Inflation is not new, but price increases can still be shocking. I recently vacationed in the Hamptons, a tony beach outside of New York, where I was stunned to pay $800 for a single cart of groceries. It was not in a large gourmet store, but rather at the IGA, which is the American equivalent of the British Tesco. Food prices are rising everywhere, but in places like this they have reached nosebleed levels.
Wealthy locals and vacation shoppers are noticing this, but don’t seem to be limiting their spending. Everyone else travels an hour or more to shop outside of resort areas, order dry goods from Costco, and grow their own produce.
This story is extreme, but by no means unique. To the extent that the wealthy in the United States are not yet reducing their spending, they may be an important and underexplored factor behind the inflation felt by all.
The top two-fifths of the U.S. income distribution accounts for 60% of consumer spending, while the bottom two-fifths account for just 22%, according to 2020 statistics from the BLS.
Income inequality is not the same as wealth inequality. But the two can go hand in hand. People who earn higher incomes tend to receive a higher percentage of stock compensation. They also have significantly more housing capital (which tends to further encourage consumer spending, according to IMF research).
The American Enterprise Institute, a right-wing think tank, estimated in February that the wealth effect of asset gains and cash extraction from real estate refinancing (which has not yet corrected, like stocks) was $900 billion, with a consumption impact that began last year and will continue through 2022.
Amazon’s Jeff Bezos can build a half-billion-dollar yacht, and it won’t change anyone’s life but him. But when the top quintile of Americans as a whole benefits from 80% of the wealth effect of rising stock and house values (AEI estimate), I suspect it starts to have a real impact on the inflation and the overall structure of our economy. , which over the past 30 years of falling real interest rates has become heavily financialized.
Gavekal founder Charles Gave explained the underlying dynamics of all of this in a recent client article. “If the market rate [of interest] is too low compared to the natural rate, then financial engineering pays off. . . borrowing to capture the spread will lead to an increase in the value of assets that yield more than the market rate, but also an increase in indebtedness.
The problem is that fewer new assets will be created – why invest in a factory or workforce training when you can buy back shares? One of the practical results of this unfortunate trade-off between Wall Street and Main Street is a drop in productivity. Falling productivity and artificially low rates often correspond to periods of inflationary recovery, just like in the 1970s.
The only way out is the pain of higher interest rates. The cost of capital in the market must be normalized to reduce financialization, the unproductive allocation of resources and the inequalities that accompany it.
Unfortunately, the pain of this paradigm shift (like the benefits of the previous one) will not be shared equally. Rising rates have hit the poor hardest, raising the cost of non-expendable items such as food, housing and paying for credit cards and other loans. The wealthy can keep spending, while others have to make tougher economic choices.
The US real estate market is the best example of the economic and social downsides of extremely financialized growth. Historically, high home prices — which are partly the result of more cash buyers and investors in the market, as well as zoning restrictions and financing trends that favor the wealthy — mean that more people rent. Today, rents are rising not just in major cities, but across most of the country.
But the people who tend to rent are the least likely to be able to pay the highest prices. According to 2021 Pew Data, 60% of renters are in the bottom quartile of US income. If you look at net worth, including asset wealth, that figure jumps to 87.6%. As discretionary income gets down to the basics, the picture of consumption is even more skewed in favor of the wealthy.
Of course, no economic paradigm lasts forever. Higher interest rates will eventually drive down the values of artificially inflated assets.
Meanwhile, the Biden White House is doing what it can to dull the inflationary pain for workers. He freed up strategic oil reserves in a partially successful effort to lower prices at the pump, extending pandemic-era caps on some student loan repayments and pushing for antitrust action in areas where corporate concentration (which developed alongside financialization) may be responsible for some inflationary pressure.
But other changes are needed. The success of corporate lobbyists in reversing efforts to close the interest gap is shameful. The cancellation of student debt – generous as it is – will not change the fact that the cost of four years of private college in the United States (an elastic cost that can be increased indefinitely by the world’s wealthy) is almost twice the median family income. Housing markets continue to call for major reform.
I suspect it will take a younger generation to push through these kinds of systemic changes. They just don’t have as much heritage to protect.