphelar, the spherical transparent cells that can be used in windows and don’t require tilting mechanisms.
The problem for those in “power” is that once these solar farms are built, they will supply energy that is essentially free. Maintenance costs will be minimal and can eventually be performed by automation, powered by the panels themselves.
What this means is that nobody can make any money out of it any more. This, my friends, is the problem.
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May 28th, 2010 by Stuart Leave a reply »
In 2008, total worldwide energy consumption was 474 exajoules (474×10^18 J) with 80 to 90 percent derived from the combustion of fossil fuels. This is equivalent to an average power consumption rate of 15 terawatts (1.504×10^13 W).
Exajoule? Terawatt? WTF? Ok hang on.
Here is a reference table. I think we’re going to need it for this article.
Multiplication factor
Prefix
Symbol
1,000,000,000,000,000,000,000,000 = 1024 yotta Y
1,000,000,000,000,000,000,000 = 1021 zetta Z
1,000,000,000,000,000,000 = 1018 exa E
1,000,000,000,000,000 = 1015 peta P
1,000,000,000,000 = 1012 tera T
1,000,000,000 = 109 giga G
1,000,000 = 106 mega M
1,000 = 103 kilo k
100 = 102 hecto h
10 = 10 deka da
0.1 = 10-1 deci d
0.01 = 10-2 centi c
0.001 = 10-3 milli m
0.000 001 = 10-6 micro m
0.000,000,001 = 10-9 nano n
0.000,000,000,001 = 10-12 pico p
0.000,000,000,000,001 = 10-15 femto f
0.000,000,000,000,000,001 = 10-18 atto a
0.000,000,000,000,000,000,001 = 10-21 zepto z
0.000,000,000,000,000,000,000,001 = 10-24 yocto y
http://www.educypedia.be/electronics/metrixprefix.htm
“Industrial users (agriculture, mining, manufacturing, and construction) consume about 37% of the total 15 TW. Personal and commercial transportation consumes 20%; residential heating, lighting, and appliances use 11%; and commercial uses (lighting, heating and cooling of commercial buildings, and provision of water and sewer services) amount to 5% of the total.
The other 27% of the world’s energy is lost in energy transmission and generation.”
The average residential usage of each American is 11.4kW,
So now let’s see whether or not we can generate this vast amount of energy.
Solar
The available solar energy resources are 3.8 YJ/yr (120,000 TW).
To put it another way, we use less than half a zetajoule a year, while the sun provides 3800 ZJ a year.
Oh. Well there we have it. 8000 times the energy we need right now, just from the sun.
Thanks for reading, and good night.
Ok let’s not get carried away. Obviously there is the difficulty of harnessing this energy, but this just shows the sheer volume of abundant energy that we can utilise.
Wind
Currently has the capacity for a poultry 159.2GW. Still, that’s enough for 131 DeLoreans to travel through time.
Wave and Tidal
The power of waves is about 3TW, and the available tidal energy is 0.8TW. Note that this is close to the 5.5TW (37% of 15TW) currently needed for ALL industrial, agricultural, mining, and construction needs.
There is some talk on Wikipedia about “Celestial dynamics” – ie screwing up our orbit if we harness too much of it, so it’s probably best we don’t delve too deep into this… Luckily, we don’t need to.
Geothermal
In 2004, 200PJ (57 TWh) of electricity was generated from geothermal resources, and an additional 270 PJ of geothermal energy was used directly, mostly for space heating.
According to Wikipedia, in 2007, the world had a global capacity for 10 GW of electricity generation and an additional 28 GW of direct heating. (about 0.3% of our needs).
However, the much cited MIT report (mentioned in Zeitgeist Addendum) estimated that 13.3YJ (13,300ZJ) of energy is stored in rocks in the USA. (source – 14.06mb – see page 18). Yes, that’s enough for 26,000 years, although it is constantly renewing itself.
Localisation
All these energy sources are based on the idea of a centralised collection supplying the population. In reality, what we may see is far more localised harnessing to supply smaller systems. Take home solar panels and other off-grid technologies.
In 2005, the average monthly residential electricity consumption in American was 938 kilowatt hours (kWh), according to the Energy Information Administration. That’s 30.84kWh/day per household.
“At high noon on a cloudless day at the equator, the power of the sun is about 1 kW/m². Accounting for clouds, and the fact that most of the world is not on the equator, and that the sun sets in the evening, the correct measure of solar power is insolation – the average number of kilowatt-hours per square meter per day. For the weather and latitudes of the United States and Europe, typical insolation ranges from 4kWh/m²/day in northern climes to 6.5 kWh/m²/day in the sunniest regions.”
So in theory, if you have 8m² of 100% efficient solar panels, that should be enough to completely supply the average home. There are lots of factors involved, of course, the sun wouldn’t be direct for most of the time, there could be clouds, there could be inefficiencies in the system etc, but that’s a rough guide.
Combine this with wind turbines on each house, or a small hydro-electric generator in the stream near your house, or several other localised solutions, and it seems that most residential needs can be met relatively easily. If anyone has more practical experience in this area I would like to hear your thoughts.
With batteries, you can store the energy you don’t use immediately and make the energy you collect last much longer, without having to sell it back to the grid.
Search “Off grid” on YouTube for thousands of examples of completely self sufficient systems.
Efficiency
Of course, residential needs only count for 11% of the energy we consume.
Although the sun and our geothermal potential gives us thousands of times the energy we need, so any more discussion is pointless, an important thing to mention when discussing energy needs is the efficiency of our current systems. Currently there is so much inefficiency in transport, distribution, and industry that we’re probably using a lot more than we really need to.
Take LEDs as a simple example, which for most purposes are 10x more efficient than incandescent lights.
Now imagine that instead of driving hundreds of trucks across the continent, we install a conveyor belt (or more likely, a network of continual belts). The only energy needed would be that needed to drive the wheel at one end of each belt, in order to move the belt. Even if there were problems along the way, a remote controlled (or eventually automated) robotic probe could be sent to perform maintenance at very little energy cost.
All we need to do is think a little more logically about how we do things, and how we are wasting so much energy, and there can be huge savings made. Technology will increase efficiency, but so will basic human ingenuity, if applied.
Do we have the resources?
It seems that we do. Geothermal and solar appear to have the potential to supply us many times over.
Solar is the fastest growing technology and seems to be the one that will take over from fossil fuels. Its major drawback is the cost of solar cells, also there is the problem of utilising it in high northern and southern latitude countries where there is less sunlight in the winter. However, these countries often have the space or surrounding sea to utilise wind, wave, and tidal power.
The problem is not lack of energy, or even the technology to harness it, it’s the willingness. It’s the heel dragging in setting up the projects, the incredible persistence of the governments in pushing non-renewable sources, and the lack of awareness in the general public.
The cost of solar panels is undoubtedly a major factor. However, the technology is already at a level where large farms are completely feasible. It’s also highly innovative. Take Sphelar, the spherical transparent cells that can be used in windows and don’t require tilting mechanisms.
The problem for those in “power” is that once these solar farms are built, they will supply energy that is essentially free. Maintenance costs will be minimal and can eventually be performed by automation, powered by the panels themselves.
What this means is that nobody can make any money out of it any more. This, my friends, is the problem.
- Sent using Google Toolbar"
Healing by 2-Way Video - The Rise of Telemedicine - NYTimes.com
Healing by 2-Way Video - The Rise of Telemedicine - NYTimes.com: "The Doctor Will See You Now. Please Log On.
Michael Stravato for The New York Times
Dr. Jerry Jones uses two-way video at his home in Houston to consult with a patient across town. Dr. Jones is under contract to NuPhysicia, one of the new telemedicine companies.
By MILT FREUDENHEIM
Published: May 28, 2010
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ONE day last summer, Charlie Martin felt a sharp pain in his lower back. But he couldn’t jump into his car and rush to the doctor’s office or the emergency room: Mr. Martin, a crane operator, was working on an oil rig in the South China Sea off Malaysia.
Related
Video NuPhysicia Videos of Doctor-Patient Visits (inplacemedical.com)
Enlarge This Image
Michael Stravato for The New York Times
From thousands of miles away, Dr. Oscar Boultinghouse checks the eye of a patient.
He could, though, get in touch with a doctor thousands of miles away, via two-way video. Using an electronic stethoscope that a paramedic on the rig held in place, Dr. Oscar W. Boultinghouse, an emergency medicine physician in Houston, listened to Mr. Martin’s heart.
“The extreme pain strongly suggested a kidney stone,” Dr. Boultinghouse said later. A urinalysis on the rig confirmed the diagnosis, and Mr. Martin flew to his home in Mississippi for treatment.
Mr. Martin, 32, is now back at work on the same rig, the Courageous, leased by Shell Oil. He says he is grateful he could discuss his pain by video with the doctor. “It’s a lot better than trying to describe it on a phone,” Mr. Martin says.
Dr. Boultinghouse and two colleagues — Michael J. Davis and Glenn G. Hammack— run NuPhysicia, a start-up company they spun out from the University of Texas in 2007 that specializes in face-to-face telemedicine, connecting doctors and patients by two-way video.
Spurred by health care trends and technological advances, telemedicine is growing into a mainstream industry. A fifth of Americans live in places where primary care physicians are scarce, according to government statistics. That need is converging with advances that include lower costs for video-conferencing equipment, more high-speed communications links by satellite, and greater ability to work securely and dependably over the Internet.
“The technology has improved to the point where the experience of both the doctor and patient are close to the same as in-person visits, and in some cases better,” says Dr. Kaveh Safavi, head of global health care for Cisco Systems, which is supporting trials of its own high-definition video version of telemedicine in California, Colorado and New Mexico.
The interactive telemedicine business has been growing by almost 10 percent annually, to more than $500 million in revenue in North America this year, according to Datamonitor, the market research firm. It is part of the $3.9 billion telemedicine category that includes monitoring devices in homes and hundreds of health care applications for smartphones.
Christine Chang, a health care technology analyst at Datamonitor’s Ovum unit, says telemedicine will allow doctors to take better care of larger numbers of patients. “Some patients will be seen by teleconferencing, some will send questions by e-mail, others will be monitored” using digitized data on symptoms or indicators like glucose levels, she says.
Eventually, she predicts, “one patient a day might come into a doctor’s office, in person.”
Although telemedicine has been around for years, it is gaining traction as never before. Medicare, Medicaid and other government health programs have been reimbursing doctors and hospitals that provide care remotely to rural and underserved areas. Now a growing number of big insurance companies, like the UnitedHealth Group and several Blue Cross plans, are starting to market interactive video to large employers. The new federal health care law provides $1 billion a year to study telemedicine and other innovations.
With the expansion of reimbursement, Americans are on the brink of “a gold rush of new investment in telemedicine,” says Dr. Bernard A. Harris Jr., managing partner at Vesalius Ventures, a venture capital firm based in Houston. He has worked on telemedicine projects since he helped build medical systems for NASA during his days as an astronaut in the 1990s.
Face-to-face telemedicine technology can be as elaborate as a high-definition video system, like Cisco’s, that can cost up to hundreds of thousands of dollars. Or it can be as simple as the Webcams available on many laptops.
NuPhysicia uses equipment in the middle of that range — standard videoconferencing hookups made by Polycom, a video conferencing company based in Pleasanton, Calif. Analysts say the setup may cost $30,000 to $45,000 at the patient’s end — with a suitcase or cart containing scopes and other special equipment — plus a setup for the doctor that costs far less.
Telemedicine has its skeptics. State regulators at the Texas Medical Board have raised concerns that doctors might miss an opportunity to pick up subtle medical indicators when they cannot touch a patient. And while it does not oppose telemedicine, the American Academy of Family Physicians says patients should keep in contact with a primary physician who can keep tabs on their health needs, whether in the virtual or the real world.
“Telemedicine can improve access to care in remote sites and rural areas,” says Dr. Lori J. Heim, the academy’s president. “But not all visits will take place between a patient and their primary-care doctor.”
Dr. Boultinghouse dismisses such concerns. “In today’s world, the physical exam plays less and less of a role,” he says. “We live in the age of imaging.”
ON the rig Courageous, Mr. Martin is part of a crew of 100. Travis G. Fitts Jr., vice president for human resources, health, safety and environment at Scorpion Offshore, which owns the rig, says that examining a worker via two-way video can be far cheaper in a remote location than flying him to a hospital by helicopter at $10,000 a trip.
Some rigs have saved $500,000 or more a year, according to NuPhysicia, which has contracts with 19 oil rigs around the world, including one off Iraq. Dr. Boultinghouse says the Deepwater Horizon drilling disaster in the Gulf of Mexico may slow or block new drilling in United States waters, driving the rigs to more remote locations and adding to demand for telemedicine.
NuPhysicia also offers video medical services to land-based employers with 500 or more workers at a site. The camera connection is an alternative to an employer’s on-site clinics, typically staffed by a nurse or a physician assistant.
Mustang Cat, a Houston-based distributor that sells and services Caterpillar tractors and other earth-moving equipment, signed on with NuPhysicia last year. “We’ve seen the benefit, ” says Kurt Hanson, general counsel at Mustang, a family-owned company. Instead of taking a half-day or more off to consult a doctor, workers can get medical advice on the company’s premises.
NuPhysicia’s business grew out of work that its founders did for the state of Texas. Mr. Hammack, NuPhysicia’s president, is a former assistant vice president of the University of Texas Medical Branch at Galveston, where he led development of the state’s pioneering telemedicine program in state prisons from the mid-1990s to 2007. Dr. Davis is a cardiologist.
Working with Dr. Boultinghouse, Dr. Davis and other university doctors conducted more than 600,000 video visits with inmates. Significant improvement was seen in inmates’ health, including measures of blood pressure and cholesterol, according to a 2004 report on the system in the Journal of the American Medical Association.
In March, California officials released a report they had ordered from NuPhysicia with a plan for making over their state’s prison health care. The makeover would build on the Texas example by expanding existing telemedicine and electronic medical record systems and putting the University of California in charge.
California spends more than $40 a day per inmate for health care, including expenses for guards who accompany them on visits to outside doctors. NuPhysicia says that this cost is more than four times the rate in Texas and Georgia, and almost triple that of New Jersey, where telemedicine is used for mental health care and some medical specialties.
“Telemedicine makes total sense in prisons,” says Christopher Kosseff, a senior vice president and head of correctional health care at the University of Medicine and Dentistry of New Jersey. “It’s a wonderful way of providing ready access to specialty health care while maintaining public safety.”
- Sent using Google Toolbar"
Michael Stravato for The New York Times
Dr. Jerry Jones uses two-way video at his home in Houston to consult with a patient across town. Dr. Jones is under contract to NuPhysicia, one of the new telemedicine companies.
By MILT FREUDENHEIM
Published: May 28, 2010
* Sign in to Recommend
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ONE day last summer, Charlie Martin felt a sharp pain in his lower back. But he couldn’t jump into his car and rush to the doctor’s office or the emergency room: Mr. Martin, a crane operator, was working on an oil rig in the South China Sea off Malaysia.
Related
Video NuPhysicia Videos of Doctor-Patient Visits (inplacemedical.com)
Enlarge This Image
Michael Stravato for The New York Times
From thousands of miles away, Dr. Oscar Boultinghouse checks the eye of a patient.
He could, though, get in touch with a doctor thousands of miles away, via two-way video. Using an electronic stethoscope that a paramedic on the rig held in place, Dr. Oscar W. Boultinghouse, an emergency medicine physician in Houston, listened to Mr. Martin’s heart.
“The extreme pain strongly suggested a kidney stone,” Dr. Boultinghouse said later. A urinalysis on the rig confirmed the diagnosis, and Mr. Martin flew to his home in Mississippi for treatment.
Mr. Martin, 32, is now back at work on the same rig, the Courageous, leased by Shell Oil. He says he is grateful he could discuss his pain by video with the doctor. “It’s a lot better than trying to describe it on a phone,” Mr. Martin says.
Dr. Boultinghouse and two colleagues — Michael J. Davis and Glenn G. Hammack— run NuPhysicia, a start-up company they spun out from the University of Texas in 2007 that specializes in face-to-face telemedicine, connecting doctors and patients by two-way video.
Spurred by health care trends and technological advances, telemedicine is growing into a mainstream industry. A fifth of Americans live in places where primary care physicians are scarce, according to government statistics. That need is converging with advances that include lower costs for video-conferencing equipment, more high-speed communications links by satellite, and greater ability to work securely and dependably over the Internet.
“The technology has improved to the point where the experience of both the doctor and patient are close to the same as in-person visits, and in some cases better,” says Dr. Kaveh Safavi, head of global health care for Cisco Systems, which is supporting trials of its own high-definition video version of telemedicine in California, Colorado and New Mexico.
The interactive telemedicine business has been growing by almost 10 percent annually, to more than $500 million in revenue in North America this year, according to Datamonitor, the market research firm. It is part of the $3.9 billion telemedicine category that includes monitoring devices in homes and hundreds of health care applications for smartphones.
Christine Chang, a health care technology analyst at Datamonitor’s Ovum unit, says telemedicine will allow doctors to take better care of larger numbers of patients. “Some patients will be seen by teleconferencing, some will send questions by e-mail, others will be monitored” using digitized data on symptoms or indicators like glucose levels, she says.
Eventually, she predicts, “one patient a day might come into a doctor’s office, in person.”
Although telemedicine has been around for years, it is gaining traction as never before. Medicare, Medicaid and other government health programs have been reimbursing doctors and hospitals that provide care remotely to rural and underserved areas. Now a growing number of big insurance companies, like the UnitedHealth Group and several Blue Cross plans, are starting to market interactive video to large employers. The new federal health care law provides $1 billion a year to study telemedicine and other innovations.
With the expansion of reimbursement, Americans are on the brink of “a gold rush of new investment in telemedicine,” says Dr. Bernard A. Harris Jr., managing partner at Vesalius Ventures, a venture capital firm based in Houston. He has worked on telemedicine projects since he helped build medical systems for NASA during his days as an astronaut in the 1990s.
Face-to-face telemedicine technology can be as elaborate as a high-definition video system, like Cisco’s, that can cost up to hundreds of thousands of dollars. Or it can be as simple as the Webcams available on many laptops.
NuPhysicia uses equipment in the middle of that range — standard videoconferencing hookups made by Polycom, a video conferencing company based in Pleasanton, Calif. Analysts say the setup may cost $30,000 to $45,000 at the patient’s end — with a suitcase or cart containing scopes and other special equipment — plus a setup for the doctor that costs far less.
Telemedicine has its skeptics. State regulators at the Texas Medical Board have raised concerns that doctors might miss an opportunity to pick up subtle medical indicators when they cannot touch a patient. And while it does not oppose telemedicine, the American Academy of Family Physicians says patients should keep in contact with a primary physician who can keep tabs on their health needs, whether in the virtual or the real world.
“Telemedicine can improve access to care in remote sites and rural areas,” says Dr. Lori J. Heim, the academy’s president. “But not all visits will take place between a patient and their primary-care doctor.”
Dr. Boultinghouse dismisses such concerns. “In today’s world, the physical exam plays less and less of a role,” he says. “We live in the age of imaging.”
ON the rig Courageous, Mr. Martin is part of a crew of 100. Travis G. Fitts Jr., vice president for human resources, health, safety and environment at Scorpion Offshore, which owns the rig, says that examining a worker via two-way video can be far cheaper in a remote location than flying him to a hospital by helicopter at $10,000 a trip.
Some rigs have saved $500,000 or more a year, according to NuPhysicia, which has contracts with 19 oil rigs around the world, including one off Iraq. Dr. Boultinghouse says the Deepwater Horizon drilling disaster in the Gulf of Mexico may slow or block new drilling in United States waters, driving the rigs to more remote locations and adding to demand for telemedicine.
NuPhysicia also offers video medical services to land-based employers with 500 or more workers at a site. The camera connection is an alternative to an employer’s on-site clinics, typically staffed by a nurse or a physician assistant.
Mustang Cat, a Houston-based distributor that sells and services Caterpillar tractors and other earth-moving equipment, signed on with NuPhysicia last year. “We’ve seen the benefit, ” says Kurt Hanson, general counsel at Mustang, a family-owned company. Instead of taking a half-day or more off to consult a doctor, workers can get medical advice on the company’s premises.
NuPhysicia’s business grew out of work that its founders did for the state of Texas. Mr. Hammack, NuPhysicia’s president, is a former assistant vice president of the University of Texas Medical Branch at Galveston, where he led development of the state’s pioneering telemedicine program in state prisons from the mid-1990s to 2007. Dr. Davis is a cardiologist.
Working with Dr. Boultinghouse, Dr. Davis and other university doctors conducted more than 600,000 video visits with inmates. Significant improvement was seen in inmates’ health, including measures of blood pressure and cholesterol, according to a 2004 report on the system in the Journal of the American Medical Association.
In March, California officials released a report they had ordered from NuPhysicia with a plan for making over their state’s prison health care. The makeover would build on the Texas example by expanding existing telemedicine and electronic medical record systems and putting the University of California in charge.
California spends more than $40 a day per inmate for health care, including expenses for guards who accompany them on visits to outside doctors. NuPhysicia says that this cost is more than four times the rate in Texas and Georgia, and almost triple that of New Jersey, where telemedicine is used for mental health care and some medical specialties.
“Telemedicine makes total sense in prisons,” says Christopher Kosseff, a senior vice president and head of correctional health care at the University of Medicine and Dentistry of New Jersey. “It’s a wonderful way of providing ready access to specialty health care while maintaining public safety.”
- Sent using Google Toolbar"
Business Law Prof Blog: Plutonomy
Business Law Prof Blog: Plutonomy: "Plutonomy
Speaking of comments, my colleague over at the Akron Law Cafe, Brant Lee, has generated quite a few of them with his recent post: Facts about inequality. As I understand him, he basically is asking at what point the American Dream becomes a lottery ticket. In other words, one version of the U.S. social contract is that we forgo any meaningful safety net for the poor in exchange for seemingly limitless upside for the wealthy. The consideration that gets the poor to go along with this contract is the possibility that they too might join the wealthy if they just work hard enough. Lee points out that there is data to suggest this consideration may be illusory.
Purely by coincidence, I happened to watch Michael Moore's 'Capitalism: A Love Story' recently. In the movie, Moore references a 2006 Citigroup memo that discusses investment strategies designed to take advantage of the fact that the U.S. is essentially what the memo refers to as a plutonomy: an economy 'powered by the wealthy, who aggrandize[] larger chunks of the economy to themselves.' (The quoted language is apparently from a 2005 memo.) The related point the memo makes is that democracy is actually a potential drag on a plutonomy because at some point the poor may exercise their right to vote and change the rules of the game for the rich. (For more on the Citigroup memo, go here.)
Then today we get news on a report on Iceland's financial crisis that criticizes:
Iceland's three biggest banks -- Landsbanki, Kaupthing and Glitnir -- for creating a system that benefited powerful businessmen and banking tycoons at the expense of creditors and shareholders.
Of course, there are very compelling alternative formulations of our social contract. But at least the news out of Iceland provides some cold comfort to those who buy the version discussed above--it's not just a U.S. thing.
SJP
- Sent using Google Toolbar"
Speaking of comments, my colleague over at the Akron Law Cafe, Brant Lee, has generated quite a few of them with his recent post: Facts about inequality. As I understand him, he basically is asking at what point the American Dream becomes a lottery ticket. In other words, one version of the U.S. social contract is that we forgo any meaningful safety net for the poor in exchange for seemingly limitless upside for the wealthy. The consideration that gets the poor to go along with this contract is the possibility that they too might join the wealthy if they just work hard enough. Lee points out that there is data to suggest this consideration may be illusory.
Purely by coincidence, I happened to watch Michael Moore's 'Capitalism: A Love Story' recently. In the movie, Moore references a 2006 Citigroup memo that discusses investment strategies designed to take advantage of the fact that the U.S. is essentially what the memo refers to as a plutonomy: an economy 'powered by the wealthy, who aggrandize[] larger chunks of the economy to themselves.' (The quoted language is apparently from a 2005 memo.) The related point the memo makes is that democracy is actually a potential drag on a plutonomy because at some point the poor may exercise their right to vote and change the rules of the game for the rich. (For more on the Citigroup memo, go here.)
Then today we get news on a report on Iceland's financial crisis that criticizes:
Iceland's three biggest banks -- Landsbanki, Kaupthing and Glitnir -- for creating a system that benefited powerful businessmen and banking tycoons at the expense of creditors and shareholders.
Of course, there are very compelling alternative formulations of our social contract. But at least the news out of Iceland provides some cold comfort to those who buy the version discussed above--it's not just a U.S. thing.
SJP
- Sent using Google Toolbar"
Plutonomy: Buying Luxury, Explaining Global Imbalances
See page 33 for Analyst Certification and Important Disclosures
Industry Note
Equity Strategy
Iw†…€y€x'ÁÁ5†tyrÁE†‰†ƒ Á8‰wftytyrÁ@w€gfwÁBxgfwfyhp„
October 16, 2005
SUMMARY
➤ The World is dividing into two blocs - the Plutonomy and the rest. The U.S.,
Ajay Kapur, CFA
+1-212-816-4813 ajay.kapur@citigroup.com
Niall Macleod
+44-20-7986-4449 niall.j.macleod@citigroup.com
Narendra Singh
+1-212-816-2807 narendra.singh@citigroup.com
UK, and Canada are the key Plutonomies - economies powered by the wealthy. Continental Europe (ex-Italy) and Japan are in the egalitarian bloc. ➤ Equity risk premium embedded in “global imbalances” are unwarranted. In plutonomies the rich absorb a disproportionate chunk of the economy and have a massive impact on reported aggregate numbers like savings rates, current account deficits, consumption levels, etc. This imbalance in inequality expresses itself in the standard scary “ global imbalances”. We worry less. ➤ There is no “average consumer” in a Plutonomy. Consensus analyses focusing on the “average” consumer are flawed from the start. The Plutonomy Stock Basket outperformed MSCI AC World by 6.8% per year since 1985. Does even better if equities beat housing. Select names: Julius Baer, Bulgari, Richemont, Kuoni, and Toll Brothers.
WELCOME TO THE PLUTONOMY MACHINE
In early September we wrote about the (ir)relevance of oil to equities and introduced the idea that the U.S.is a Plutonomy - a concept that generated great interest from our clients. As global strategists, this got us thinking about how to buy stocks based on this plutonomy thesis, and the subsequent thesis that it will gather strength and amass breadth. In researching this idea on a global level and looking for stock ideas we also chanced upon some interesting big picture implications. This process manifested itself with our own provocative thesis: that the so called “global imbalances” that worry so many of our equity clients who may subsequently put a lower multiple on equities due to these imbalances, is not as dangerous and hostile as one might think. Our economics team led by Lewis Alexander researches and writes about these issues regularly and they are the experts. But as we went about our business of finding stock ideas for our clients, we thought it important to highlight this provocative macro thesis that emerged, and if correct, could have major implications in terms of how equity investors assess the risk embedded in equity markets. Sometimes kicking the tires can tell you a lot about the car-business. Well, here goes. Little of this note should tally with conventional thinking. Indeed, traditional thinking is likely to have issues with most of it. We will posit that: 1) the world is dividing into two blocs - the plutonomies, where economic growth is powered by and largely consumed by the wealthy few, and the rest. Plutonomies have occurred before in sixteenth century Spain, in seventeenth century Holland, the Gilded Age and the Roaring Twenties in the U.S. What are the common drivers of Plutonomy? Disruptive technology-driven productivity gains, creative financial innovation, capitalistCitigroup Research is a division of Citigroup Global Markets Inc. (the "Firm"), which does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Non-US research analysts who have prepared this report, and who may be associated persons of the member or member organization, are not registered/qualified as research analysts with the NYSE and/or NASD, but instead have satisfied the registration/qualification requirements or other research-related standards of a non-US jurisdiction.
Global
friendly cooperative governments, an international dimension of immigrants and overseas conquests invigorating wealth creation, the rule of law, and patenting inventions. Often these wealth waves involve great complexity, exploited best by the rich and educated of the time. 2) We project that the plutonomies (the U.S., UK, and Canada) will likely see even more income inequality, disproportionately feeding off a further rise in the profit share in their economies, capitalist-friendly governments, more technology-driven productivity, and globalization. 3) Most “Global Imbalances” (high current account deficits and low savings rates, high consumer debt levels in the Anglo-Saxon world, etc) that continue to (unprofitably) preoccupy the world’s intelligentsia look a lot less threatening when examined through the prism of plutonomy. The risk premium on equities that might derive from the dyspeptic “global imbalance” school is unwarranted - the earth is not going to be shaken off its axis, and sucked into the cosmos by these “imbalances”. The earth is being held up by the muscular arms of its entrepreneur-plutocrats, like it, or not. Fixing these “global imbalances” that many pundits fret about requires time travel to change relative fertility rates in the U.S. versus Japan and Continental Europe. Why? There is compelling evidence that a key driver of current account imbalances is demographic differences between regions. Clearly, this is tough. Or, it would require making the income distribution in the Anglo-Saxon plutonomies (the U.S., UK, and Canada) less skewed to the rich, and relatively egalitarian Europe and Japan to suddenly embrace income inequality. Both moves would involve revolutionary tectonic shifts in politics and society. Note that we have not taken recourse to the conventional curatives of global rebalance - the dollar needs to drop, either abruptly, or smoothly, the Chinese need to revalue, the Europeans/Japanese need to pump domestic demand, etc. These have merit, but, in our opinion, miss the key driver of imbalances - the select plutonomy of a few nations, the equality of others. Indeed, it is the “unequal inequality”, or the imbalances in inequality across nations that corresponds with the “global imbalances” that so worry some of the smartest people we know. 4) In a plutonomy there is no such animal as “the U.S. consumer” or “the UK consumer”, or indeed the “Russian consumer”. There are rich consumers, few in number, but disproportionate in the gigantic slice of income and consumption they take. There are the rest, the “non-rich”, the multitudinous many, but only accounting for surprisingly small bites of the national pie. Consensus analyses that do not tease out the profound impact of the plutonomy on spending power, debt loads, savings rates (and hence current account deficits), oil price impacts etc, i.e., focus on the “average” consumer are flawed from the start. It is easy to drown in a lake with an average depth of 4 feet, if one steps into its deeper extremes. Since consumption accounts for 65% of the world economy, and consumer staples and discretionary sectors for 19.8% of the MSCI AC World Index, understanding how the plutonomy impacts consumption is key for equity market participants. 5) Since we think the plutonomy is here, is going to get stronger, its membership swelling from globalized enclaves in the emerging world, we think a “plutonomy basket” of stocks should continue do well. These toys for the wealthy have pricing 2
power, and staying power. They are Giffen goods, more desirable and demanded the more expensive they are.
RIDING THE GRAVY TRAIN - WHERE ARE THE PLUTONOMIES?
The U.S., UK, and Canada are world leaders in plutonomy. (While data quality in this field can be dated in emerging markets, and less than ideal in developed markets, we have done our best to source information from the most reliable and credible government and academic sources. There is an extensive bibliography at the end of this note). Countries and regions that are not plutonomies: Scandinavia, France, Germany, other continental Europe (except Italy), and Japan.
THE UNITED STATES PLUTONOMY - THE GILDED AGE, THE ROARING TWENTIES, AND THE NEW MANAGERIAL ARISTOCRACY
Let’s dive into some of the details. As Figure 1 shows the top 1% of households in the U.S., (about 1 million households) accounted for about 20% of overall U.S. income in 2000, slightly smaller than the share of income of the bottom 60% of households put together. That’s about 1 million households compared with 60 million households, both with similar slices of the income pie! Clearly, the analysis of the top 1% of U.S. households is paramount. The usual analysis of the “average” U.S. consumer is flawed from the start. To continue with the U.S., the top 1% of households also account for 33% of net worth, greater than the bottom 90% of households put together. It gets better (or worse, depending on your political stripe) - the top 1% of households account for 40% of financial net worth, more than the bottom 95% of households put together. This is data for 2000, from the Survey of Consumer Finances (and adjusted by academic Edward Wolff). Since 2000 was the peak year in equities, and the top 1% of households have a lot more equities in their net worth than the rest of the population who tend to have more real estate, these data might exaggerate the U.S. plutonomy a wee bit. Was the U.S. always a plutonomy - powered by the wealthy, who aggrandized larger chunks of the economy to themselves? Not really. For those interested in the details, we recommend “Wealth and Democracy: A Political History of the American Rich” by Kevin Phillips, Broadway Books, 2002.
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Figure 1. Characterizing the U.S. Plutonomy: Based on the Consumer Finance Survey, the Top 1% Accounted For 20% of Income, 40% of Financial Wealth and 33% of Net Worth in the U.S. (More Than the Net Worth of the Bottom 95% Households Put Together) in 2001
Year Top 1% Next 4% Next 5% Next 10% Top 20% 4th 20% 3rd 20% Bottom 40%
A. Net Worth 1983 1989 1992 1995 1998 2001 B. Financial Wealth 1983 1989 1992 1995 1998 2001 C. Income 1982 1988 1991 1994 1997 2000
33.8 37.4 37.2 38.5 38.1 33.4 42.9 46.9 45.6 47.2 47.3 39.7 12.8 16.6 15.7 14.4 16.6 20.0
22.3 21.6 22.8 21.8 21.3 25.8 25.1 23.9 25.0 24.6 21.0 27.8 13.3 13.3 14.8 14.5 14.4 15.2
12.1 11.6 11.8 11.5 11.5 12.3 12.3 11.6 11.5 11.2 11.4 12.3 10.3 10.4 10.6 10.4 10.2 10.0
13.1 13.0 12.0 12.1 12.5 12.9 11.0 11.0 10.2 10.1 11.2 11.4 15.5 15.2 15.3 15.9 15.0 13.5
81.3 83.5 83.8 83.9 83.4 84.4 91.3 93.4 92.3 93.0 90.9 91.3 51.9 55.6 56.4 55.1 56.2 58.6
12.6 12.3 11.5 11.4 11.9 11.3 7.9 7.4 7.3 6.9 8.3 7.8 21.6 20.6 20.4 20.6 20.5 19.0
5.2 4.8 4.4 4.5 4.5 3.9 1.7 1.7 1.5 1.4 1.9 1.7 14.2 13.2 12.8 13.6 12.8 12.3
0.9 -0.7 0.4 0.2 0.2 0.3 -0.9 -2.5 -1.1 -1.3 -1.1 -0.7 12.3 10.7 10.5 10.7 10.5 10.1
Source: Table 2 from Edward Wolff (please see reference 26 in the bibliography at the end of the report). Computations done by Prof. Wolff from the 1983, 1989, 1992, 1995, 1998, and 2001 Surveys of Consumer Finances. For the computation of percentile shares of net worth, households are ranked according to their net worth; for percentile shares of financial wealth, households are ranked according to their financial wealth; and for percentile shares of income, households are ranked according to their income. Net worth in Prof Wolff’s calculation is the difference in value between total assets and total liabilities or debt. Total assets are defined as the sum of: (1) the gross value of owner-occupied housing; (2) other real estate owned by the household; (3) cash and demand deposits; (4) time and savings deposits, certificates of deposit, and money market accounts; (5) government bonds, corporate bonds, foreign bonds, and other financial securities; (6) the cash surrender value of life insurance plans; (7) the cash surrender value of pension plans, including IRAs, Keogh, and 401(k) plans; (8) corporate stock and mutual funds; (9) net equity in unincorporated businesses; and (10) equity in trust funds. Total liabilities are the sum of: (1) mortgage debt, (2) consumer debt, including auto loans, and (3) other debt. Prof Wolff defines Financial wealth as net worth minus net equity in owner-occupied housing. Financial wealth is a more "liquid" concept than marketable wealth, since one's home is difficult to convert into cash in the short term.
Figure 2. The Income Share of the Top 0.1% of U.S. Households Has Risen from Under 2% in the Early 1970s to Over 7% in 2000, Based on Tax Data
35 30 25 20 15 10 5 0 1913
USA, income share of top 5%
Top 1%-5% Top 0.1%-1% Top 0.1%
35 30 25 20 15 10 5 0
1924
1935
1946
1957
1968
1979
1990
2001
(Please see references 18 in the bibliography at the end of the report). Due difference in sources and method of calculations the income share estimates from tax based data do not exactly match Survey of Consumer Finance data. Source: Prof. Emmanuel Saez et. al., reference 18.
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We will focus here on data from Prof. Emmanuel Saez of U.C. Berkeley who works with data from tax sources. Figure 2 shows the share of income for the top 0.1%, 1% and 5% in the U.S. since the 1910s. Clearly the fortunes of the top 0.1% fluctuate the most. Indeed, the fortunes of the top 5% (or even top 10%), or the top 1%, are almost entirely driven by the fortunes of the top 0.1% (roughly 100,000 households). With the exception of the boom in the Roaring 1920s, this super-rich group kept losing out its share of incomes in WWI, the Great Depression and WWII, and till the early eighties. Why? The answers are unclear, but the massive loss of capital income (dividend, rents, interest income, but not capital gains) from progressive corporate and estate taxation is a possible candidate. The rise in their share since the mid-eighties might be related to the reduction in corporate and income taxes. Also, to a new wave of entrepreneurs and managers earning disproportionate incomes as they drove and participated in the ongoing technology boom. As Figure 3 shows, while in the early 20th century capital income was the big chunk for the top 0.1% of households, the resurgence in their fortunes since the mid-eighties was mainly from oversized salaries. The rich in the U.S. went from coupon-clipping, dividend-receiving rentiers to a Managerial Aristocracy indulged by their shareholders.
Figure 3. The Metamorphosis of the Highest 1% of Income Earners in the U.S.: from Rentier Rich to a Managerial Technocratic Aristocracy
100 90 80 70 60 50 40 30 20 10 0 16 26 36 46 56 66 76 86 96 Wage Interest USA Sources of Income, Top 1% Entreprenurial Rents Dividends 1999 100 90 80 70 60 50 40 30 20 10 0
Please see reference 18 in the bibliography at the end of the report for the data underlying the chart. Based on tax returns data. Source: Citigroup Investment Research
EGALITARIAN JAPAN, CONTINENTAL EUROPE AND THE PLUTONOMIES OF CANADA AND THE UK
How did the Plutonomy fare in other countries over time? As Figures 4 and 5 show, the UK and Canada, pretty much follow the U.S. script. Japan, France, and the Netherlands are a bit different. These were all plutonomies before the Great Depression, but the War, taxation, and new post-War institutional structures generated much more egalitarian societies, that hold even today. Only Switzerland remained unchanged. Neutrality through the wars saw its capital preserved, the lack of a progressive income and wealth tax regime, and low taxes helped.
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Figure 4. Plutonomy At Work: The Income Share of the Top 1% Has Risen Dramatically Since the Late 1970s in the U.S., the U.K., and Canada
19 17 15 13 11 9 7 5 60 63 66 69 72 75 78 81 84 87 90 93 96 99 02
Please see references 18, 4, 22 in the bibliography at the end of the report for the data underlying the chart. Estimates based on tax return data. Source: Citigroup Investment Research
Income Share of the Top 1%
19 17
USA UK Canada
15 13 11 9 7 5
Figure 5. Of Egalitarian Bent: The Income Share of the Top 1% Is Much Smaller and Is Not Rising as Much, If at All, in Switzerland, the Netherlands, Japan, and France
19 17 15 13 11 9 7 5 60 63 66 69 72 75 78 81 84 87 90 93 96 99 02
Please see references 7,17,15,4 in the bibliography at the end of the report for the data underlying the chart. Estimates based on tax return data. Source: Citigroup Investment Research
Income Share of the Top 1% Switzerland France Japan Netherlands
19 17 15 13 11 9 7 5
See Figures 6 thru 11 for a panorama of plutonomy and egalitarianism.
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Figure 6. Plutonomy in the UK: The Income Share of the Top 0.5% Rose from Under 4% in the mid 70s to Over 9% in the Late 1990s
30 25 20 15 10 5 UK, Income Share of the Top 5% Top 1%-5% Top 0.5%-1% Top 0.5% 20 15 10 5 30 25
0 0 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999
Please see reference 4 in the bibliography at the end of the report for the data. Source: Citigroup Investment Research
Figure 7. Return of Plutonomy in Canada: The Income Share of the Top 5% Is at the Highest Level Since the 1940s
40 35 30 25 20 15 10 5 0 1920 1930 1940 1950 1960 1970 1980 1990 Canada, Income Share of the Top 5% Top 1%-5% Top 0.1%-1% Top 0.1% 40 35 30 25 20 15 10 5 0 2000
Please see reference 22 in the bibliography at the end of the report for the data. Source: Citigroup Investment Research and http://elsa.berkeley.edu/~saez/index.html
Figure 8. Switzerland Benefits From Neutrality: Remarkably Stable Income Share of the Very Rich Over the Past 60 Years
25 20 15 10 5 0 1933 Top 1%-5% Top 0.1%-1% Top 0.1% Switzerland, income share of top 5% 25 20 15 10 5 0 1996
1942
1951
1960
1969
1978
1987
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Please see reference 7 in the bibliography at the end of the report for the data. Source: Citigroup Investment Research
Figure 9. France: The Income Share of the Rich Fell During WWII But Stayed Stable in the 1980s and 1990s
35 30 25 20 15 10 5 0 17 26 35 44 53 62 71 80 89 98 France, income share of top 5% Top 1%-5% Top 0.1%-1% Top 0.1% 35 30 25 20 15 10 5 0
Please see reference 17 in the bibliography at the end of the report for the data. Source: Citigroup Investment Research
Figure 10. The Netherlands: Decline in the Share of the Top 5% and the Very Rich Until 1980. Share Relatively Stable in Recent Years
45 40 35 30 25 20 15 10 5 0 14 19 24 29 34 39 44 49 54 59 64 69 74 79 84 89 94 99
Please see reference 4 in the bibliography at the end of the report for the data. Source: Citigroup Investment Research
Netherlands, income share of top 5% Top 1%-5% Top 0.1%-1% Top 0.1%
45 40 35 30 25 20 15 10 5 0
Figure 11. Japan: The Income Share of the Top 0.1% and the Top 1% Remarkably Flat in the Post-War Period.
35 30 25 20 15 10 5 0 07 17 27 37 47 57 67 77 87 97 2002 Japan, income share of top 5% Top 1%-5% Top 0.1%-1% Top 0.1% 35 30 25 20 15 10 5 0
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Please see reference 15 in the bibliography at the end of the report for the data. Source: Citigroup Investment Research
PLUTONOMY WAVES - TECHNOLOGY, IMMIGRATION, FINANCE, COMPLEXITY (AND DOPAMINE) DRIVEN?
The reasons why some societies generate plutonomies and others don’t are somewhat opaque, and we’ll let the sociologists and economists continue debating this one. Kevin Phillips in his masterly “Wealth and Democracy” argues that a few common factors seem to support “wealth waves” - a fascination with technology (an Anglo-Saxon thing according to him), the role of creative finance, a cooperative government, an international dimension of immigrants and overseas conquests invigorating wealth creation, the rule of law, and patenting inventions. Often these wealth waves involve great complexity. “One explanation of ...increasing polarization of wealth comes from considering these great transformations as surges of complexity - waves of economic, political and commercial change - profound enough to break down old vocational and price relationships, greatly favoring persons with position, capital, skills, and education” (page 259, author’s emphasis). Clearly, a speculative instinct is key to generating and sustaining these complex and risky transformations. Here, a new, rather out-of-the box hypothesis suggests that dopamine differentials can explain differences in risk-taking between societies. John Mauldin, the author of “Bulls-Eye Investing” in an email last month cited this work. The thesis: Dopamine, a pleasure-inducing brain chemical, is linked with curiosity, adventure, entrepreneurship, and helps drive results in uncertain environments. Populations generally have about 2% of their members with high enough dopamine levels with the curiosity to emigrate. Ergo, immigrant nations like the U.S. and Canada, and increasingly the UK, have high dopamine-intensity populations. If encouraged to keep the rewards of their high dopamine-induced risk-seeking entrepreneurialism, these countries will be more prone to wealth waves, unequally distributed. Presto, a plutonomy driven by dopamine! Interesting that Kevin Phillips also mentioned the role of immigrants in driving great wealth waves (oblivious to the role of dopamine, though). He emphasizes the role of the in-migration of skilled and well-capitalized refugees and cosmopolitan elites in catalyzing wealth waves. Being the son of refugee parents from the India-Pakistan partition in 1947, and now a wandering global nomad, I can see this argument quite clearly. (Also, I need to get my dopamine level checked.) Phillips talks of the four great powers - Spain in the fifty years after 1492, the United Provinces (Holland) in the sixteenth century, seventeenth century England, and nineteenth century U.S., all benefiting from waves of immigrants, fleeing persecution, and nabbing opportunities in distant lands.
WHY THE PLUTONOMY WILL GET STRONGER WHERE IT EXISTS, PERHAPS ATTRACT NEW COUNTRIES
We posit that the drivers of plutonomy in the U.S. (the UK and Canada) are likely to strengthen, entrenching and buttressing plutonomy where it exists. The six drivers of the current plutonomy: 1) an ongoing technology/biotechnology revolution, 2) capitalistfriendly governments and tax regimes, 3) globalization that re-arranges global supply 9
chains with mobile well-capitalized elites and immigrants, 4) greater financial complexity and innovation, 5) the rule of law, and 6) patent protection are all well ensconced in the U.S., the UK, and Canada. They are also gaining strength in the emerging world. Eastern Europe is embracing many of these attributes, as are China, India, and Russia. Even Continental Europe may succumb and be seduced by these drivers of plutonomy. As we argued in the Global Investigator, “Earnings - Don’t Worry, Capitalists Still on Top”, June 10, 2005, the profit share of GDP is highly likely to keep rising to the highs seen in the 1950s/60s. New markets like China and India, their contribution to the global labor supply, the ongoing productivity revolution, the quasi-Bretton Woods system in the U.S. dollar bloc, and inflation-fighting central banks should all help. However, a high profit share like in the 1950s/60s does not ensure plutonomy. Indeed, in the 1950s/60s, U.S. and other key countries did not see increasing income inequality. Society and governments need to be amenable to disproportionately allow/encourage the few to retain that fatter profit share. The Managerial Aristocracy, like in the Gilded Age, the Roaring Twenties, and the thriving nineties, needs to commandeer a vast chunk of that rising profit share, either through capital income, or simply paying itself a lot. We think that despite the post-bubble angst against celebrity CEOs, the trend of cost-cutting balance sheet-improving CEOs might just give way to risk-seeking CEOs, re-leveraging, going for growth and expecting disproportionate compensation for it. It sounds quite unlikely, but that’s why we think it is quite possible. Meanwhile Private Equity and LBO funds are filling the risk-seeking and re-leveraging void, expecting and realizing disproportionate remuneration for their skills.
THOSE SCARY “GLOBAL IMBALANCES” - REFLECT PLUTONOMY AND DEMOGRAPHY, QUITE LOGICAL AND UNTHREATENING
We have all heard the lament. A bearish guru, somber and serious, spelling out that the end is near if something is not done urgently about those really huge, nasty “Global Imbalances”. The U.S. savings rate is too low, the U.S. current account deficit is too high, foreigners are not going to keep financing this unless compensated with higher interest rates, and a sharply lower U.S. dollar. The world, being so imbalanced, is about to tip over it’s axis, all hell is going to break loose, so don’t any equities - the risk premium is high reflecting these imbalances and is going to go higher (i.e., lower stock prices) when the earth finally does keel over. A more balanced view acknowledges these nasty imbalances, but predicts a gentle, gradual dollar decline, a yuan revaluation, and the hope that Asians and European (exUK) consumers will embark on a spending journey, righting the world. A tough workout, but she’ll be right. Almost all the smart folks we know - our investors, our colleagues, our friends in academia, politicians believe in some variant of these two stories. There are very few exceptions who consider these “Global Imbalances” not scary but perfectly natural and rather harmless. (We can think of Gavekal as one of these exceptions, but their repose of comfort is different from ours - they have a new book out “The Brave New World”, elucidating the new business model of global “Platform” companies, etc).
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Our point here is not to dismiss the conventional views as outright wrong. However, we offer a competing view and, in some instance, a view that is complementary to the conventional explanation. Our view, if right, suggests that applying an excessive risk premium to “Global Imbalances” is a flawed approach to equity investing. Note that our house view, for instance, sees no cataclysmic collapse in the dollar. The U.S. current account deficit is anticipated to remain flat at 6.8% of GDP. The Japanese and the Euro surpluses are expected to continue. A plutonomy world is not inconsistent with these forecasts.
Figure 12. Global Imbalances: Plutonomies Are Running Current Account Deficits. Non-Plutonomies Are Running Current Account Surpluses
3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 -5.0 -6.0 Non-Plutonomies Current Account % GDP Plutonomies Current Account % GDP 80 82 84 86 88 90 92 94 96 98 00 02 04 06
Note: For our purposes, Plutonomies = U.S., U.K. and Canada. Non-Plutonomies = EuroZone, Japan, and Switzerland. Missing are the newly industrialized nations of Asia and China. Source: International Monetary Fund and Datastream
3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 -5.0 -6.0
First a quick glance at these Global imbalances. Figure 12 shows the current account balances for plutonomies (the U.S., UK, and Canada) and the others - continental Europe and Japan. We have left out China and other emerging markets because we do not have their income inequality data, although they are definitely an important part of the “Global Imbalance” story. Well, it seems that the plutonomies (the U.S., UK, and Canada together) have deteriorating current account balances; the others are running a combined current account surplus. Current account balances are driven by three possible sources - the net savings of the government, the corporate sector and the household sector. Figure 13 shows our bottomup estimates for corporate free cash flow/sales, a close cousin of corporate savings these look similarly good across the world, both for plutonomies and the others. We won’t pursue this avenue as a key driver of today’s imbalances.
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Figure 13. Free Cash Flow to Sales Is High Across the Major Regions. No Difference Between Plutonomies and the Others
6 5 4 3 2 1 0 -1 -2 -3 -4 1/88 US 1/91 1/94 Europe 1/97 1/00 Japan 1/03 1/06 FCF to Sales
Source: Citigroup Investment Research and Worldscope
How about government deficits? Well, they seem to be equally bad in the U.S., UK, Continental Europe, and very bad in Japan. Hmm. We’ll leave this one alone too.
Figure 14. The Gap in the Savings Rate of Plutonomies and the Others Moves Closely with the Gap in the Current Account Balance
-5.0 -5.5 -6.0 -6.5 -7.0 -3.0 -7.5 -8.0 -8.5 -9.0 80 82 84 86 88 90 92 94 96 98 00 02 04 06
Note: For our purposes, Plutonomies = U.S., U.K. and Canada. Non-Plutonomies = EuroZone, Japan and Switzerland. Missing are the newly industrialized nations of Asia and China. Source: International Monetary Fund and Datastream
Difference, Household Savings Rate of Plutonomies less Non-Plutonomies Difference, Current Acc % GDP of Plutonomies less Non-Plutonomies (RS)
2.0 1.0 0.0 -1.0 -2.0
-4.0 -5.0 -6.0 -7.0
We need to focus on the household sector (the consumer in simple English) as the key driver of those current account imbalances that so worry the equity bears. Indeed, Figure 14 shows the gap between the households sector’s savings rate for the plutonomies (U.S., UK, and Canada) less those of continental Europe and Japan. This gap is large and moves with the gap in the current accounts of these two blocs. Our contention is simple - while the drivers of savings rates in countries are many - we focus on plutonomy as a key new explanation for different savings rates in different 12
countries. (As an aside, considerable empirical research shows that the external imbalances between the U.S., Europe, and Japan are driven by demography. The U.S. is just younger than Japan, driving household savings differences that drive those current account differences. This topic is beyond the scope of our story here. For those interested, check out “Capital Flows Among the G-7 Nations: A Demographic Perspective”, Michael Feroli, U.S. Federal Reserve Board, October 2003). Our contention: when the top, say 1% of households in a country see their share of income rise sharply, i.e., a plutonomy emerges, this is often in times of frenetic technology/financial innovation driven wealth waves, accompanied by asset booms, equity and/or property. Feeling wealthier, the rich decide to consume a part of their capital gains right away. In other words, they save less from their income, the wellknown wealth effect. The key point though is that this new lower savings rate is applied to their newer massive income. Remember they got a much bigger chunk of the economy, that’s how it became a plutonomy. The consequent decline in absolute savings for them (and the country) is huge when this happens. They just account for too large a part of the national economy; even a small fall in their savings rate overwhelms the decisions of all the rest. Figure 15 provides a simple example of how this happens.
Figure 15. A Numerical Example: If the Income Share of the Top Group Is High, A Reduction in the Savings Rate of the Top Income Group (due to Asset Appreciation, for example) Can More than Offset Any Increase in the Savings Rates of Others
Pre-Plutonomy Income Top 20% $20 Next 20% $20 Third 20% $20 Fourth 20% $20 Poorest 20% $20 Total $100 Plutonomy Emerges: Income Top 20% $60 Next 20% $10 Next 20% $10 Next 20% $10 Poorest $10 Total $100 Savings rate 10% 10% 10% 10% 10% 10% New savings rate 5% or 8% or 9% 11% 11% 11% 11% 7.4% or 9.2% or 9.8% Savings $2 $2 $2 $2 $2 $10 Savings $3 or $4.8 or $5.4 $1.1 $1.1 $1.1 $1.1 $7.4 or $9.2 or $9.8
Source: Citigroup Investment Research
There is proof that high income earners, who saw their share of income go up in the U.S. in the nineties, and enjoyed the equity boom, reduced their savings rate as in our example. Indeed, in the real world, it went negative! Since that reduced savings rate was applied to their new enlarged chunk of income, sure enough the total savings rate fell sharply. Dean Maki and Michael Palumbo, wrote the paper (at Alan Greenspan’s suggestion) that demonstrated this fall in the savings rate of the rich in response to the equity boom (See Maki and Palumbo, “Disentangling the Wealth Effect: A Cohort Analysis of Household Savings in the 1990s”, April 2001). Figure 16 demonstrates the savings rates at different points for different income groups.) The very rich, the top 20%, had a savings rate of 8%, much higher than other less affluent groups in 1992. By 2000 this savings rate had gone from 8%- to -2%! The wealth effect at work. And then this reduced savings rate 13
of the rich hit their huge incomes, swollen by the plutonomy, savaging the U.S.’s overall savings rate. This is our contribution to the debate. Plutonomy plus an asset boom equals a drop in the overall savings rate. (Asset booms by themselves, i.e., the wealth effect by itself does not do the trick, as we will show soon.)
Figure 16. Household Savings Rates of the Rich Fell in the Stock Boom in the 1990s While Those of the Lower Income Groups Rose (Maki-Palumbo Estimates)
10 8 6 4 2 0 -2 -4 Top Quintile Rich are saving a lower proportion of their income (actually dissaving) in 2000 compared to 1992 (Maki-Palumbo estimates) 61-80% 41%-60% 21%-40% Bottom Quintile Savings Rate by Income Quintiles Year 1992 Year 2000 Lower income 10 savings rate 8 higher 6 4 2 0 -2 -4
Please see reference 14 in the bibliography at the end of the report for the data underlying the chart. Based on tax returns data. Source: Citigroup Investment Research
Let’s look at some of the coolest figures that amplify and verify this idea. Figure 17 plots the share of the top 1% of U.S. households since 1929. Our thesis is that the higher the share of income going to the top 1%, the lower the overall household savings rate (shown inverted in Figure 17). There is a pretty tight correlation between the two, despite the many other drivers of savings rates (demography, interest rates, financial deepening, retirement security, etc). The same information is shown in Figure 18, a scatter plot - when the rich take a very high share of overall income, the national household savings rate drops, and vice versa. In a plutonomy, the rich drop their savings rate, consume a larger fraction of their bloated, very large share of the economy. This behavior overshadows the decisions of everybody else. The behavior of the exceptionally rich drives the national numbers - the “appallingly low” overall savings rates, the “over-extended consumer”, and the “unsustainable” current accounts that accompany this phenomenon. We want to spend little time worrying about these (non)issues, neither do we think they warrant any risk premium on equities. They simply reflect the reality of demographic differences between nations, and that some nations are plutonomies, while others are not. Unequal inequality among nations is mirrored in the logical imbalances between them.
14
Figure 17. The Aggregate U.S. Household Savings Rate and the Income Share of the Top 1% Moves More Closely Together
20 18 16 14 12 Depression 10 8
Income share of the top 1% Savings Rate (RS, reverse scale)
-4 -2 0 2 4 6 8
World War II
10 12
6 29 34 39 44 49 54 59 64 69 74 79 84 89 94 99 04
Please see reference 18 in the bibliography at the end of the report for the data underlying income share. Source: Bureau of Economic Analysis
Figure 18. There is a High and Negative Correlation Between the U.S. Household Savings Rate and Income Concentration (1929-02, World War II Years 1940-44 Excluded)
12 Household Savings Rate 10 8 6 4 2 0 -2 8 10 Income share of the top 1% of households 12 14 16 18 y = -0.74x + 15.07 R2 = 0.70 12 10 8 6 4 2 0 -2 20
Note: Similar high correlations are obtained even if we use the income share of the top 10% (RSq = 0.70) or the income share of the top 5% (RSq = 0.73). Please see reference 18 in the bibliography at the end of the report for the data underlying income share. Source: Citigroup Investment Research
How about more empirical verification of the relationship between the household savings rate and the share of the rich in other plutonomies like the UK and Canada? Figure 19 shows the relationship for the UK using data from 1951 onwards. Note the clear negative relationship that we expect. In the nineties, there seems to have been an upward shift in the relationship between the UK personal savings rate and income inequality. There are number of drivers for the savings rate, as highlighted earlier, and 15
the impact of these other drivers could shift the relationship around - our comfort comes from the persistence of the negative relationship in the UK.
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Figure 19. In the U.K., A Strongly Negative Relationship Between Income Concentration (Plutonomy) and the Aggregate Household Savings Rate. The Relationship Shifted Upward in the 1990s
14 12 10 1989 8 6 4 2 0 4 6 8 10 12 14 UK, Income Share of the Top 1% y = -1.80x + 20.57 R2 = 0.70 1951-88 1990-99 Household Savings Rate 14 y = -1.72x + 28.48 2 R = 0.81 12 10 8 6 4 2 0
Please see reference 4 in the bibliography at the end of the report for the data underlying the chart. Based on tax returns data. Source: Citigroup Investment Research
Figure 20. Canada Also Shows a Close Relationship Between Income Concentration (Plutonomy) and the Aggregate Household Savings Rate
14 13 12 11 10 9 15 8 7 61 64 67 70 73 76 79 82 85 88 91 94 97 00 03 06
Please see reference 22 in the bibliography at the end of the report for the data underlying the chart. Based on tax returns data. Source: Citigroup Investment Research and http://elsa.berkeley.edu/~saez/index.html
Canada, income share of top 1% of population Household Savings Rate RS, reverse scale)
-5
0
5
10
20
17
Figure 21. Canada: High and Negative Correlation Between Aggregate Household Savings Rates and Income Concentration
25 Household Savings Rate 25
20 y = -2.21x + 31.14 R2 = 0.48
20
15
15
10
10
5 Canada, Income Share of top 1% 0 7 8 9 10 11 12 13 14
5
0
Note: Similar high correlations are obtained even if we use the income share of the top 10% (RSq = 0.60) or the income share of the top 5% (RSq = 0.62). Source: Citigroup Investment Research and http://elsa.berkeley.edu/~saez/index.html
Canada also confirms our thesis. A plutonomy begets a lower household savings rate. See Figures 20 and 21. We have also attempted, in Figure 22, to put the relationship on a cross border-basis for the eight countries where we have comparable data. Again, plutonomies like the U.S., Canada, and the UK have lower household savings rates than the more egalitarian countries like France, the Netherlands, Switzerland, Spain, and Japan.
Figure 22. Cross-Border Comparison: Countries With Lower Income Concentration (Continental Europe) Tend to Have Higher Aggregate Household Savings Rates High Income Concentration (Plutonomy) Is Associated with Lower Household Savings Rates
14 Household Savings Rate (for year shown) 12 10 8 6 4 2 0 4 8 y = -0.92x + 16.82 R2 = 0.79 JP(02) UK(99) CN(00) US(02) Income Share of Top 1% 12 16 FR(98) NL(99) SZ(96) SP(02)
Please see references 18, 4, 22, 7, 17, 15 in the bibliography at the end of the report for the data underlying the chart. Based on tax returns data. Source: Citigroup Investment Research and http://elsa.berkeley.edu/~saez/index.html
One quick point - we asserted earlier that a plutonomy plus an asset boom corresponded with a decline in the household savings rate. It was not just the standard asset boom spawning a wealth effect and ergo higher consumer spending and a lower savings rate. 18
Is there as tight a relationship between asset prices and the savings rate as there is between income inequality and the savings rate (correlation -0.7) shown in Figure 17? Well, in Figure 23 we plot the 10-year returns of the U.S. stock market with the household savings rate. While the relationship is tight in the great bull market between 1982-2000, the huge bull market in the 1950s and 1960s sees no real wealth effect. (The overall correlation of +0.19, i.e., low AND the wrong sign). Why? Among other sensible reasons we do not know, we think it was the absence of plutonomy in that period that kept the spending decisions of the rich, obviously enjoying solid equity gains, from dominating the overall numbers. They were just not disproportionately a big part of the economy then. That would have to wait for the 1980s.
Figure 23. U.S.: It Takes Plutonomy (Income Concentration) and Asset Inflation to Lower the Aggregate Household Savings Rate - Asset Inflation Alone May Not Be Enough
30% 25% 20% 15% 10% 5% 0% -5% -10% 10 15
Annual average 5-year total return, S&P500 Household Savings Rate (RS, reverse scale)
0 5
Bull Market, But No Plutonomy implies no decline in savings rate
Bull Market & Plutonomy implies decline in savings rate Correl = 0.19
20 25 30
37 41 45 49 53 57 61 65 69 73 77 81 85 89 93 97 01 05
Source: Citigroup Investment Research and Datastream
A skeptic, while agreeing with our plutonomy thesis, may still not be convinced about the ability of households to sustain the low savings rate. Surely, even in the brave new world of plutonomies we describe, households cannot forever keep their savings rate low? We have two interesting dynamics in place that should prevent a sharp drop in consumption and so pushing the savings rate higher. One, the difference of the household’s financial assets to disposable income (assets with value of housing stock excluded) and its liabilities to disposable income exceeds its historical average. Households can afford to run down their assets to finance consumption for a while. Please see Figure 24 we have borrowed from Lewis Alexander, our Chief Economist.
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Figure 24. The U.S. Household’s Financial Assets Are Far in Excess of Its Liabilities Even After the Correction in the TMT Bubble. It Can Afford to Maintain Its Low Savings Rate for a While
Financial Assets and Liabilities of Households (Percent of Diposable Income)
Percent 500 450 400 350 300 250 200 150 100 50 1/80
Percent 500 450 400 350 300 250 200 150 100 50
Financial Assets (left scale) Liabilities (right scale)
1/85
1/90
1/95
1/00
1/05
Source: Bureau of Economic Analysis, Federal Reserve Board, and Citigroup Investment Research
Two, as this note has been arguing it is the rich who are driving the low savings rate and high consumption in plutonomies. For the top decile in the U.S., the total net worth to income ratio is exceptionally high at 7.5 times compared to 4.5 times for the rest of the households. The high cushion of net worth of the rich, combined with their gigantic share of income and consumption can sustain the low savings rate (and therefore the current account deficit) in the plutonomies. Please see figure 25.
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Figure 25. U.S.: Net Worth to Income Ratio for the Rich Is High and Rising. Drives and Sustains High Consumption out of Their Massive Income; Keeping Aggregate Savings Rate Low and Current Account Deficit Large
8 7 6 5 4 3 2 1 0 Less than 20-39.9 40-59.9 60-79.9 80-89.9 20 Income Percentiles of Families 90-100 Net Worth to Family Income, By Income Percentiles For Survey Years 1989, 1992, 1995, 1998, 2001 8 7 6 5 4 3 2 1 0
Source: Survey of Consumer Finances, Federal Reserve Board, and Citigroup Investment Research
To summarize so far, plutonomies see the rich absorb a disproportionate chunk of the economy, their decision to lower their savings rate, often corresponding to the asset booms that often accompany plutonomy, has a massive negative impact on reported aggregate numbers like savings rates, current account deficits, consumption levels, etc. We believe the key global imbalance is that some large economies have become plutonomies, and others have not -- this imbalance in inequality expresses itself in the standard scary “global imbalances” that so worry the bears and most observers. They do not worry us much. In addition, the emerging market entrepreneur/plutocrats (Russian oligarchs, Chinese real estate/manufacturing tycoons, Indian software moguls, Latin American oil/agriculture barons), benefiting disproportionately from globalization are logically diversifying into the asset markets of the developed plutonomies. They are attracted by the facets that facilitated the re-emergence of plutonomies in the U.S., UK, and Canada - technology, internationalism, the rule of law, financial innovation and capitalist-friendly cooperative governments. This further inflates the asset markets in these plutonomies, enabling the rich there to lower their savings rates further, and worsening their current account balances further. Just as misery loves company, we posit that the “plutos” like to hang out together. We stress that our analysis of the relationship between income concentration (plutonomy) and the household savings rates is confined to industrialized countries. This relationship in emerging markets is weak or non-existent. As mentioned earlier, the emerging markets’ elites often do their spending and investment in developed plutonomies rather than at home.
WHAT MIGHT CHANGE THIS?
Our view that plutonomy is driving savings and consumption imbalances is all very well. But before examining how to make money from this theme, we want to look at what might cause it to change.
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THE DEATH OF PLUTONOMY
At the heart of plutonomy, is income inequality. Societies that are willing to tolerate/endorse income inequality, are willing to tolerate/endorse plutonomy. Earlier, we postulated a number of key tenets for the creation of plutonomy. As a reminder, these were: 1) an ongoing technology/biotechnology revolution, 2) capitalistfriendly governments and tax regimes, 3) globalization that re-arranges global supply chains with mobile well-capitalized elites and immigrants, 4) greater financial complexity and innovation, 5) the rule of law, and 6) patent protection. We make the assumption that the technology revolution, and financial innovation, are likely to continue. So an examination of what might disrupt Plutonomy - or worse, reverse it - falls to societal analysis: will electorates continue to endorse it, or will they end it, and why. Organized societies have two ways of expropriating wealth - through the revocation of property rights or through the tax system. Capital markets, like human beings, generally strive for certainty and stability. The pricing of assets is easier, projections more comfortable, etc. For this reason, in developed capital markets, governments have learnt the lessons of level playing fields, regulatory certainty, and the sanctity of property rights. However this does not mean that governments are incapable of revoking property rights. While this tends to be something more often seen in countries with a shorter history of capitalist democracy, such as the Ukraine (attempts to undo prior privatizations), or Russia (where some of our clients believe events surrounding Mikhail Khodorovsky to be a form of nationalization), it can happen in the strangest of places. For example, in 2001, UK government withdrawal of financial support bankrupted Railtrack, the UK rail operator, effectively re-nationalizing railway assets on the cheap. But these moves are exceptional and generally counter-productive as they raise the risk premium, in theory, for future transactions with that power. If the government is willing to be a contestant and simultaneously set and change the rules of the game to their advantage, the rewards of the game must rise to attract other participants. The more likely means of expropriation is through the tax system. Corporate tax rates could rise, choking off returns to the private sector, and personal taxation rates could rise - dividend, capital-gains, and inheritance tax rises would hurt the plutonomy. There is a third way to change things though not necessarily by expropriation, and that is to slow down the rate of wealth creation or accumulation by the rich - generally through a reduction in the profit share of GDP. This could occur through a change in rules that affect the balance of power between labor and capital. Classic examples of this tend to fall under one of two buckets - the regulation of the domestic labor markets through minimum wages, regulating the number of hours worked, deciding who can and cannot work etc, or by dictating where goods and services can be imported from (protectionism).
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WHERE DO WE STAND TODAY?
In the plutonomies, there seems little threat from the first of these challenges: blatant expropriation of property by governments. There are few examples of governments changing the rules in the plutonomies and engaging in widespread nationalization, or asset re-distribution. Likewise, if anything, the trends of taxation are positive for corporates, with fiscal competition in Europe forcing rates lower, year by year. Ironically, this is happening most in non-plutonomy countries, like Germany. This is good for the profit share, of which the mega-rich, through their holdings of equity, are “long”. However, even if the profit share is rising, the fruits of those profits could be taxed before ending up in the pockets of the rich. In other words, dividend, capital gains and estate taxes could all rise. However, we struggle to find examples of this happening. Indeed, in the U.S., the current administration’s attempts to change the estate tax code and make permanent dividend tax cuts, plays directly into the hands of the plutonomy. While such Pluto-friendly policies are not widely being copied around the world, we have not found examples of the opposite occurring elsewhere. Protectionism or regulation. Here, we believe lies a cornerstone of the current wave of plutonomy, and with it, the potential for capitalists around the world to profit. The wave of globalization that the world is currently surfing, is clearly to the benefit of global capitalists, as we have highlighted. But it is also to the disadvantage of developed market labor, especially at the lower end of the food-chain. There are periodic attempts by countries to redress this balance - Jospin’s introduction of the 35 hour working week in France to the anticipated benefit of labor being one example. But in general, on-going globalization is making it easier for companies to either outsource manufacturing (source from cheap emerging markets like China and India) or “offshore” manufacturing (move production to lower cost countries). Brunswick, the recreational services company, is typical of the “globalized” world we now live in. We were intrigued to see in the company’s September 27 presentation, that in 2000, the company had 17 manufacturing/procurement centers globally, 14 of them in North America, high cost European countries or Japan. Today, five years later, they have 40 manufacturing/sourcing /engineering centers. Of these half are in low-cost countries. Such examples abound in today’s globalized world. The final option for countries willing to consider it, is to in-source labor. For example, in the UK, between May 2004 accession of the 10 new countries into the EU, and March 2005, 176,000 workers have moved from the accession countries to the UK and joined the workforce. Leaving aside any demand benefits they might bring, this does, in theory keep the price of labor contained. It interests us that the Plutonomy countries (U.S.A, UK, Australia, and Canada) all have - generally - a welcoming attitude to skilled immigration. Of the pre-accession EU 15 countries, only a handful, the UK and Ireland included allow full and free labor movement from the new EU 10 countries into their labor markets. The vast majority, Germany, Austria, Italy etc., are refusing to allow accession countries full freedom of movement until 2009-11.
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So, property rights look as if they are being protected, tax policies helpful, and the profit share should continue to rise, through globalization and the productivity/technology wave. Our conclusion? The three levers governments and societies could pull on to end plutonomy are benign. Property rights are generally still intact, taxation policies neutral to favorable, and globalization is keeping the supply of labor in surplus, acting as a brake on wage inflation.
IS THERE A BACKLASH BUILDING?
Plutonomy, we suspect is elastic. Concentration of wealth and spending in the hands of a few, probably has its limits. What might cause the elastic to snap back? We can see a number of potential challenges to plutonomy. The first, and probably most potent, is through a labor backlash. Outsourcing, offshoring or insourcing of cheap labor is done to undercut current labor costs. Those being undercut are losers in the short term. While there is evidence that this is positive for the average worker (for example Ottaviano and Peri) it is also clear that high-cost substitutable labor loses. Low-end developed market labor might not have much economic power, but it does have equal voting power with the rich. We see plenty of examples of the outsourcing or offshoring of labor being attacked as “unpatriotic” or plain unfair. This tends to lead to calls for protectionism to save the low-skilled domestic jobs being lost. This is a cause championed, generally, by left-wing politicians. At the other extreme, insourcing, or allowing mass immigration, which might price domestic workers out of jobs, leads to calls for anti-immigration policies, at worst championed by those on the far right. To this end, the rise of the far right in a number of European countries, or calls (from the right) to slow down the accession of Turkey into the EU, and calls from the left to rebuild trade barriers and protect workers (the far left of Mr. Lafontaine, garnered 8.5% of the vote in the German election, fighting predominantly on this issue), are concerning signals. This is not something restricted to Europe. Sufficient numbers of politicians in other countries have championed slowing immigration or free trade (Ross Perot, Pauline Hanson etc.). A second related threat, might come from productive labor no longer maintaining its productive edge. Again, we find Kevin Phillips’s arguments in his book, Wealth and Democracy, fascinating. Phillips highlights the problems in the late 1700s Netherlands, where an increasing obsession with financial speculation (sound familiar?) caused nonfinancial skilled labor that had built that country’s wealth, to seek their success in other countries. Likewise, Britain’s failure to keep its educational advantage in what were then high-tech areas caused them to lose their competitive advantage that had been maintained until the First World War. Are there similarities with Asian economies, versus the plutonomies, today? A third threat comes from the potential social backlash. To use Rawls-ian analysis, the invisible hand stops working. Perhaps one reason that societies allow plutonomy, is because enough of the electorate believe they have a chance of becoming a Plutoparticipant. Why kill it off, if you can join it? In a sense this is the embodiment of the 24
“American dream”. But if voters feel they cannot participate, they are more likely to divide up the wealth pie, rather than aspire to being truly rich. Could the plutonomies die because the dream is dead, because enough of society does not believe they can participate? The answer is of course yes. But we suspect this is a threat more clearly felt during recessions, and periods of falling wealth, than when average citizens feel that they are better off. There are signs around the world that society is unhappy with plutonomy - judging by how tight electoral races are. But as yet, there seems little political fight being born out on this battleground. A related threat comes from the backlash to “Robber-barron” economies. The population at large might still endorse the concept of plutonomy but feel they have lost out to unfair rules. In a sense, this backlash has been epitomized by the media coverage and actual prosecution of high-profile ex-CEOs who presided over financial misappropriation. This “backlash” seems to be something that comes with bull markets and their subsequent collapse. To this end, the cleaning up of business practice, by highprofile champions of fair play, might actually prolong plutonomy. Our overall conclusion is that a backlash against plutonomy is probable at some point. However, that point is not now. So long as economies continue to grow, and enough of the electorates feel that they are benefiting and getting rich in absolute terms, even if they are less well off in relative terms, there is little threat to Plutonomy in the U.S., UK, etc. But the balance of power between right (generally pro-plutonomy) and left (generally pro-equality) is on a knife-edge in many countries. Just witness how close the U.S. election was last year, or how close the results of the German election were. A collapse in wealth in the plutonomies, felt by the masses, and/or prolonged recession could easily raise the prospects of anti-plutonomy policy. We should at this point make clear that we have no view on whether plutonomies are good or bad, our analysis here is based on the facts, not what we want society to look like.
HOW TO PLAY PLUTONOMY
So, Plutonomies exist, and explain much of the world’s imbalances. There is no such thing as “The U.S. Consumer” or “UK Consumer”, but rich and poor consumers in these countries, with different savings habits and different prospects. The rich are getting richer; they dominate spending. Their trend of getting richer looks unlikely to end anytime soon. How do we make money from this theme? We see two ways. The first is simple. If you believe, like us, that the Plutonomy exists, and explains why global imbalances have built up (for example the savings rate differentials), and you believe there is no imminent threat to plutonomy, you must in turn believe that the current “end of the world is nigh” risk premium on equities, due to current account deficits, is too high. Conclusion: buy equities. There is however a more refined way to play plutonomy, and this is to buy shares in the companies that make the toys that the Plutonomists enjoy. 25
As the rich have been getting progressively richer over the last 30 years, saving less and spending more, the fortunes of companies that sell to the rich ought to have been good. Not only have the rich been earning and spending more, but they are less price elastic than typical consumers. In fact we believe they have a preference for Giffen goods, i.e., the more expensive they are, the more they are purchased. One way we can measure this is to look at price inflation for a basket of luxury goods. Thankfully, Forbes magazine each year publishes its “Cost of Living Extremely Well” Indices, which measures annual price changes in a basket of high end consumer items, from luxury yachts, to the cost of dinner at the world’s top restaurants, right down to the cost of a pair of fine English shoes. Figure 26 shows this index, back to 1976, and the aggregate CPI for the U.S. Since 1976, when this index started, the inflation rate of luxury products that the rich buy, has risen far faster than overall CPI. Turned around another way, the corporate price deflator for luxury items, or pricing power for luxury companies, has been relatively positive.
Figure 26. Forbes “The Cost of Living Extremely Well Index” - Pricing Power for Luxury Goods Much Stronger than Overall CPI Over Time
700 600 500 400 300 200 100 Clewi Index CPI
700 600 500 400 300 200 100 1976 1980 1984 1988 1992 1996 2000 2004
Source: Citigroup Investment Research, Forbes, and Datastream
This pricing power is surely a huge benefit to luxury related companies. In theory, all other things being equal, this added pricing power should have led to outperformance, and if maintained, should continue to do so.
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Figure 27. The Plutonomy Basket: Stocks That Leverage of Plutonomy
Company RIC Rating GICS Industry Group Market Price Oct 13 Val. U$m
1. Porsche 2. Dickson Concepts 3. Beneteau 4. Bulgari 5. Burberry 6. Coach 7. Hermes 8. LVMH
PSHG_p.DE 0113.HK BEN.PA BULG.MI BRBY.L COH RMS.PA MC.PA
3H NR NR 1M 1M NR NR NR NR 1M NR NR NR 1H NR NR
Autos & Components Capital Goods Cons Durables & App Cons Durables & App Cons Durables & App Cons Durables & App Cons Durables & App Cons Durables & App Cons Durables & App Cons Durables & App Cons Durables & App Cons Durables & App Cons Durables & App Cons Durables & App Cons Durables & App Consumer Services Consumer Services Consumer Services Consumer Services Consumer Services Consumer Services Div Financials Div Financials Retailing
6,282 452 1,404 3,215 3,093
EUR601.63 $11.3 EUR67.5 EUR9.055 £3.7125
11,116 $29.24 8,058 EUR184.1
39,346 EUR67.3 2,998 $49.26
9. Polo Ralph RL Lauren 10. Richemont CFR.VX 11. Rodriguez ROD.PA Group 12. Tasaki 7968 Shinju 13. Tod's TOD.MI 14. Toll Brothers 15. Wolford 16. Four Seasons Hotels 17. Kuoni TOL WOF.F FSH-SV.TO
21,304 SwF48.2 735 161 1,776 5,838 101 1,850 EUR49.3 ¥488 EUR49.2 $37.5 EUR17 $66.54
KUNN.S
1M NR NR NR NR 1H NR NR
1,178 801 3,874 150 920 3,877 1,801 5,491
SwF510 $0.805 HK$11.9 ¥920,000 $16.04 SwF95.15 SwF36 $38.55
18. Mandarin MOIL.SI Oriental 19. Shangri-La 0069.HK Asia 20. Shinwa Art 2437 Auction 21. Sothebys BID 22. Julius BaerBAER.VX 23. Vontobel VONN.SW 24. Tiffany TIF
Source: Citigroup Investment Research and Datastream
To test this, we built a basket of companies that serve or sell to the rich, the beneficiaries of Plutonomy. The companies - not all followed by Citigroup Investment Research - fall into a number of areas, from Private Banking (for example Julius Baer), to traditional luxury goods like Bulgari, through art auction houses (e.g., Sotheby’s), and of course luxury toys, such as Porsche. The full basket is in Figure 27. We emphasize that a stock’s inclusion in this basket in no way makes it a recommended buy, from Citigroup Investment Research, unless rated so by our respective analyst. The basis for inclusion was that a majority of the company’s revenues were/are derived from the “rich”. Hence Bombardier, the manufacturer of Lear Jets, did not make the list,
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though clearly that product is a typical plutonomy “toy”. This list is by no means exhaustive. So how did it perform? Since 1985, our starting point for this plutonomy basket, it has generated an annualized return of 17.8%, handsomely outperforming indices such as the S&P500. “Aha”, we hear you say, “you are picking up a sector effect!” Well, we tried sectoradjusting our basket, to remove what is a predominantly consumer sector bias, and found this made very little difference to the results. The basket still performed very well through the 1980s and 1990s. While there is some survivor bias, in our list, compared to standard indices, we nevertheless find what we expected: that the plutonomy basket performed exceptionally well. So well in fact, that our fashion-loving colleague Priscilla pointed out the obvious “wow, I can get rich by owning the plutonomy stocks, and then spend my money on these products”. Figure 28 shows the performance of the Plutonomy Basket back to 1985, in absolute terms, and in Figure 29 relative to the MSCI AC World Index. This is a handsome outperformance. But there are periods where the basket performed poorly or less well, for example after the 1987 stock market crash, or in a more muted fashion during the recent bear market.
Figure 28. The Plutonomy Basket Has Handsomely Outperformed the Global Equity Market Since 1985, on Average by 6.8% a Year
3500 3000 2500 2000 1500 1000 500 0 1/85 1/88
Absolute Price Performance Plutonomy Basket (Eq-Wgt) MSCI AC World
1/91
1/94
1/97
1/00
1/03
1/06
Note: Price performance of the Plutonomy basket is calculated based on 5 stocks in 1985, 14 stocks in 1990, 20 stocks in 2000 and 24 stocks in 2005. Source: Citigroup Investment Research, Datastream, and MSCI
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Figure 29. Up, Up and Away: Plutonomy Basket Outperforms World Equities Handsomely 450 400 350 300 250 200 150 100 50 1/85 1/88 1/91 1/94 1/97 1/00 1/03 1/06 Plutonomy Basket Performance Relative to MSCI AC World
Source: Citigroup Investment Research, Datastream, and MSCI
This is hardly a major surprise; given that the Plutonomy is fuelled by an equity market boom, and threatened by a bust, given the rich are disproportionately long the equity market. The average person, by contrast, tends to have a disproportionate amount of their wealth tied up in housing. While a stock market boom should help the rich, a housing boom should help the average Joe. Belsky and Prakken’s paper suggests that housing booms tend to get reflected in spending more rapidly than stock market booms - in other words, the wealth effect from house price rises gets turned on more quickly than from equity prices rising. It is interesting when we look at the performance of the stock market relative to the housing market, and compare this to the performance of the Plutonomy basket relative to the broad equity market, we find that during periods of house price appreciation relative to stock market appreciation, our plutonomy basket moves sideways. See Figure 30.
Figure 30. If Stocks beat Housing, Plutonomy Basket Does Even Better - The Rich Have disproportionately More Equities than Housing
600 500 400 300 200 100 0
US stock market / housing prices, LS Plutonomy basket rel to world stock market, RS Equities underperformance stifles luxury basket advance. If equities beat housing going forward, luxury may do well.
400 350 300 250 200 150 100 50 0
1/85
1/88
1/91
1/94
1/97
1/00
1/03
1/06
Note: U.S. housing prices based on NAR Median Sales Prices of existing 1-Family Homes Source: Citigroup Investment Research, Datastream, National Association of Realtors, and MSCI
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If like us, you believe that attempts by the UK, U.S., and Australian authorities to cool the housing market is likely to work, and you believe, like us, that equities are likely to perform well in coming years, this is a good time to switch out of stocks that sell to the masses and back to the plutonomy basket.
Conclusion
We are not often shocked. But shocked we were, when we published our note on the Irrelevance of Oil, several weeks ago, and discovered just how significant the rich were in terms of income, wealth and consumption in the U.S. Looking into this in more detail, we have found that the U.S. is not alone. Un-equal societies abound in the Anglo-Saxon world. This income inequality, we have called Plutonomy. Outlandish it may sound, but examined through the prism of plutonomy, some of the great mysteries of the economic world seem to look less mystifying. As we showed, there is a clear relationship between income inequality and low savings rates: the rich are happy to run low or negative savings given their growing pool of wealth. In turn, those countries with low/negative household savings rates tend to be the countries associated with current account deficits. So why should we equity strategists care about this? Well simply, because the issue that most consistently seems to vex our equity client base, from a top down perspective, is the U.S. current account deficit, the associated lack of savings, and the build-up of debt. It is both intellectually fashionable and elegant, apparently, to attack “the crazy American consumer, and his/her overspending”. This has of course, from a portfolio perspective, been a costly trade to run-with, over the last 10 years. Those “crazy American consumers” seem to be in rude health. Their imminent demise has been a long time imminent. If we are right, that the rise of income inequality, the rise of the rich, the rise of plutonomy, is largely to blame for these “perplexing” global imbalances. Surely, then, it is the collapse of plutonomy, rather than the collapse of the U.S. dollar that we should worry about to bring an end to imbalances. In other words, we are fretting unnecessarily about global imbalances. In turn, the risk premium on equities is probably too high. Secondly, we hear so often about “the consumer”. But when we examine the data, there is no such thing as “the consumer” in the U.S. or UK, or other plutonomy countries. There are rich consumers, and there are the rest. The rich are getting richer, we have contended, and they dominate consumption. As the rich have been getting richer, so too stocks associated with the rich, have performed exceptionally well. Our Plutonomy Basket, generated returns of 17.8% per annum, on average, from 1985. If Plutonomy continues, which we think it will, if income inequality is allowed to persist and widen, the plutonomy basket should continue to do very well. Names in this basket that our analysts recommend as buys include Julius Baer, Bulgari, Burberry, Richemont, Kuoni, and Toll Brothers.
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Bibliography
1. Alveredo, Facundo & Saez, Emmanuel. “Income and Wealth Concentration in Spain in a Historical and Fiscal Perspective. September 2005. 2. Atkinson, A.B. “Income Inequality in OECD Countries: Data and Explanations: Center for Economic Studies Working Paper No. 881.” Center for Economic Research, Feb. 2003 3. Atkinson, A.B. “Top Incomes in the United Kingdom over the Twentieth Century”. Discussion Paper in Economic and Social History, Univeristy of Oxford. December 2003. 4. Atkinson, A.B. and Salverda, Wiemer “Top Incomes in the Netherlands and the United Kingdom over the Twentieth Century”. Discussion Paper in Economic and Social History, Univeristy of Oxford. June 2003. 5. Bayoumi, Tamim & Edison, Hali “Is Wealth Increasingly Driving Consumption?”. DNB Staff Reports 2003, No. 101 6. © Belsky, Eric & Prakken, Joel. “Housing Wealth Effects: Housing’s Impact on Wealth Accumulation, Wealth Distribution and Consumer Spending”. December 2004. W-4-13. Joint Center for Housing Studies. © 2004 President and Fellows of Harvard College. 7. Dell, Fabian; Piketty, Thomas; Saez, Emmanuel; “Income and Wealth Concentration in the Switzerland Over the 20th Century”. Discussion Paper 590. Centre for Economic Policy Research. May 2005. 8. Feroli, Michael. “Capital Flows Among the G-7 Nations: A Demographic Perspective”. Federal Research Board Division of Research and Statistics. October 2003. 9. Heshmati, Almas “The World Distribution of Income and Income Inequality”, IZA Discussion Paper No. 1267. Institute for the Study of Labor. August 2004. 10. Juster F. Thomas; Lupton, Joseph P.; Smith, James P.; Stafford, Frank. “The Decline in Household Saving and the Wealth Effect”. University of Michigan, Board of Governors of the Federal Reserve System. April 2004. 11. Kaplan, Richard “Economic Inequality and the Role of Law”. Kaplan PP5. December 2003. 12. Kpczuk, Wojciech & Saez, Emmanuel. “Top Wealth Shares in the United States, 1916-2000: Evidence From Estate Tax Returns”. National Bureau of Economic Research. March 2004. 13. Leigh, Andrew “Permanent Income Inequality: Australia, Britain, Germany, and United States Compared”. Social Policy Evaluation, Analysis and Research Centre, Research School of Social Sciences, Australian National University. September 2005. 14. Maki, Dean M. & Palumbo, Michael G. “Disentangling the Wealth Effect: A Cohort Analysis of Household Saving in the 1990’s”. Board of Governors of the Federal Reserve System & Putnam Investments. April 2001. 31
15. Moriguchi, Chiaki & Saez, Emmanuel. “The Evolution of Income Concentration in Japan, 1885 - 2002: Evidence from Income Tax Statistics”. National Bureau of Economic Research. August 2005. 16. Phillips, Kevin. “Wealth and Democracy”. Broadway Books. 2002. 17. Piketty, Thomas “Income Inequality in France 1901 - 1998” April 2001. 18. Piketty, Thomas & Saez, Emmanuel “Income Inequality in the United States, 1913 - 2002. November 2004. 19. Schmidt-Hebbel, Kalus & Serven, Luis. “Income Inequality and Aggregate Saving. The Cross-Country Evidence”. Policy Research Working Paper 1561. The World Bank, Policy Research Department, Macroeconomics and Growth Division, January 1996. 20. Saez, Emmanual “Income and Wealth Concentration in a Historical and International Perspective”. February 2004. 21. Saez, Emmanuel “Reported Incomes and Marginal Tax Rates, 1960-2000: Evidence and Policy Implications”. National Bureau of Economic Research. January 2004. 22. Saez, Emmanuel. “Top Incomes in the United States and Canada over the Twentieth Century” 23. Saez, Emmanuel & Veall, Michael R. “The Evolution of High Incomes in Northern America: Lessons from Canadian Evidence”. The American Economic Review. June 2005. 24. Smeeding, Timothy. “Globalization, Inequality, and the Rich Countries of the G20: Evidence From the Luxembourg Income Study”. The Maxwell School of Syracuse University Center for Policy Research. November 2002. 25. Smeeding, Timothy M. “Public Policy, Economic Inequality, and Poverty: The United States in Comparative Perspective”. The Maxwell School of Syracuse University Center for Policy Research. May 2005. 26. Wolff, Edward N. “Changes in Household Wealth in the 1980’s and 1990’s in the U.S.” International Perspectives on Household Wealth, Elgar Publishing Ltd., April 2004.
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ANALYST CERTIFICATION
APPENDIX A-1
I, Ajay Kapur, Niall Macleod, Narendra Singh, research analyst and the author of this report, hereby certify that all of the views expressed in this research report accurately reflect my personal views about any and all of the subject issuer(s) or securities. I also certify that no part of my compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report.
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Industry Note
Equity Strategy
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October 16, 2005
SUMMARY
➤ The World is dividing into two blocs - the Plutonomy and the rest. The U.S.,
Ajay Kapur, CFA
+1-212-816-4813 ajay.kapur@citigroup.com
Niall Macleod
+44-20-7986-4449 niall.j.macleod@citigroup.com
Narendra Singh
+1-212-816-2807 narendra.singh@citigroup.com
UK, and Canada are the key Plutonomies - economies powered by the wealthy. Continental Europe (ex-Italy) and Japan are in the egalitarian bloc. ➤ Equity risk premium embedded in “global imbalances” are unwarranted. In plutonomies the rich absorb a disproportionate chunk of the economy and have a massive impact on reported aggregate numbers like savings rates, current account deficits, consumption levels, etc. This imbalance in inequality expresses itself in the standard scary “ global imbalances”. We worry less. ➤ There is no “average consumer” in a Plutonomy. Consensus analyses focusing on the “average” consumer are flawed from the start. The Plutonomy Stock Basket outperformed MSCI AC World by 6.8% per year since 1985. Does even better if equities beat housing. Select names: Julius Baer, Bulgari, Richemont, Kuoni, and Toll Brothers.
WELCOME TO THE PLUTONOMY MACHINE
In early September we wrote about the (ir)relevance of oil to equities and introduced the idea that the U.S.is a Plutonomy - a concept that generated great interest from our clients. As global strategists, this got us thinking about how to buy stocks based on this plutonomy thesis, and the subsequent thesis that it will gather strength and amass breadth. In researching this idea on a global level and looking for stock ideas we also chanced upon some interesting big picture implications. This process manifested itself with our own provocative thesis: that the so called “global imbalances” that worry so many of our equity clients who may subsequently put a lower multiple on equities due to these imbalances, is not as dangerous and hostile as one might think. Our economics team led by Lewis Alexander researches and writes about these issues regularly and they are the experts. But as we went about our business of finding stock ideas for our clients, we thought it important to highlight this provocative macro thesis that emerged, and if correct, could have major implications in terms of how equity investors assess the risk embedded in equity markets. Sometimes kicking the tires can tell you a lot about the car-business. Well, here goes. Little of this note should tally with conventional thinking. Indeed, traditional thinking is likely to have issues with most of it. We will posit that: 1) the world is dividing into two blocs - the plutonomies, where economic growth is powered by and largely consumed by the wealthy few, and the rest. Plutonomies have occurred before in sixteenth century Spain, in seventeenth century Holland, the Gilded Age and the Roaring Twenties in the U.S. What are the common drivers of Plutonomy? Disruptive technology-driven productivity gains, creative financial innovation, capitalistCitigroup Research is a division of Citigroup Global Markets Inc. (the "Firm"), which does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Non-US research analysts who have prepared this report, and who may be associated persons of the member or member organization, are not registered/qualified as research analysts with the NYSE and/or NASD, but instead have satisfied the registration/qualification requirements or other research-related standards of a non-US jurisdiction.
Global
friendly cooperative governments, an international dimension of immigrants and overseas conquests invigorating wealth creation, the rule of law, and patenting inventions. Often these wealth waves involve great complexity, exploited best by the rich and educated of the time. 2) We project that the plutonomies (the U.S., UK, and Canada) will likely see even more income inequality, disproportionately feeding off a further rise in the profit share in their economies, capitalist-friendly governments, more technology-driven productivity, and globalization. 3) Most “Global Imbalances” (high current account deficits and low savings rates, high consumer debt levels in the Anglo-Saxon world, etc) that continue to (unprofitably) preoccupy the world’s intelligentsia look a lot less threatening when examined through the prism of plutonomy. The risk premium on equities that might derive from the dyspeptic “global imbalance” school is unwarranted - the earth is not going to be shaken off its axis, and sucked into the cosmos by these “imbalances”. The earth is being held up by the muscular arms of its entrepreneur-plutocrats, like it, or not. Fixing these “global imbalances” that many pundits fret about requires time travel to change relative fertility rates in the U.S. versus Japan and Continental Europe. Why? There is compelling evidence that a key driver of current account imbalances is demographic differences between regions. Clearly, this is tough. Or, it would require making the income distribution in the Anglo-Saxon plutonomies (the U.S., UK, and Canada) less skewed to the rich, and relatively egalitarian Europe and Japan to suddenly embrace income inequality. Both moves would involve revolutionary tectonic shifts in politics and society. Note that we have not taken recourse to the conventional curatives of global rebalance - the dollar needs to drop, either abruptly, or smoothly, the Chinese need to revalue, the Europeans/Japanese need to pump domestic demand, etc. These have merit, but, in our opinion, miss the key driver of imbalances - the select plutonomy of a few nations, the equality of others. Indeed, it is the “unequal inequality”, or the imbalances in inequality across nations that corresponds with the “global imbalances” that so worry some of the smartest people we know. 4) In a plutonomy there is no such animal as “the U.S. consumer” or “the UK consumer”, or indeed the “Russian consumer”. There are rich consumers, few in number, but disproportionate in the gigantic slice of income and consumption they take. There are the rest, the “non-rich”, the multitudinous many, but only accounting for surprisingly small bites of the national pie. Consensus analyses that do not tease out the profound impact of the plutonomy on spending power, debt loads, savings rates (and hence current account deficits), oil price impacts etc, i.e., focus on the “average” consumer are flawed from the start. It is easy to drown in a lake with an average depth of 4 feet, if one steps into its deeper extremes. Since consumption accounts for 65% of the world economy, and consumer staples and discretionary sectors for 19.8% of the MSCI AC World Index, understanding how the plutonomy impacts consumption is key for equity market participants. 5) Since we think the plutonomy is here, is going to get stronger, its membership swelling from globalized enclaves in the emerging world, we think a “plutonomy basket” of stocks should continue do well. These toys for the wealthy have pricing 2
power, and staying power. They are Giffen goods, more desirable and demanded the more expensive they are.
RIDING THE GRAVY TRAIN - WHERE ARE THE PLUTONOMIES?
The U.S., UK, and Canada are world leaders in plutonomy. (While data quality in this field can be dated in emerging markets, and less than ideal in developed markets, we have done our best to source information from the most reliable and credible government and academic sources. There is an extensive bibliography at the end of this note). Countries and regions that are not plutonomies: Scandinavia, France, Germany, other continental Europe (except Italy), and Japan.
THE UNITED STATES PLUTONOMY - THE GILDED AGE, THE ROARING TWENTIES, AND THE NEW MANAGERIAL ARISTOCRACY
Let’s dive into some of the details. As Figure 1 shows the top 1% of households in the U.S., (about 1 million households) accounted for about 20% of overall U.S. income in 2000, slightly smaller than the share of income of the bottom 60% of households put together. That’s about 1 million households compared with 60 million households, both with similar slices of the income pie! Clearly, the analysis of the top 1% of U.S. households is paramount. The usual analysis of the “average” U.S. consumer is flawed from the start. To continue with the U.S., the top 1% of households also account for 33% of net worth, greater than the bottom 90% of households put together. It gets better (or worse, depending on your political stripe) - the top 1% of households account for 40% of financial net worth, more than the bottom 95% of households put together. This is data for 2000, from the Survey of Consumer Finances (and adjusted by academic Edward Wolff). Since 2000 was the peak year in equities, and the top 1% of households have a lot more equities in their net worth than the rest of the population who tend to have more real estate, these data might exaggerate the U.S. plutonomy a wee bit. Was the U.S. always a plutonomy - powered by the wealthy, who aggrandized larger chunks of the economy to themselves? Not really. For those interested in the details, we recommend “Wealth and Democracy: A Political History of the American Rich” by Kevin Phillips, Broadway Books, 2002.
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Figure 1. Characterizing the U.S. Plutonomy: Based on the Consumer Finance Survey, the Top 1% Accounted For 20% of Income, 40% of Financial Wealth and 33% of Net Worth in the U.S. (More Than the Net Worth of the Bottom 95% Households Put Together) in 2001
Year Top 1% Next 4% Next 5% Next 10% Top 20% 4th 20% 3rd 20% Bottom 40%
A. Net Worth 1983 1989 1992 1995 1998 2001 B. Financial Wealth 1983 1989 1992 1995 1998 2001 C. Income 1982 1988 1991 1994 1997 2000
33.8 37.4 37.2 38.5 38.1 33.4 42.9 46.9 45.6 47.2 47.3 39.7 12.8 16.6 15.7 14.4 16.6 20.0
22.3 21.6 22.8 21.8 21.3 25.8 25.1 23.9 25.0 24.6 21.0 27.8 13.3 13.3 14.8 14.5 14.4 15.2
12.1 11.6 11.8 11.5 11.5 12.3 12.3 11.6 11.5 11.2 11.4 12.3 10.3 10.4 10.6 10.4 10.2 10.0
13.1 13.0 12.0 12.1 12.5 12.9 11.0 11.0 10.2 10.1 11.2 11.4 15.5 15.2 15.3 15.9 15.0 13.5
81.3 83.5 83.8 83.9 83.4 84.4 91.3 93.4 92.3 93.0 90.9 91.3 51.9 55.6 56.4 55.1 56.2 58.6
12.6 12.3 11.5 11.4 11.9 11.3 7.9 7.4 7.3 6.9 8.3 7.8 21.6 20.6 20.4 20.6 20.5 19.0
5.2 4.8 4.4 4.5 4.5 3.9 1.7 1.7 1.5 1.4 1.9 1.7 14.2 13.2 12.8 13.6 12.8 12.3
0.9 -0.7 0.4 0.2 0.2 0.3 -0.9 -2.5 -1.1 -1.3 -1.1 -0.7 12.3 10.7 10.5 10.7 10.5 10.1
Source: Table 2 from Edward Wolff (please see reference 26 in the bibliography at the end of the report). Computations done by Prof. Wolff from the 1983, 1989, 1992, 1995, 1998, and 2001 Surveys of Consumer Finances. For the computation of percentile shares of net worth, households are ranked according to their net worth; for percentile shares of financial wealth, households are ranked according to their financial wealth; and for percentile shares of income, households are ranked according to their income. Net worth in Prof Wolff’s calculation is the difference in value between total assets and total liabilities or debt. Total assets are defined as the sum of: (1) the gross value of owner-occupied housing; (2) other real estate owned by the household; (3) cash and demand deposits; (4) time and savings deposits, certificates of deposit, and money market accounts; (5) government bonds, corporate bonds, foreign bonds, and other financial securities; (6) the cash surrender value of life insurance plans; (7) the cash surrender value of pension plans, including IRAs, Keogh, and 401(k) plans; (8) corporate stock and mutual funds; (9) net equity in unincorporated businesses; and (10) equity in trust funds. Total liabilities are the sum of: (1) mortgage debt, (2) consumer debt, including auto loans, and (3) other debt. Prof Wolff defines Financial wealth as net worth minus net equity in owner-occupied housing. Financial wealth is a more "liquid" concept than marketable wealth, since one's home is difficult to convert into cash in the short term.
Figure 2. The Income Share of the Top 0.1% of U.S. Households Has Risen from Under 2% in the Early 1970s to Over 7% in 2000, Based on Tax Data
35 30 25 20 15 10 5 0 1913
USA, income share of top 5%
Top 1%-5% Top 0.1%-1% Top 0.1%
35 30 25 20 15 10 5 0
1924
1935
1946
1957
1968
1979
1990
2001
(Please see references 18 in the bibliography at the end of the report). Due difference in sources and method of calculations the income share estimates from tax based data do not exactly match Survey of Consumer Finance data. Source: Prof. Emmanuel Saez et. al., reference 18.
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We will focus here on data from Prof. Emmanuel Saez of U.C. Berkeley who works with data from tax sources. Figure 2 shows the share of income for the top 0.1%, 1% and 5% in the U.S. since the 1910s. Clearly the fortunes of the top 0.1% fluctuate the most. Indeed, the fortunes of the top 5% (or even top 10%), or the top 1%, are almost entirely driven by the fortunes of the top 0.1% (roughly 100,000 households). With the exception of the boom in the Roaring 1920s, this super-rich group kept losing out its share of incomes in WWI, the Great Depression and WWII, and till the early eighties. Why? The answers are unclear, but the massive loss of capital income (dividend, rents, interest income, but not capital gains) from progressive corporate and estate taxation is a possible candidate. The rise in their share since the mid-eighties might be related to the reduction in corporate and income taxes. Also, to a new wave of entrepreneurs and managers earning disproportionate incomes as they drove and participated in the ongoing technology boom. As Figure 3 shows, while in the early 20th century capital income was the big chunk for the top 0.1% of households, the resurgence in their fortunes since the mid-eighties was mainly from oversized salaries. The rich in the U.S. went from coupon-clipping, dividend-receiving rentiers to a Managerial Aristocracy indulged by their shareholders.
Figure 3. The Metamorphosis of the Highest 1% of Income Earners in the U.S.: from Rentier Rich to a Managerial Technocratic Aristocracy
100 90 80 70 60 50 40 30 20 10 0 16 26 36 46 56 66 76 86 96 Wage Interest USA Sources of Income, Top 1% Entreprenurial Rents Dividends 1999 100 90 80 70 60 50 40 30 20 10 0
Please see reference 18 in the bibliography at the end of the report for the data underlying the chart. Based on tax returns data. Source: Citigroup Investment Research
EGALITARIAN JAPAN, CONTINENTAL EUROPE AND THE PLUTONOMIES OF CANADA AND THE UK
How did the Plutonomy fare in other countries over time? As Figures 4 and 5 show, the UK and Canada, pretty much follow the U.S. script. Japan, France, and the Netherlands are a bit different. These were all plutonomies before the Great Depression, but the War, taxation, and new post-War institutional structures generated much more egalitarian societies, that hold even today. Only Switzerland remained unchanged. Neutrality through the wars saw its capital preserved, the lack of a progressive income and wealth tax regime, and low taxes helped.
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Figure 4. Plutonomy At Work: The Income Share of the Top 1% Has Risen Dramatically Since the Late 1970s in the U.S., the U.K., and Canada
19 17 15 13 11 9 7 5 60 63 66 69 72 75 78 81 84 87 90 93 96 99 02
Please see references 18, 4, 22 in the bibliography at the end of the report for the data underlying the chart. Estimates based on tax return data. Source: Citigroup Investment Research
Income Share of the Top 1%
19 17
USA UK Canada
15 13 11 9 7 5
Figure 5. Of Egalitarian Bent: The Income Share of the Top 1% Is Much Smaller and Is Not Rising as Much, If at All, in Switzerland, the Netherlands, Japan, and France
19 17 15 13 11 9 7 5 60 63 66 69 72 75 78 81 84 87 90 93 96 99 02
Please see references 7,17,15,4 in the bibliography at the end of the report for the data underlying the chart. Estimates based on tax return data. Source: Citigroup Investment Research
Income Share of the Top 1% Switzerland France Japan Netherlands
19 17 15 13 11 9 7 5
See Figures 6 thru 11 for a panorama of plutonomy and egalitarianism.
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Figure 6. Plutonomy in the UK: The Income Share of the Top 0.5% Rose from Under 4% in the mid 70s to Over 9% in the Late 1990s
30 25 20 15 10 5 UK, Income Share of the Top 5% Top 1%-5% Top 0.5%-1% Top 0.5% 20 15 10 5 30 25
0 0 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999
Please see reference 4 in the bibliography at the end of the report for the data. Source: Citigroup Investment Research
Figure 7. Return of Plutonomy in Canada: The Income Share of the Top 5% Is at the Highest Level Since the 1940s
40 35 30 25 20 15 10 5 0 1920 1930 1940 1950 1960 1970 1980 1990 Canada, Income Share of the Top 5% Top 1%-5% Top 0.1%-1% Top 0.1% 40 35 30 25 20 15 10 5 0 2000
Please see reference 22 in the bibliography at the end of the report for the data. Source: Citigroup Investment Research and http://elsa.berkeley.edu/~saez/index.html
Figure 8. Switzerland Benefits From Neutrality: Remarkably Stable Income Share of the Very Rich Over the Past 60 Years
25 20 15 10 5 0 1933 Top 1%-5% Top 0.1%-1% Top 0.1% Switzerland, income share of top 5% 25 20 15 10 5 0 1996
1942
1951
1960
1969
1978
1987
7
Please see reference 7 in the bibliography at the end of the report for the data. Source: Citigroup Investment Research
Figure 9. France: The Income Share of the Rich Fell During WWII But Stayed Stable in the 1980s and 1990s
35 30 25 20 15 10 5 0 17 26 35 44 53 62 71 80 89 98 France, income share of top 5% Top 1%-5% Top 0.1%-1% Top 0.1% 35 30 25 20 15 10 5 0
Please see reference 17 in the bibliography at the end of the report for the data. Source: Citigroup Investment Research
Figure 10. The Netherlands: Decline in the Share of the Top 5% and the Very Rich Until 1980. Share Relatively Stable in Recent Years
45 40 35 30 25 20 15 10 5 0 14 19 24 29 34 39 44 49 54 59 64 69 74 79 84 89 94 99
Please see reference 4 in the bibliography at the end of the report for the data. Source: Citigroup Investment Research
Netherlands, income share of top 5% Top 1%-5% Top 0.1%-1% Top 0.1%
45 40 35 30 25 20 15 10 5 0
Figure 11. Japan: The Income Share of the Top 0.1% and the Top 1% Remarkably Flat in the Post-War Period.
35 30 25 20 15 10 5 0 07 17 27 37 47 57 67 77 87 97 2002 Japan, income share of top 5% Top 1%-5% Top 0.1%-1% Top 0.1% 35 30 25 20 15 10 5 0
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Please see reference 15 in the bibliography at the end of the report for the data. Source: Citigroup Investment Research
PLUTONOMY WAVES - TECHNOLOGY, IMMIGRATION, FINANCE, COMPLEXITY (AND DOPAMINE) DRIVEN?
The reasons why some societies generate plutonomies and others don’t are somewhat opaque, and we’ll let the sociologists and economists continue debating this one. Kevin Phillips in his masterly “Wealth and Democracy” argues that a few common factors seem to support “wealth waves” - a fascination with technology (an Anglo-Saxon thing according to him), the role of creative finance, a cooperative government, an international dimension of immigrants and overseas conquests invigorating wealth creation, the rule of law, and patenting inventions. Often these wealth waves involve great complexity. “One explanation of ...increasing polarization of wealth comes from considering these great transformations as surges of complexity - waves of economic, political and commercial change - profound enough to break down old vocational and price relationships, greatly favoring persons with position, capital, skills, and education” (page 259, author’s emphasis). Clearly, a speculative instinct is key to generating and sustaining these complex and risky transformations. Here, a new, rather out-of-the box hypothesis suggests that dopamine differentials can explain differences in risk-taking between societies. John Mauldin, the author of “Bulls-Eye Investing” in an email last month cited this work. The thesis: Dopamine, a pleasure-inducing brain chemical, is linked with curiosity, adventure, entrepreneurship, and helps drive results in uncertain environments. Populations generally have about 2% of their members with high enough dopamine levels with the curiosity to emigrate. Ergo, immigrant nations like the U.S. and Canada, and increasingly the UK, have high dopamine-intensity populations. If encouraged to keep the rewards of their high dopamine-induced risk-seeking entrepreneurialism, these countries will be more prone to wealth waves, unequally distributed. Presto, a plutonomy driven by dopamine! Interesting that Kevin Phillips also mentioned the role of immigrants in driving great wealth waves (oblivious to the role of dopamine, though). He emphasizes the role of the in-migration of skilled and well-capitalized refugees and cosmopolitan elites in catalyzing wealth waves. Being the son of refugee parents from the India-Pakistan partition in 1947, and now a wandering global nomad, I can see this argument quite clearly. (Also, I need to get my dopamine level checked.) Phillips talks of the four great powers - Spain in the fifty years after 1492, the United Provinces (Holland) in the sixteenth century, seventeenth century England, and nineteenth century U.S., all benefiting from waves of immigrants, fleeing persecution, and nabbing opportunities in distant lands.
WHY THE PLUTONOMY WILL GET STRONGER WHERE IT EXISTS, PERHAPS ATTRACT NEW COUNTRIES
We posit that the drivers of plutonomy in the U.S. (the UK and Canada) are likely to strengthen, entrenching and buttressing plutonomy where it exists. The six drivers of the current plutonomy: 1) an ongoing technology/biotechnology revolution, 2) capitalistfriendly governments and tax regimes, 3) globalization that re-arranges global supply 9
chains with mobile well-capitalized elites and immigrants, 4) greater financial complexity and innovation, 5) the rule of law, and 6) patent protection are all well ensconced in the U.S., the UK, and Canada. They are also gaining strength in the emerging world. Eastern Europe is embracing many of these attributes, as are China, India, and Russia. Even Continental Europe may succumb and be seduced by these drivers of plutonomy. As we argued in the Global Investigator, “Earnings - Don’t Worry, Capitalists Still on Top”, June 10, 2005, the profit share of GDP is highly likely to keep rising to the highs seen in the 1950s/60s. New markets like China and India, their contribution to the global labor supply, the ongoing productivity revolution, the quasi-Bretton Woods system in the U.S. dollar bloc, and inflation-fighting central banks should all help. However, a high profit share like in the 1950s/60s does not ensure plutonomy. Indeed, in the 1950s/60s, U.S. and other key countries did not see increasing income inequality. Society and governments need to be amenable to disproportionately allow/encourage the few to retain that fatter profit share. The Managerial Aristocracy, like in the Gilded Age, the Roaring Twenties, and the thriving nineties, needs to commandeer a vast chunk of that rising profit share, either through capital income, or simply paying itself a lot. We think that despite the post-bubble angst against celebrity CEOs, the trend of cost-cutting balance sheet-improving CEOs might just give way to risk-seeking CEOs, re-leveraging, going for growth and expecting disproportionate compensation for it. It sounds quite unlikely, but that’s why we think it is quite possible. Meanwhile Private Equity and LBO funds are filling the risk-seeking and re-leveraging void, expecting and realizing disproportionate remuneration for their skills.
THOSE SCARY “GLOBAL IMBALANCES” - REFLECT PLUTONOMY AND DEMOGRAPHY, QUITE LOGICAL AND UNTHREATENING
We have all heard the lament. A bearish guru, somber and serious, spelling out that the end is near if something is not done urgently about those really huge, nasty “Global Imbalances”. The U.S. savings rate is too low, the U.S. current account deficit is too high, foreigners are not going to keep financing this unless compensated with higher interest rates, and a sharply lower U.S. dollar. The world, being so imbalanced, is about to tip over it’s axis, all hell is going to break loose, so don’t any equities - the risk premium is high reflecting these imbalances and is going to go higher (i.e., lower stock prices) when the earth finally does keel over. A more balanced view acknowledges these nasty imbalances, but predicts a gentle, gradual dollar decline, a yuan revaluation, and the hope that Asians and European (exUK) consumers will embark on a spending journey, righting the world. A tough workout, but she’ll be right. Almost all the smart folks we know - our investors, our colleagues, our friends in academia, politicians believe in some variant of these two stories. There are very few exceptions who consider these “Global Imbalances” not scary but perfectly natural and rather harmless. (We can think of Gavekal as one of these exceptions, but their repose of comfort is different from ours - they have a new book out “The Brave New World”, elucidating the new business model of global “Platform” companies, etc).
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Our point here is not to dismiss the conventional views as outright wrong. However, we offer a competing view and, in some instance, a view that is complementary to the conventional explanation. Our view, if right, suggests that applying an excessive risk premium to “Global Imbalances” is a flawed approach to equity investing. Note that our house view, for instance, sees no cataclysmic collapse in the dollar. The U.S. current account deficit is anticipated to remain flat at 6.8% of GDP. The Japanese and the Euro surpluses are expected to continue. A plutonomy world is not inconsistent with these forecasts.
Figure 12. Global Imbalances: Plutonomies Are Running Current Account Deficits. Non-Plutonomies Are Running Current Account Surpluses
3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 -5.0 -6.0 Non-Plutonomies Current Account % GDP Plutonomies Current Account % GDP 80 82 84 86 88 90 92 94 96 98 00 02 04 06
Note: For our purposes, Plutonomies = U.S., U.K. and Canada. Non-Plutonomies = EuroZone, Japan, and Switzerland. Missing are the newly industrialized nations of Asia and China. Source: International Monetary Fund and Datastream
3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 -5.0 -6.0
First a quick glance at these Global imbalances. Figure 12 shows the current account balances for plutonomies (the U.S., UK, and Canada) and the others - continental Europe and Japan. We have left out China and other emerging markets because we do not have their income inequality data, although they are definitely an important part of the “Global Imbalance” story. Well, it seems that the plutonomies (the U.S., UK, and Canada together) have deteriorating current account balances; the others are running a combined current account surplus. Current account balances are driven by three possible sources - the net savings of the government, the corporate sector and the household sector. Figure 13 shows our bottomup estimates for corporate free cash flow/sales, a close cousin of corporate savings these look similarly good across the world, both for plutonomies and the others. We won’t pursue this avenue as a key driver of today’s imbalances.
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Figure 13. Free Cash Flow to Sales Is High Across the Major Regions. No Difference Between Plutonomies and the Others
6 5 4 3 2 1 0 -1 -2 -3 -4 1/88 US 1/91 1/94 Europe 1/97 1/00 Japan 1/03 1/06 FCF to Sales
Source: Citigroup Investment Research and Worldscope
How about government deficits? Well, they seem to be equally bad in the U.S., UK, Continental Europe, and very bad in Japan. Hmm. We’ll leave this one alone too.
Figure 14. The Gap in the Savings Rate of Plutonomies and the Others Moves Closely with the Gap in the Current Account Balance
-5.0 -5.5 -6.0 -6.5 -7.0 -3.0 -7.5 -8.0 -8.5 -9.0 80 82 84 86 88 90 92 94 96 98 00 02 04 06
Note: For our purposes, Plutonomies = U.S., U.K. and Canada. Non-Plutonomies = EuroZone, Japan and Switzerland. Missing are the newly industrialized nations of Asia and China. Source: International Monetary Fund and Datastream
Difference, Household Savings Rate of Plutonomies less Non-Plutonomies Difference, Current Acc % GDP of Plutonomies less Non-Plutonomies (RS)
2.0 1.0 0.0 -1.0 -2.0
-4.0 -5.0 -6.0 -7.0
We need to focus on the household sector (the consumer in simple English) as the key driver of those current account imbalances that so worry the equity bears. Indeed, Figure 14 shows the gap between the households sector’s savings rate for the plutonomies (U.S., UK, and Canada) less those of continental Europe and Japan. This gap is large and moves with the gap in the current accounts of these two blocs. Our contention is simple - while the drivers of savings rates in countries are many - we focus on plutonomy as a key new explanation for different savings rates in different 12
countries. (As an aside, considerable empirical research shows that the external imbalances between the U.S., Europe, and Japan are driven by demography. The U.S. is just younger than Japan, driving household savings differences that drive those current account differences. This topic is beyond the scope of our story here. For those interested, check out “Capital Flows Among the G-7 Nations: A Demographic Perspective”, Michael Feroli, U.S. Federal Reserve Board, October 2003). Our contention: when the top, say 1% of households in a country see their share of income rise sharply, i.e., a plutonomy emerges, this is often in times of frenetic technology/financial innovation driven wealth waves, accompanied by asset booms, equity and/or property. Feeling wealthier, the rich decide to consume a part of their capital gains right away. In other words, they save less from their income, the wellknown wealth effect. The key point though is that this new lower savings rate is applied to their newer massive income. Remember they got a much bigger chunk of the economy, that’s how it became a plutonomy. The consequent decline in absolute savings for them (and the country) is huge when this happens. They just account for too large a part of the national economy; even a small fall in their savings rate overwhelms the decisions of all the rest. Figure 15 provides a simple example of how this happens.
Figure 15. A Numerical Example: If the Income Share of the Top Group Is High, A Reduction in the Savings Rate of the Top Income Group (due to Asset Appreciation, for example) Can More than Offset Any Increase in the Savings Rates of Others
Pre-Plutonomy Income Top 20% $20 Next 20% $20 Third 20% $20 Fourth 20% $20 Poorest 20% $20 Total $100 Plutonomy Emerges: Income Top 20% $60 Next 20% $10 Next 20% $10 Next 20% $10 Poorest $10 Total $100 Savings rate 10% 10% 10% 10% 10% 10% New savings rate 5% or 8% or 9% 11% 11% 11% 11% 7.4% or 9.2% or 9.8% Savings $2 $2 $2 $2 $2 $10 Savings $3 or $4.8 or $5.4 $1.1 $1.1 $1.1 $1.1 $7.4 or $9.2 or $9.8
Source: Citigroup Investment Research
There is proof that high income earners, who saw their share of income go up in the U.S. in the nineties, and enjoyed the equity boom, reduced their savings rate as in our example. Indeed, in the real world, it went negative! Since that reduced savings rate was applied to their new enlarged chunk of income, sure enough the total savings rate fell sharply. Dean Maki and Michael Palumbo, wrote the paper (at Alan Greenspan’s suggestion) that demonstrated this fall in the savings rate of the rich in response to the equity boom (See Maki and Palumbo, “Disentangling the Wealth Effect: A Cohort Analysis of Household Savings in the 1990s”, April 2001). Figure 16 demonstrates the savings rates at different points for different income groups.) The very rich, the top 20%, had a savings rate of 8%, much higher than other less affluent groups in 1992. By 2000 this savings rate had gone from 8%- to -2%! The wealth effect at work. And then this reduced savings rate 13
of the rich hit their huge incomes, swollen by the plutonomy, savaging the U.S.’s overall savings rate. This is our contribution to the debate. Plutonomy plus an asset boom equals a drop in the overall savings rate. (Asset booms by themselves, i.e., the wealth effect by itself does not do the trick, as we will show soon.)
Figure 16. Household Savings Rates of the Rich Fell in the Stock Boom in the 1990s While Those of the Lower Income Groups Rose (Maki-Palumbo Estimates)
10 8 6 4 2 0 -2 -4 Top Quintile Rich are saving a lower proportion of their income (actually dissaving) in 2000 compared to 1992 (Maki-Palumbo estimates) 61-80% 41%-60% 21%-40% Bottom Quintile Savings Rate by Income Quintiles Year 1992 Year 2000 Lower income 10 savings rate 8 higher 6 4 2 0 -2 -4
Please see reference 14 in the bibliography at the end of the report for the data underlying the chart. Based on tax returns data. Source: Citigroup Investment Research
Let’s look at some of the coolest figures that amplify and verify this idea. Figure 17 plots the share of the top 1% of U.S. households since 1929. Our thesis is that the higher the share of income going to the top 1%, the lower the overall household savings rate (shown inverted in Figure 17). There is a pretty tight correlation between the two, despite the many other drivers of savings rates (demography, interest rates, financial deepening, retirement security, etc). The same information is shown in Figure 18, a scatter plot - when the rich take a very high share of overall income, the national household savings rate drops, and vice versa. In a plutonomy, the rich drop their savings rate, consume a larger fraction of their bloated, very large share of the economy. This behavior overshadows the decisions of everybody else. The behavior of the exceptionally rich drives the national numbers - the “appallingly low” overall savings rates, the “over-extended consumer”, and the “unsustainable” current accounts that accompany this phenomenon. We want to spend little time worrying about these (non)issues, neither do we think they warrant any risk premium on equities. They simply reflect the reality of demographic differences between nations, and that some nations are plutonomies, while others are not. Unequal inequality among nations is mirrored in the logical imbalances between them.
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Figure 17. The Aggregate U.S. Household Savings Rate and the Income Share of the Top 1% Moves More Closely Together
20 18 16 14 12 Depression 10 8
Income share of the top 1% Savings Rate (RS, reverse scale)
-4 -2 0 2 4 6 8
World War II
10 12
6 29 34 39 44 49 54 59 64 69 74 79 84 89 94 99 04
Please see reference 18 in the bibliography at the end of the report for the data underlying income share. Source: Bureau of Economic Analysis
Figure 18. There is a High and Negative Correlation Between the U.S. Household Savings Rate and Income Concentration (1929-02, World War II Years 1940-44 Excluded)
12 Household Savings Rate 10 8 6 4 2 0 -2 8 10 Income share of the top 1% of households 12 14 16 18 y = -0.74x + 15.07 R2 = 0.70 12 10 8 6 4 2 0 -2 20
Note: Similar high correlations are obtained even if we use the income share of the top 10% (RSq = 0.70) or the income share of the top 5% (RSq = 0.73). Please see reference 18 in the bibliography at the end of the report for the data underlying income share. Source: Citigroup Investment Research
How about more empirical verification of the relationship between the household savings rate and the share of the rich in other plutonomies like the UK and Canada? Figure 19 shows the relationship for the UK using data from 1951 onwards. Note the clear negative relationship that we expect. In the nineties, there seems to have been an upward shift in the relationship between the UK personal savings rate and income inequality. There are number of drivers for the savings rate, as highlighted earlier, and 15
the impact of these other drivers could shift the relationship around - our comfort comes from the persistence of the negative relationship in the UK.
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Figure 19. In the U.K., A Strongly Negative Relationship Between Income Concentration (Plutonomy) and the Aggregate Household Savings Rate. The Relationship Shifted Upward in the 1990s
14 12 10 1989 8 6 4 2 0 4 6 8 10 12 14 UK, Income Share of the Top 1% y = -1.80x + 20.57 R2 = 0.70 1951-88 1990-99 Household Savings Rate 14 y = -1.72x + 28.48 2 R = 0.81 12 10 8 6 4 2 0
Please see reference 4 in the bibliography at the end of the report for the data underlying the chart. Based on tax returns data. Source: Citigroup Investment Research
Figure 20. Canada Also Shows a Close Relationship Between Income Concentration (Plutonomy) and the Aggregate Household Savings Rate
14 13 12 11 10 9 15 8 7 61 64 67 70 73 76 79 82 85 88 91 94 97 00 03 06
Please see reference 22 in the bibliography at the end of the report for the data underlying the chart. Based on tax returns data. Source: Citigroup Investment Research and http://elsa.berkeley.edu/~saez/index.html
Canada, income share of top 1% of population Household Savings Rate RS, reverse scale)
-5
0
5
10
20
17
Figure 21. Canada: High and Negative Correlation Between Aggregate Household Savings Rates and Income Concentration
25 Household Savings Rate 25
20 y = -2.21x + 31.14 R2 = 0.48
20
15
15
10
10
5 Canada, Income Share of top 1% 0 7 8 9 10 11 12 13 14
5
0
Note: Similar high correlations are obtained even if we use the income share of the top 10% (RSq = 0.60) or the income share of the top 5% (RSq = 0.62). Source: Citigroup Investment Research and http://elsa.berkeley.edu/~saez/index.html
Canada also confirms our thesis. A plutonomy begets a lower household savings rate. See Figures 20 and 21. We have also attempted, in Figure 22, to put the relationship on a cross border-basis for the eight countries where we have comparable data. Again, plutonomies like the U.S., Canada, and the UK have lower household savings rates than the more egalitarian countries like France, the Netherlands, Switzerland, Spain, and Japan.
Figure 22. Cross-Border Comparison: Countries With Lower Income Concentration (Continental Europe) Tend to Have Higher Aggregate Household Savings Rates High Income Concentration (Plutonomy) Is Associated with Lower Household Savings Rates
14 Household Savings Rate (for year shown) 12 10 8 6 4 2 0 4 8 y = -0.92x + 16.82 R2 = 0.79 JP(02) UK(99) CN(00) US(02) Income Share of Top 1% 12 16 FR(98) NL(99) SZ(96) SP(02)
Please see references 18, 4, 22, 7, 17, 15 in the bibliography at the end of the report for the data underlying the chart. Based on tax returns data. Source: Citigroup Investment Research and http://elsa.berkeley.edu/~saez/index.html
One quick point - we asserted earlier that a plutonomy plus an asset boom corresponded with a decline in the household savings rate. It was not just the standard asset boom spawning a wealth effect and ergo higher consumer spending and a lower savings rate. 18
Is there as tight a relationship between asset prices and the savings rate as there is between income inequality and the savings rate (correlation -0.7) shown in Figure 17? Well, in Figure 23 we plot the 10-year returns of the U.S. stock market with the household savings rate. While the relationship is tight in the great bull market between 1982-2000, the huge bull market in the 1950s and 1960s sees no real wealth effect. (The overall correlation of +0.19, i.e., low AND the wrong sign). Why? Among other sensible reasons we do not know, we think it was the absence of plutonomy in that period that kept the spending decisions of the rich, obviously enjoying solid equity gains, from dominating the overall numbers. They were just not disproportionately a big part of the economy then. That would have to wait for the 1980s.
Figure 23. U.S.: It Takes Plutonomy (Income Concentration) and Asset Inflation to Lower the Aggregate Household Savings Rate - Asset Inflation Alone May Not Be Enough
30% 25% 20% 15% 10% 5% 0% -5% -10% 10 15
Annual average 5-year total return, S&P500 Household Savings Rate (RS, reverse scale)
0 5
Bull Market, But No Plutonomy implies no decline in savings rate
Bull Market & Plutonomy implies decline in savings rate Correl = 0.19
20 25 30
37 41 45 49 53 57 61 65 69 73 77 81 85 89 93 97 01 05
Source: Citigroup Investment Research and Datastream
A skeptic, while agreeing with our plutonomy thesis, may still not be convinced about the ability of households to sustain the low savings rate. Surely, even in the brave new world of plutonomies we describe, households cannot forever keep their savings rate low? We have two interesting dynamics in place that should prevent a sharp drop in consumption and so pushing the savings rate higher. One, the difference of the household’s financial assets to disposable income (assets with value of housing stock excluded) and its liabilities to disposable income exceeds its historical average. Households can afford to run down their assets to finance consumption for a while. Please see Figure 24 we have borrowed from Lewis Alexander, our Chief Economist.
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Figure 24. The U.S. Household’s Financial Assets Are Far in Excess of Its Liabilities Even After the Correction in the TMT Bubble. It Can Afford to Maintain Its Low Savings Rate for a While
Financial Assets and Liabilities of Households (Percent of Diposable Income)
Percent 500 450 400 350 300 250 200 150 100 50 1/80
Percent 500 450 400 350 300 250 200 150 100 50
Financial Assets (left scale) Liabilities (right scale)
1/85
1/90
1/95
1/00
1/05
Source: Bureau of Economic Analysis, Federal Reserve Board, and Citigroup Investment Research
Two, as this note has been arguing it is the rich who are driving the low savings rate and high consumption in plutonomies. For the top decile in the U.S., the total net worth to income ratio is exceptionally high at 7.5 times compared to 4.5 times for the rest of the households. The high cushion of net worth of the rich, combined with their gigantic share of income and consumption can sustain the low savings rate (and therefore the current account deficit) in the plutonomies. Please see figure 25.
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Figure 25. U.S.: Net Worth to Income Ratio for the Rich Is High and Rising. Drives and Sustains High Consumption out of Their Massive Income; Keeping Aggregate Savings Rate Low and Current Account Deficit Large
8 7 6 5 4 3 2 1 0 Less than 20-39.9 40-59.9 60-79.9 80-89.9 20 Income Percentiles of Families 90-100 Net Worth to Family Income, By Income Percentiles For Survey Years 1989, 1992, 1995, 1998, 2001 8 7 6 5 4 3 2 1 0
Source: Survey of Consumer Finances, Federal Reserve Board, and Citigroup Investment Research
To summarize so far, plutonomies see the rich absorb a disproportionate chunk of the economy, their decision to lower their savings rate, often corresponding to the asset booms that often accompany plutonomy, has a massive negative impact on reported aggregate numbers like savings rates, current account deficits, consumption levels, etc. We believe the key global imbalance is that some large economies have become plutonomies, and others have not -- this imbalance in inequality expresses itself in the standard scary “global imbalances” that so worry the bears and most observers. They do not worry us much. In addition, the emerging market entrepreneur/plutocrats (Russian oligarchs, Chinese real estate/manufacturing tycoons, Indian software moguls, Latin American oil/agriculture barons), benefiting disproportionately from globalization are logically diversifying into the asset markets of the developed plutonomies. They are attracted by the facets that facilitated the re-emergence of plutonomies in the U.S., UK, and Canada - technology, internationalism, the rule of law, financial innovation and capitalist-friendly cooperative governments. This further inflates the asset markets in these plutonomies, enabling the rich there to lower their savings rates further, and worsening their current account balances further. Just as misery loves company, we posit that the “plutos” like to hang out together. We stress that our analysis of the relationship between income concentration (plutonomy) and the household savings rates is confined to industrialized countries. This relationship in emerging markets is weak or non-existent. As mentioned earlier, the emerging markets’ elites often do their spending and investment in developed plutonomies rather than at home.
WHAT MIGHT CHANGE THIS?
Our view that plutonomy is driving savings and consumption imbalances is all very well. But before examining how to make money from this theme, we want to look at what might cause it to change.
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THE DEATH OF PLUTONOMY
At the heart of plutonomy, is income inequality. Societies that are willing to tolerate/endorse income inequality, are willing to tolerate/endorse plutonomy. Earlier, we postulated a number of key tenets for the creation of plutonomy. As a reminder, these were: 1) an ongoing technology/biotechnology revolution, 2) capitalistfriendly governments and tax regimes, 3) globalization that re-arranges global supply chains with mobile well-capitalized elites and immigrants, 4) greater financial complexity and innovation, 5) the rule of law, and 6) patent protection. We make the assumption that the technology revolution, and financial innovation, are likely to continue. So an examination of what might disrupt Plutonomy - or worse, reverse it - falls to societal analysis: will electorates continue to endorse it, or will they end it, and why. Organized societies have two ways of expropriating wealth - through the revocation of property rights or through the tax system. Capital markets, like human beings, generally strive for certainty and stability. The pricing of assets is easier, projections more comfortable, etc. For this reason, in developed capital markets, governments have learnt the lessons of level playing fields, regulatory certainty, and the sanctity of property rights. However this does not mean that governments are incapable of revoking property rights. While this tends to be something more often seen in countries with a shorter history of capitalist democracy, such as the Ukraine (attempts to undo prior privatizations), or Russia (where some of our clients believe events surrounding Mikhail Khodorovsky to be a form of nationalization), it can happen in the strangest of places. For example, in 2001, UK government withdrawal of financial support bankrupted Railtrack, the UK rail operator, effectively re-nationalizing railway assets on the cheap. But these moves are exceptional and generally counter-productive as they raise the risk premium, in theory, for future transactions with that power. If the government is willing to be a contestant and simultaneously set and change the rules of the game to their advantage, the rewards of the game must rise to attract other participants. The more likely means of expropriation is through the tax system. Corporate tax rates could rise, choking off returns to the private sector, and personal taxation rates could rise - dividend, capital-gains, and inheritance tax rises would hurt the plutonomy. There is a third way to change things though not necessarily by expropriation, and that is to slow down the rate of wealth creation or accumulation by the rich - generally through a reduction in the profit share of GDP. This could occur through a change in rules that affect the balance of power between labor and capital. Classic examples of this tend to fall under one of two buckets - the regulation of the domestic labor markets through minimum wages, regulating the number of hours worked, deciding who can and cannot work etc, or by dictating where goods and services can be imported from (protectionism).
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WHERE DO WE STAND TODAY?
In the plutonomies, there seems little threat from the first of these challenges: blatant expropriation of property by governments. There are few examples of governments changing the rules in the plutonomies and engaging in widespread nationalization, or asset re-distribution. Likewise, if anything, the trends of taxation are positive for corporates, with fiscal competition in Europe forcing rates lower, year by year. Ironically, this is happening most in non-plutonomy countries, like Germany. This is good for the profit share, of which the mega-rich, through their holdings of equity, are “long”. However, even if the profit share is rising, the fruits of those profits could be taxed before ending up in the pockets of the rich. In other words, dividend, capital gains and estate taxes could all rise. However, we struggle to find examples of this happening. Indeed, in the U.S., the current administration’s attempts to change the estate tax code and make permanent dividend tax cuts, plays directly into the hands of the plutonomy. While such Pluto-friendly policies are not widely being copied around the world, we have not found examples of the opposite occurring elsewhere. Protectionism or regulation. Here, we believe lies a cornerstone of the current wave of plutonomy, and with it, the potential for capitalists around the world to profit. The wave of globalization that the world is currently surfing, is clearly to the benefit of global capitalists, as we have highlighted. But it is also to the disadvantage of developed market labor, especially at the lower end of the food-chain. There are periodic attempts by countries to redress this balance - Jospin’s introduction of the 35 hour working week in France to the anticipated benefit of labor being one example. But in general, on-going globalization is making it easier for companies to either outsource manufacturing (source from cheap emerging markets like China and India) or “offshore” manufacturing (move production to lower cost countries). Brunswick, the recreational services company, is typical of the “globalized” world we now live in. We were intrigued to see in the company’s September 27 presentation, that in 2000, the company had 17 manufacturing/procurement centers globally, 14 of them in North America, high cost European countries or Japan. Today, five years later, they have 40 manufacturing/sourcing /engineering centers. Of these half are in low-cost countries. Such examples abound in today’s globalized world. The final option for countries willing to consider it, is to in-source labor. For example, in the UK, between May 2004 accession of the 10 new countries into the EU, and March 2005, 176,000 workers have moved from the accession countries to the UK and joined the workforce. Leaving aside any demand benefits they might bring, this does, in theory keep the price of labor contained. It interests us that the Plutonomy countries (U.S.A, UK, Australia, and Canada) all have - generally - a welcoming attitude to skilled immigration. Of the pre-accession EU 15 countries, only a handful, the UK and Ireland included allow full and free labor movement from the new EU 10 countries into their labor markets. The vast majority, Germany, Austria, Italy etc., are refusing to allow accession countries full freedom of movement until 2009-11.
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So, property rights look as if they are being protected, tax policies helpful, and the profit share should continue to rise, through globalization and the productivity/technology wave. Our conclusion? The three levers governments and societies could pull on to end plutonomy are benign. Property rights are generally still intact, taxation policies neutral to favorable, and globalization is keeping the supply of labor in surplus, acting as a brake on wage inflation.
IS THERE A BACKLASH BUILDING?
Plutonomy, we suspect is elastic. Concentration of wealth and spending in the hands of a few, probably has its limits. What might cause the elastic to snap back? We can see a number of potential challenges to plutonomy. The first, and probably most potent, is through a labor backlash. Outsourcing, offshoring or insourcing of cheap labor is done to undercut current labor costs. Those being undercut are losers in the short term. While there is evidence that this is positive for the average worker (for example Ottaviano and Peri) it is also clear that high-cost substitutable labor loses. Low-end developed market labor might not have much economic power, but it does have equal voting power with the rich. We see plenty of examples of the outsourcing or offshoring of labor being attacked as “unpatriotic” or plain unfair. This tends to lead to calls for protectionism to save the low-skilled domestic jobs being lost. This is a cause championed, generally, by left-wing politicians. At the other extreme, insourcing, or allowing mass immigration, which might price domestic workers out of jobs, leads to calls for anti-immigration policies, at worst championed by those on the far right. To this end, the rise of the far right in a number of European countries, or calls (from the right) to slow down the accession of Turkey into the EU, and calls from the left to rebuild trade barriers and protect workers (the far left of Mr. Lafontaine, garnered 8.5% of the vote in the German election, fighting predominantly on this issue), are concerning signals. This is not something restricted to Europe. Sufficient numbers of politicians in other countries have championed slowing immigration or free trade (Ross Perot, Pauline Hanson etc.). A second related threat, might come from productive labor no longer maintaining its productive edge. Again, we find Kevin Phillips’s arguments in his book, Wealth and Democracy, fascinating. Phillips highlights the problems in the late 1700s Netherlands, where an increasing obsession with financial speculation (sound familiar?) caused nonfinancial skilled labor that had built that country’s wealth, to seek their success in other countries. Likewise, Britain’s failure to keep its educational advantage in what were then high-tech areas caused them to lose their competitive advantage that had been maintained until the First World War. Are there similarities with Asian economies, versus the plutonomies, today? A third threat comes from the potential social backlash. To use Rawls-ian analysis, the invisible hand stops working. Perhaps one reason that societies allow plutonomy, is because enough of the electorate believe they have a chance of becoming a Plutoparticipant. Why kill it off, if you can join it? In a sense this is the embodiment of the 24
“American dream”. But if voters feel they cannot participate, they are more likely to divide up the wealth pie, rather than aspire to being truly rich. Could the plutonomies die because the dream is dead, because enough of society does not believe they can participate? The answer is of course yes. But we suspect this is a threat more clearly felt during recessions, and periods of falling wealth, than when average citizens feel that they are better off. There are signs around the world that society is unhappy with plutonomy - judging by how tight electoral races are. But as yet, there seems little political fight being born out on this battleground. A related threat comes from the backlash to “Robber-barron” economies. The population at large might still endorse the concept of plutonomy but feel they have lost out to unfair rules. In a sense, this backlash has been epitomized by the media coverage and actual prosecution of high-profile ex-CEOs who presided over financial misappropriation. This “backlash” seems to be something that comes with bull markets and their subsequent collapse. To this end, the cleaning up of business practice, by highprofile champions of fair play, might actually prolong plutonomy. Our overall conclusion is that a backlash against plutonomy is probable at some point. However, that point is not now. So long as economies continue to grow, and enough of the electorates feel that they are benefiting and getting rich in absolute terms, even if they are less well off in relative terms, there is little threat to Plutonomy in the U.S., UK, etc. But the balance of power between right (generally pro-plutonomy) and left (generally pro-equality) is on a knife-edge in many countries. Just witness how close the U.S. election was last year, or how close the results of the German election were. A collapse in wealth in the plutonomies, felt by the masses, and/or prolonged recession could easily raise the prospects of anti-plutonomy policy. We should at this point make clear that we have no view on whether plutonomies are good or bad, our analysis here is based on the facts, not what we want society to look like.
HOW TO PLAY PLUTONOMY
So, Plutonomies exist, and explain much of the world’s imbalances. There is no such thing as “The U.S. Consumer” or “UK Consumer”, but rich and poor consumers in these countries, with different savings habits and different prospects. The rich are getting richer; they dominate spending. Their trend of getting richer looks unlikely to end anytime soon. How do we make money from this theme? We see two ways. The first is simple. If you believe, like us, that the Plutonomy exists, and explains why global imbalances have built up (for example the savings rate differentials), and you believe there is no imminent threat to plutonomy, you must in turn believe that the current “end of the world is nigh” risk premium on equities, due to current account deficits, is too high. Conclusion: buy equities. There is however a more refined way to play plutonomy, and this is to buy shares in the companies that make the toys that the Plutonomists enjoy. 25
As the rich have been getting progressively richer over the last 30 years, saving less and spending more, the fortunes of companies that sell to the rich ought to have been good. Not only have the rich been earning and spending more, but they are less price elastic than typical consumers. In fact we believe they have a preference for Giffen goods, i.e., the more expensive they are, the more they are purchased. One way we can measure this is to look at price inflation for a basket of luxury goods. Thankfully, Forbes magazine each year publishes its “Cost of Living Extremely Well” Indices, which measures annual price changes in a basket of high end consumer items, from luxury yachts, to the cost of dinner at the world’s top restaurants, right down to the cost of a pair of fine English shoes. Figure 26 shows this index, back to 1976, and the aggregate CPI for the U.S. Since 1976, when this index started, the inflation rate of luxury products that the rich buy, has risen far faster than overall CPI. Turned around another way, the corporate price deflator for luxury items, or pricing power for luxury companies, has been relatively positive.
Figure 26. Forbes “The Cost of Living Extremely Well Index” - Pricing Power for Luxury Goods Much Stronger than Overall CPI Over Time
700 600 500 400 300 200 100 Clewi Index CPI
700 600 500 400 300 200 100 1976 1980 1984 1988 1992 1996 2000 2004
Source: Citigroup Investment Research, Forbes, and Datastream
This pricing power is surely a huge benefit to luxury related companies. In theory, all other things being equal, this added pricing power should have led to outperformance, and if maintained, should continue to do so.
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Figure 27. The Plutonomy Basket: Stocks That Leverage of Plutonomy
Company RIC Rating GICS Industry Group Market Price Oct 13 Val. U$m
1. Porsche 2. Dickson Concepts 3. Beneteau 4. Bulgari 5. Burberry 6. Coach 7. Hermes 8. LVMH
PSHG_p.DE 0113.HK BEN.PA BULG.MI BRBY.L COH RMS.PA MC.PA
3H NR NR 1M 1M NR NR NR NR 1M NR NR NR 1H NR NR
Autos & Components Capital Goods Cons Durables & App Cons Durables & App Cons Durables & App Cons Durables & App Cons Durables & App Cons Durables & App Cons Durables & App Cons Durables & App Cons Durables & App Cons Durables & App Cons Durables & App Cons Durables & App Cons Durables & App Consumer Services Consumer Services Consumer Services Consumer Services Consumer Services Consumer Services Div Financials Div Financials Retailing
6,282 452 1,404 3,215 3,093
EUR601.63 $11.3 EUR67.5 EUR9.055 £3.7125
11,116 $29.24 8,058 EUR184.1
39,346 EUR67.3 2,998 $49.26
9. Polo Ralph RL Lauren 10. Richemont CFR.VX 11. Rodriguez ROD.PA Group 12. Tasaki 7968 Shinju 13. Tod's TOD.MI 14. Toll Brothers 15. Wolford 16. Four Seasons Hotels 17. Kuoni TOL WOF.F FSH-SV.TO
21,304 SwF48.2 735 161 1,776 5,838 101 1,850 EUR49.3 ¥488 EUR49.2 $37.5 EUR17 $66.54
KUNN.S
1M NR NR NR NR 1H NR NR
1,178 801 3,874 150 920 3,877 1,801 5,491
SwF510 $0.805 HK$11.9 ¥920,000 $16.04 SwF95.15 SwF36 $38.55
18. Mandarin MOIL.SI Oriental 19. Shangri-La 0069.HK Asia 20. Shinwa Art 2437 Auction 21. Sothebys BID 22. Julius BaerBAER.VX 23. Vontobel VONN.SW 24. Tiffany TIF
Source: Citigroup Investment Research and Datastream
To test this, we built a basket of companies that serve or sell to the rich, the beneficiaries of Plutonomy. The companies - not all followed by Citigroup Investment Research - fall into a number of areas, from Private Banking (for example Julius Baer), to traditional luxury goods like Bulgari, through art auction houses (e.g., Sotheby’s), and of course luxury toys, such as Porsche. The full basket is in Figure 27. We emphasize that a stock’s inclusion in this basket in no way makes it a recommended buy, from Citigroup Investment Research, unless rated so by our respective analyst. The basis for inclusion was that a majority of the company’s revenues were/are derived from the “rich”. Hence Bombardier, the manufacturer of Lear Jets, did not make the list,
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though clearly that product is a typical plutonomy “toy”. This list is by no means exhaustive. So how did it perform? Since 1985, our starting point for this plutonomy basket, it has generated an annualized return of 17.8%, handsomely outperforming indices such as the S&P500. “Aha”, we hear you say, “you are picking up a sector effect!” Well, we tried sectoradjusting our basket, to remove what is a predominantly consumer sector bias, and found this made very little difference to the results. The basket still performed very well through the 1980s and 1990s. While there is some survivor bias, in our list, compared to standard indices, we nevertheless find what we expected: that the plutonomy basket performed exceptionally well. So well in fact, that our fashion-loving colleague Priscilla pointed out the obvious “wow, I can get rich by owning the plutonomy stocks, and then spend my money on these products”. Figure 28 shows the performance of the Plutonomy Basket back to 1985, in absolute terms, and in Figure 29 relative to the MSCI AC World Index. This is a handsome outperformance. But there are periods where the basket performed poorly or less well, for example after the 1987 stock market crash, or in a more muted fashion during the recent bear market.
Figure 28. The Plutonomy Basket Has Handsomely Outperformed the Global Equity Market Since 1985, on Average by 6.8% a Year
3500 3000 2500 2000 1500 1000 500 0 1/85 1/88
Absolute Price Performance Plutonomy Basket (Eq-Wgt) MSCI AC World
1/91
1/94
1/97
1/00
1/03
1/06
Note: Price performance of the Plutonomy basket is calculated based on 5 stocks in 1985, 14 stocks in 1990, 20 stocks in 2000 and 24 stocks in 2005. Source: Citigroup Investment Research, Datastream, and MSCI
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Figure 29. Up, Up and Away: Plutonomy Basket Outperforms World Equities Handsomely 450 400 350 300 250 200 150 100 50 1/85 1/88 1/91 1/94 1/97 1/00 1/03 1/06 Plutonomy Basket Performance Relative to MSCI AC World
Source: Citigroup Investment Research, Datastream, and MSCI
This is hardly a major surprise; given that the Plutonomy is fuelled by an equity market boom, and threatened by a bust, given the rich are disproportionately long the equity market. The average person, by contrast, tends to have a disproportionate amount of their wealth tied up in housing. While a stock market boom should help the rich, a housing boom should help the average Joe. Belsky and Prakken’s paper suggests that housing booms tend to get reflected in spending more rapidly than stock market booms - in other words, the wealth effect from house price rises gets turned on more quickly than from equity prices rising. It is interesting when we look at the performance of the stock market relative to the housing market, and compare this to the performance of the Plutonomy basket relative to the broad equity market, we find that during periods of house price appreciation relative to stock market appreciation, our plutonomy basket moves sideways. See Figure 30.
Figure 30. If Stocks beat Housing, Plutonomy Basket Does Even Better - The Rich Have disproportionately More Equities than Housing
600 500 400 300 200 100 0
US stock market / housing prices, LS Plutonomy basket rel to world stock market, RS Equities underperformance stifles luxury basket advance. If equities beat housing going forward, luxury may do well.
400 350 300 250 200 150 100 50 0
1/85
1/88
1/91
1/94
1/97
1/00
1/03
1/06
Note: U.S. housing prices based on NAR Median Sales Prices of existing 1-Family Homes Source: Citigroup Investment Research, Datastream, National Association of Realtors, and MSCI
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If like us, you believe that attempts by the UK, U.S., and Australian authorities to cool the housing market is likely to work, and you believe, like us, that equities are likely to perform well in coming years, this is a good time to switch out of stocks that sell to the masses and back to the plutonomy basket.
Conclusion
We are not often shocked. But shocked we were, when we published our note on the Irrelevance of Oil, several weeks ago, and discovered just how significant the rich were in terms of income, wealth and consumption in the U.S. Looking into this in more detail, we have found that the U.S. is not alone. Un-equal societies abound in the Anglo-Saxon world. This income inequality, we have called Plutonomy. Outlandish it may sound, but examined through the prism of plutonomy, some of the great mysteries of the economic world seem to look less mystifying. As we showed, there is a clear relationship between income inequality and low savings rates: the rich are happy to run low or negative savings given their growing pool of wealth. In turn, those countries with low/negative household savings rates tend to be the countries associated with current account deficits. So why should we equity strategists care about this? Well simply, because the issue that most consistently seems to vex our equity client base, from a top down perspective, is the U.S. current account deficit, the associated lack of savings, and the build-up of debt. It is both intellectually fashionable and elegant, apparently, to attack “the crazy American consumer, and his/her overspending”. This has of course, from a portfolio perspective, been a costly trade to run-with, over the last 10 years. Those “crazy American consumers” seem to be in rude health. Their imminent demise has been a long time imminent. If we are right, that the rise of income inequality, the rise of the rich, the rise of plutonomy, is largely to blame for these “perplexing” global imbalances. Surely, then, it is the collapse of plutonomy, rather than the collapse of the U.S. dollar that we should worry about to bring an end to imbalances. In other words, we are fretting unnecessarily about global imbalances. In turn, the risk premium on equities is probably too high. Secondly, we hear so often about “the consumer”. But when we examine the data, there is no such thing as “the consumer” in the U.S. or UK, or other plutonomy countries. There are rich consumers, and there are the rest. The rich are getting richer, we have contended, and they dominate consumption. As the rich have been getting richer, so too stocks associated with the rich, have performed exceptionally well. Our Plutonomy Basket, generated returns of 17.8% per annum, on average, from 1985. If Plutonomy continues, which we think it will, if income inequality is allowed to persist and widen, the plutonomy basket should continue to do very well. Names in this basket that our analysts recommend as buys include Julius Baer, Bulgari, Burberry, Richemont, Kuoni, and Toll Brothers.
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Bibliography
1. Alveredo, Facundo & Saez, Emmanuel. “Income and Wealth Concentration in Spain in a Historical and Fiscal Perspective. September 2005. 2. Atkinson, A.B. “Income Inequality in OECD Countries: Data and Explanations: Center for Economic Studies Working Paper No. 881.” Center for Economic Research, Feb. 2003 3. Atkinson, A.B. “Top Incomes in the United Kingdom over the Twentieth Century”. Discussion Paper in Economic and Social History, Univeristy of Oxford. December 2003. 4. Atkinson, A.B. and Salverda, Wiemer “Top Incomes in the Netherlands and the United Kingdom over the Twentieth Century”. Discussion Paper in Economic and Social History, Univeristy of Oxford. June 2003. 5. Bayoumi, Tamim & Edison, Hali “Is Wealth Increasingly Driving Consumption?”. DNB Staff Reports 2003, No. 101 6. © Belsky, Eric & Prakken, Joel. “Housing Wealth Effects: Housing’s Impact on Wealth Accumulation, Wealth Distribution and Consumer Spending”. December 2004. W-4-13. Joint Center for Housing Studies. © 2004 President and Fellows of Harvard College. 7. Dell, Fabian; Piketty, Thomas; Saez, Emmanuel; “Income and Wealth Concentration in the Switzerland Over the 20th Century”. Discussion Paper 590. Centre for Economic Policy Research. May 2005. 8. Feroli, Michael. “Capital Flows Among the G-7 Nations: A Demographic Perspective”. Federal Research Board Division of Research and Statistics. October 2003. 9. Heshmati, Almas “The World Distribution of Income and Income Inequality”, IZA Discussion Paper No. 1267. Institute for the Study of Labor. August 2004. 10. Juster F. Thomas; Lupton, Joseph P.; Smith, James P.; Stafford, Frank. “The Decline in Household Saving and the Wealth Effect”. University of Michigan, Board of Governors of the Federal Reserve System. April 2004. 11. Kaplan, Richard “Economic Inequality and the Role of Law”. Kaplan PP5. December 2003. 12. Kpczuk, Wojciech & Saez, Emmanuel. “Top Wealth Shares in the United States, 1916-2000: Evidence From Estate Tax Returns”. National Bureau of Economic Research. March 2004. 13. Leigh, Andrew “Permanent Income Inequality: Australia, Britain, Germany, and United States Compared”. Social Policy Evaluation, Analysis and Research Centre, Research School of Social Sciences, Australian National University. September 2005. 14. Maki, Dean M. & Palumbo, Michael G. “Disentangling the Wealth Effect: A Cohort Analysis of Household Saving in the 1990’s”. Board of Governors of the Federal Reserve System & Putnam Investments. April 2001. 31
15. Moriguchi, Chiaki & Saez, Emmanuel. “The Evolution of Income Concentration in Japan, 1885 - 2002: Evidence from Income Tax Statistics”. National Bureau of Economic Research. August 2005. 16. Phillips, Kevin. “Wealth and Democracy”. Broadway Books. 2002. 17. Piketty, Thomas “Income Inequality in France 1901 - 1998” April 2001. 18. Piketty, Thomas & Saez, Emmanuel “Income Inequality in the United States, 1913 - 2002. November 2004. 19. Schmidt-Hebbel, Kalus & Serven, Luis. “Income Inequality and Aggregate Saving. The Cross-Country Evidence”. Policy Research Working Paper 1561. The World Bank, Policy Research Department, Macroeconomics and Growth Division, January 1996. 20. Saez, Emmanual “Income and Wealth Concentration in a Historical and International Perspective”. February 2004. 21. Saez, Emmanuel “Reported Incomes and Marginal Tax Rates, 1960-2000: Evidence and Policy Implications”. National Bureau of Economic Research. January 2004. 22. Saez, Emmanuel. “Top Incomes in the United States and Canada over the Twentieth Century” 23. Saez, Emmanuel & Veall, Michael R. “The Evolution of High Incomes in Northern America: Lessons from Canadian Evidence”. The American Economic Review. June 2005. 24. Smeeding, Timothy. “Globalization, Inequality, and the Rich Countries of the G20: Evidence From the Luxembourg Income Study”. The Maxwell School of Syracuse University Center for Policy Research. November 2002. 25. Smeeding, Timothy M. “Public Policy, Economic Inequality, and Poverty: The United States in Comparative Perspective”. The Maxwell School of Syracuse University Center for Policy Research. May 2005. 26. Wolff, Edward N. “Changes in Household Wealth in the 1980’s and 1990’s in the U.S.” International Perspectives on Household Wealth, Elgar Publishing Ltd., April 2004.
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ANALYST CERTIFICATION
APPENDIX A-1
I, Ajay Kapur, Niall Macleod, Narendra Singh, research analyst and the author of this report, hereby certify that all of the views expressed in this research report accurately reflect my personal views about any and all of the subject issuer(s) or securities. I also certify that no part of my compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report.
IMPORTANT DISCLOSURES
Analysts’ compensation is determined based upon activities and services intended to benefit the investor clients of Citigroup Global Markets Inc. and its affiliates ("the Firm"). Like all Firm employees, analysts receive compensation that is impacted by overall firm profitability, which includes revenues from, among other business units, the Private Client Division, Institutional Equities, and Investment Banking.
Citigroup Investment Research Ratings Distribution
Data current as of 30 September 2005 Buy Hold Sell Citigroup Investment Research Global Fundamental Coverage (2650) 41% 42% 18% % of companies in each rating category that are investment banking clients 48% 47% 32% Guide to Fundamental Research Investment Ratings: Citigroup Investment Research’s stock recommendations include a risk rating and an investment rating. Risk ratings, which take into account both price volatility and fundamental criteria, are: Low (L), Medium (M), High (H), and Speculative (S). Investment ratings are a function of Citigroup Investment Research’s expectation of total return (forecast price appreciation and dividend yield within the next 12 months) and risk rating. For securities in developed markets (US, UK, Europe, Japan, and Australia/New Zealand), investment ratings are: Buy (1) (expected total return of 10% or more for Low-Risk stocks, 15% or more for Medium-Risk stocks, 20% or more for High-Risk stocks, and 35% or more for Speculative stocks); Hold (2) (0%-10% for Low-Risk stocks, 0%-15% for Medium-Risk stocks, 0%-20% for High-Risk stocks, and 0%-35% for Speculative stocks); and Sell (3) (negative total return). For securities in emerging markets (Asia Pacific, Emerging Europe/Middle East/Africa, and Latin America), investment ratings are: Buy (1) (expected total return of 15% or more for Low-Risk stocks, 20% or more for Medium-Risk stocks, 30% or more for High-Risk stocks, and 40% or more for Speculative stocks); Hold (2) (5%-15% for Low-Risk stocks, 10%-20% for Medium-Risk stocks, 15%-30% for High-Risk stocks, and 20%-40% for Speculative stocks); and Sell (3) (5% or less for Low-Risk stocks, 10% or less for Medium-Risk stocks, 15% or less for High-Risk stocks, and 20% or less for Speculative stocks). Investment ratings are determined by the ranges described above at the time of initiation of coverage, a change in risk rating, or a change in target price (subject to limited management discretion). At other times, the expected total returns may fall outside of these ranges because of market price movements and/or other short-term volatility or trading patterns. Such interim deviations from specified ranges will be permitted but will become subject to review by Research Management. Your decision to buy or sell a security should be based upon your personal investment objectives and should be made only after evaluating the stock’s expected performance and risk. Between September 9, 2002, and September 12, 2003, Citigroup Investment Research’s stock ratings were based upon expected performance over the following 12 to 18 months relative to the analyst’s industry coverage universe at such time. An Outperform (1) rating indicated that we expected the stock to outperform the analyst’s industry coverage universe over the coming 12-18 months. An In-line (2) rating indicated that we expected the stock to perform approximately in line with the analyst’s coverage universe. An Underperform (3) rating indicated that we expected the stock to underperform the analyst’s coverage universe. In emerging markets, the same ratings classifications were used, but the stocks were rated based upon expected performance relative to the primary market index in the region or country. Our complementary Risk rating system -- Low (L), Medium (M), High (H), and Speculative (S) -- took into account predictability of financial results and stock price volatility. Risk ratings for Asia Pacific were determined by a quantitative screen which classified stocks into the same four risk categories. In the major markets, our Industry rating system -- Overweight, Marketweight, and Underweight -- took into account each analyst’s evaluation of their industry coverage as compared to the primary market index in their region over the following 12 to 18 months.
OTHER DISCLOSURES
For securities recommended in this report in which the Firm is not a market maker, the Firm is a liquidity provider in the issuers’ financial instruments and may act as principal in connection with such transactions. The Firm is a regular issuer of traded financial instruments linked to securities that may have been recommended in this report. The Firm regularly trades in the securities of the subject company(ies) discussed in this report. The Firm may engage in securities transactions in a manner inconsistent with this research report and, with respect to securities covered by this report, will buy or sell from customers on a principal basis. Securities recommended, offered, or sold by the Firm: (i) are not insured by the Federal Deposit Insurance Corporation; (ii) are not deposits or other obligations of any insured depository institution (including Citibank); and (iii) are subject to investment risks, including the possible loss of the principal amount invested. Although information has been obtained from and is based upon sources that the Firm believes to be reliable, we do not guarantee its accuracy and it may be incomplete and condensed. Note, however, that the Firm has taken all reasonable steps to determine the accuracy and completeness of the disclosures made in the Important Disclosures section of this report. In producing its research reports, members of the Firm’s research department may have received assistance from the subject company(ies) referred to in this report. Any such assistance may have included access to sites owned, leased or otherwise operated or controlled by the issuers and meetings with management, employees or other parties associated with the subject company(ies). Firm policy prohibits research analysts from sending draft research to subject companies. However, it should be presumed that the author of this report has had discussions with the subject company to ensure factual accuracy prior to publication. All opinions, projections and estimates constitute the judgment of the author as of the date of the report and are subject to change without notice. Prices and availability of financial instruments also are subject to change without notice. Although Citigroup Investment Research does not set a predetermined frequency for publication, if this is a fundamental research report, it is the intention of Citigroup Investment Research to provide research coverage of this/these issuer(s), including in response to news affecting this issuer, subject to applicable quiet periods
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