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BEYOND PIKETTY: THE ANATOMY OF INEQUALITY
Version 4: 22 October 2014
1. Executive Summary.
3. The “Golden Rule” and the Fundamental Laws”
4. Verifying Piketty’s “first law”.
5. Verifying Piketty’s “second law”.
6. Reconciliation of growth, saving and inflation.
7. What is “capital”?
8. Inequality and bubbles
The author acknowledges the invaluable input and editing by Terry Manning, NGO Bakens Verzet Holland www.integrateddevelopment.org
1. EXECUTIVE SUMMARY
This paper establishes the source of inequality using Thomas Piketty’s recent book “Capital in the Twenty-First Century” as a reference point.
Saving as measured in each country’s national accounts has a growth component and an inflation component.
The source of systemic inequality is the inflation component of Saving plus bubble debt.
Systemic inequality is defined by a set of 8 macroeconomic accounting principles:
1. The present (reflated) value of all past real growth ∑gr is the Gross Domestic Product, GDP.
2. The present (reflated) value of all past saving ∑sr is the produced tangible wealth as measured in each country’s national accounts.
4. The value of total wealth is the present value of all past saving imputed by market transactions to include intangible and non-produced wealth.
5. The sum of existing (non-reflated) outstanding productive investment principal ∑P is the Gross Domestic Product GDP.
6. Outstanding investment productive principal ∑P = the present reflated value of all past real growth ∑gr = GDP.
8. Using Piketty’s terms, numerical inequality will decrease only when the rate of return “r” on the national capital falls below the real economic growth rate “g” divided by the ratio “β” of national capital (national wealth) to national income.
Inequality is endemic to capitalism and debt-based economies.
Wealth is transferred upward through the deposit interest rate mechanism whereby the net interest paid by original debt holders under their debt contracts finds it way as unearned income to current deposit holders’ accounts. That unearned income is funded from nominal GDP growth and confers higher values on all traded national capital, not just its income producing portion. That is what increases inequality.
Reversing that structural inequality under the present system requires (r<g/β), or, in simple terms, that capital “runs at a loss” even when deposit interest is zero. The capital (wealth) base would then gradually deflate without affecting economic growth. This would not be capitalism as it is presently practised because new wealth would then tend to be distributed according to earned income.
Housing remains a core issue within the capitalist system worldwide because most domestic housing is economically unproductive. Its capital cost can only be repaid over time out of increased productivity passed on to income earners. Each expensive new house built means part of a factory or farm or other productive enterprise might be lost. Building expensive houses instead of cheaper ones has produced a wealthy over-housed minority and a poor under-housed majority. The same argument applies to public infrastructure, services and transfers.
The tax reforms Piketty proposes in Part Four of his book would reduce inequality much as happened when the “U” shaped wealth profiles were formed in some countries during the 20th century (as shown at Figure 4.5 of his book). The reforms did not prevent the revival of capital inequality as their effects were whittled away over time. The reforms failed because the crucial roles credit creation and public policy play in income and wealth distribution have been neglected in recent decades.
Rising structural inequality suggests that the financial system itself needs to be modernised. There are several viable options available, including combinations of “bottom up” local currency proposals where the local currency can be used to pay taxes, “top down” approaches based on interest-free public money, and much broader use of cooperative economic activity.
This paper also shows that the “fundamental laws” Piketty proposes in his book do not withstand scrutiny. There is no causal link between income and wealth inequality measured by Piketty’s ratios (β= national capital/national income) and his two productive sector ratios, (β= s/g (savings/accumulated growth)) and (β = α/r), where “α” = the ratio of annual capital income to annual national income” and “r” = the annual rate of return on capital.
Piketty’s book “Capital in the Twenty-first Century” is primarily a study of inequality. The heart of his book and his “laws” (as further defined below) is that the percentage (r-g) gives rise to a capital-based unearned income that is surplus to the monetary requirements of the productive economy.
The equations from
Piketty’s book are applied to official economic statistics for
Piketty’s own data
“Capital in the Twenty-First Century” is founded on three concepts. These are:
1) A so-called “golden rule” (r>g) where “r” is the percentage (%) annual rate of return on capital (national wealth net of debt, as Piketty defines it) [p50] and “g” is the real growth rate of annual economic output (Piketty uses National Income instead of Gross Domestic Product GDP) as measured by the international System of National Accounts (SNA).
2) A “First Fundamental Law of Capitalism” (α= r x β) where alpha “α” is the ratio of annual capital income to annual national income given as a percentage, “r” is the percentage annual rate of return on capital, beta “β” is the ratio of national capital (national wealth, as Piketty defines it) to national income [p52].
3) A “Second Fundamental Law of Capitalism” (β= s/g) where beta “β” is as already defined, “g” is the accumulated “long run” annual real growth, (apparently stated as an annual percentage), and “s” is the accumulated “long run” savings which appears to be the “ net savings rate” derived from the national accounts (also apparently stated as an annual percentage) [p166].
A) Referring to Piketty’s indicator (β= s/g) (as defined above):
productive sector ratio (s/g) for
The paper shows that Piketty’s ratio (s/g) is a measure that reflects the relationship between prices and output in the productive economy. Asset prices are defined by the aggregate physical transfer of Saving “s” from the productive economy to the non-productive investment sector as shown in Figures 2,4,7,and 13.
B) Using Piketty’s indicator (β = α/r) (as already defined above):
In Figure 8, the
annual rate of return on capital “r” from Piketty’s equation (r=α*g/s) is
compared with an actual estimated rate of return on capital for
The result shown in
Figure 8 suggests there is little or no relationship between the calculated
annual rate of return on capital using Piketty’s equation and the actual rate
of return for
3. THE “GOLDEN RULE” AND THE “FUNDAMENTAL LAWS”
“The Golden Rule”
Piketty says the “Golden Rule” (r>g) is “the central thesis of this book” [p77] because “an apparently small gap between the return on capital and the rate of growth can in the long run have powerful and destabilizing effects on the structure and dynamics of social inequality”.
Piketty neglects debt (and money) in his book altogether except during a brief discussion on public debt (pp. 547-552). That neglect is fatal to his thesis.
Plainly, Pikkety’s “net” investment return (r – g), applied to market activity in the productive sector, will inflate asset prices if it is positive. It will do so because “r”, the annual percentage (%) rate of return on net national wealth as Piketty defines it [p50] on the one hand, and “g”, the annual real growth rate of economic output (Gross Domestic Product or GDP- Piketty uses National Income-) as measured by the international System of National Accounts (SNA) on the other, both give rise to exponential functions over time. For example, if “r” were 7%/year, $1000 of wealth would increase to $2000 over 10 years. If on the other hand “g” were 3.5%/year, it would take 20 years for $1000 of “g” to increase to $2000. The historical “r” and “g” curves will therefore diverge rapidly. That divergence is the primary indicator of growing inequality.
This paper shows in detail that the only way to avoid asset price rises in the capitalist system is for the numerical after-tax rate of return on capital to be well below the real economic growth rate “g”. That, however, is the antithesis of capitalism. Asset inflation and exponential wealth expansion are therefore inherent in the capitalist system unless capital (money) is physically destroyed for example by bank failures, as happened during the great depression of the 1930’s.
When “r” is greater than “g” (r>g) the financial system is subject to inflation and investors may typically be able to accumulate surplus deposits over and above those resulting from economic growth. Piketty does not tell us how the increase in investment sector deposits creates the redistribution of wealth to investors from the rest of society but his “golden rule” is a good indicator a transfer is happening.
Describing how the transfer actually takes place calls for an understanding of the dynamics of debt-based financial structures and of “saving”.
The saving “s” Piketty uses is the “net saving” from the national accounts using the System of National Accounts (SNA). It is supposed, according to Piketty, to fund the net increase in physical capital assets at cost resulting from the growth of economic output (Gross Domestic Product or GDP). This paper shows that the aggregate saving “s” in the national accounts is less than the aggregate nominal GDP growth because the national accounts wrongly deduct consumption of fixed capital from gross capital formation whereas the actual financial flows, being the repayments of principal on outstanding productive sector debt, should instead be used.
(r-g) and the “golden rule” (r>g) ultimately refer to inflation although
Piketty does not seem to be aware that is so. Figure 1 shows the actual
accumulated numerical figures ∑s for saving “s” and ∑g for real
growth “g” for
The inflation transfer mechanism makes the curves for “s” and “g” in Figure 1 diverge.
Piketty’s “First Fundamental Law of Capitalism” (α= r x β)
Piketty himself says the “first law” is a tautology (p52). (Capital Income/ National Income = r * net national wealth / National Income) says (Capital income = r * net national capital (wealth)) because the national income cancels out from each side of the equation.
The “first law” states that income from capital is the [capital base (net national capital or wealth as Piketty defines it)* the average annual rate of return “r” (or “yield”, p52, on that wealth.)] The “first law” fails to link the productive economy properly to the investment sector even though productive sector incomes must be used to physically pay the capital income represented by “r”. The non-productive investment sector does not produce anything itself and Piketty (p45) makes abundantly clear that rentiers historically didn’t work and that their (unearned) income came from their ownership of wealth.
Figure 2 shows
measured national account SNA “Saving” “s” plotted against nominal percentage GDP growth for
Figure 3 shows the
That new debt causes the inflation that creates the wealth inequality seen around the world.
Figure 4 shows the
accumulated data for nominal GDP growth and saving “s” from Figure 2 for
Source: Piketty Zucman dataset
When the Saving figure as shown in Figure 2 is (arbitrarily) corrected for New Zealand by about 23% to cover the difference between the (higher) physical capital repayment flows and the (lower) rate of depreciation (consumption of fixed capital) used in the SNA accounting system, the GDP and outstanding investment principal curves fall on top of each other as is shown conclusively in Figure 5 for New Zealand.
GDP is therefore the sum of outstanding investment principal.
An independent test for “r” is to compare the figures for (rdt = αdt/β) derived from the “first law” in Piketty’s (Piketty-Zucman data) Table 3b with the formula (rdt = αdt* g/s) which is derived as discussed below. The “saving” in the productive sector that funds non-productive investment relates directly to the growth of productive sector debt required to fund the net after-tax interest on the country’s deposit base. [Manning 2011a, Manning 2013a]. This means that while (r>g) may indeed be an indicator of divergence between net national capital and national income it cannot numerically define it. This is shown beyond doubt in Figure 7 below.
Piketty’s “Second Fundamental Law of Capitalism” (β= s/g)
Piketty discusses his “Second Fundamental Law of Capitalism at some length [pp 168-176]. The second “law” says that (β= s/g) where beta “β” and “g” are as already defined and “s” is the “savings” (net after tax) from the national accounts [p166].
Piketty’s effort to link the productive economy to wealth as he defines it is confused. For Piketty, national wealth includes the “stock” of the current monetary value of every investment asset, and he lists those at several points. He divides them into farmland + housing + other domestic capital (both private and public) +net foreign capital. At page 47, Piketty says natural resources such as “petroleum, gas, rare earth elements, and the like” are included in that capital, but he does not focus on the difference between the wealth itself (the assets) and the monetary “value” given to those assets.
He further confuses his definition of wealth when he writes [p196] that “By definition, the law (β= s/g) applies only to those forms of capital that can be accumulated. It does not take account of the value of pure natural resources, including “pure land …”.
Farmland is apparently not “pure land” “prior to any human improvements.”
As discussed below
Piketty defines the
annual rate of return on capital or yield “r” as a net % return “over
the course of a year” [p52]. His dataset for
talks about his second “law” (β= s/g) throughout his book, his own work
shows it to be false. His Table 5a [Piketty-Zucman Wealth-Income data Set
∆β 7.5% = 0.3% (gwst from saving) + 1.4% (Ot ) + 5.9% (qt ).
In other words,
almost none of the change in “β” in
Piketty claims his “second fundamental law” has to be applied over the long term. Figure 7 shows “β” from Figure 6, the growth in “β” from savings “gwst” from Figure 6 and accumulated “st/gt” also from Figure 6 accumulated over a half century.
Figures 6 and 7 use Piketty’s own data. They confirm the work of the author of this paper and show that Piketty’s own “laws” are wrong.
Figure 7 shows the changes in “β” are related to savings “st” not to the change in savings/growth (st/gt).
Allowing for the
issues already discussed for
people have to “save” some of their income even in the absence of growth to pay
for the “hand held out at the market gate” [Manning 2013b]. That seems to have
In a debt-based system, central bank policy to manage inflation by raising interest rates reduces the demand for new debt (because the price of debt rises) while at the same time transferring more purchasing power from consumption in the productive sector to the investment sector through systemic inflation [Manning 2011a].
Existing asset prices rise only until investors withdraw from active non-productive investment as the passive interest return on deposits increases. At that point the price of investment assets falls and debt cancellation through physical repayment, business failure and household default begins. Changing interest rates have a similar effect on investment markets as major world events do: they cause a shift in the mix of active investment in relation to properties, equities and bonds that can lead to systemic collapse in both the productive and investment sectors.
The resulting additional SNA “saving”, part of “s”, accruing from the higher interest rates is dissipated in inflation in both the productive and the investment sectors and the consequent reduction of consumer demand and productive investment typically causes an accompanying recession. If that failure were to continue over a lengthy period without new debt creation there would soon be little money left in the productive economy and few productive assets left. That is what happened during the 1930’s depression. To avoid deflation in the productive economy the money supply would have to be increased through higher government spending or some other stimulatory monetary policy as has happened recently around the world through quantitative easing.
Piketty fails to address these financial system mechanics even though they form the basis for establishing asset “values” under his “second law”.
4. VERIFYING THE FIRST LAW
The two “laws” (β=s/g) and (α= r * β) are not truly independent because (from (s/g=a/r) they give other forms like (r=α*g/s).
These derived relationships are at the heart of Piketty’s suggested long term decline in the rate of growth in developed countries though he does not prove them. The decline in the rate of economic “growth” has a far simpler explanation related to the increasing proportion of services in developed economies. It is much harder to increase productivity in services than it was to increase industrial productivity during (say) the industrial revolution, while increases in bureaucratic complexity and compliance costs often lower quality of life instead of improving it.
(r=α*g/s) in Figure 8, using “α” = 30% , indicated by Piketty as a
typical value for it [p53].
Mathematically, the only time “g” can be 0 is if (r=0) or (s/α =0).
However, Piketty is not working “mathematically”, because he considers “s” and
“g” to be aggregates accumulated over the long term. Figure 8 shows Piketty’s
“r” compared with an actual estimate for it (using the bank funding rate + 2%)
calculated from the aggregated dataset for
Piketty’s “r” in Figure 8 is derived as (r=α*g/s) from the accumulated historical data used in Figure 1 where “α” is the pre-tax figure he refers to throughout his book. The after-tax figure “αdt” that Piketty calculates in his data set for Australia [Piketty-Zucman Wealth-Income data Set Australia – Table 3b] is about half the pre-tax figure used in Figure 8 and it is reasonably constant through the whole period except 1999-2000 and 2005-2008 (when it was several percent lower). Using after-tax figures in Figure 8 changes the position of the curve but not its shape. The actual rate of return estimated from the bank funding rate is plotted on an annual basis.
The plot for
Piketty’s “r” in Figure 8 gives an irrational result. An average rate of return
“r” over the entire wealth (net national capital) base of 16% as shown in
Figure 8 for New Zealand in 2013 is impossible when mortgage interest rates
there were less than half that. In
New Zealand’s gross national income in 2012 was NZ$ 198b, so “α” was then about 53/198 or a little under 27%, close enough as a first approximation to the 30% Piketty considers as a “typical” figure for developed countries. Figure 8 therefore gives a rational representation of Piketty’s “r” (before tax) as long as “α” is reasonably close to 30%.
Piketty’s “α” was also checked for an “extremely” high interest year (1988) when the Gross national income (NI) in New Zealand was NZ$54.5b, total debt was NZ$57b, and the comparable return on capital (from Figure 8) was 14.3%. Assuming similar proportioning of investment returns in 1988 as in other years, the capital income/national income ratio “r” would have been closer to 35% producing a small peak in the Piketty “r” graph as shown on Figure 8 during the 1980’s. This is much too small to affect the conclusion presented above that Piketty’s “r” is unrelated to the actual annual rate of return on capital.
Figure 9 plots the rate of return “r” (after tax) taken directly from Piketty’s data set for Australia [Piketty-Zucman Wealth-Income data Set Australia – Table 3b] over the last half century using Piketty’s two laws independently. The two laws give completely different results proving that at least one of them is false.
5. VERIFYING THE SECOND LAW
Piketty says (p48) that wealth is net of “the total amount of financial liabilities (debt)” and that agrees with the approach taken in the capital stock calculation used by the New Zealand Department of Statistics.
hinges on the “U” shape in national capital over the period from the start of
WW1 to just after WW2 [Book Figures 3.1, 3.2]. He writes that that “U” shape is
due almost exclusively to war debt and wartime inflation and the effects of the
1930’s depression. For example, average inflation in
How the change in wealth came to form Piketty’s “U” is set out below without using either of his “laws”.
The two source papers [Manning 2012 suggest that the cumulative outstanding productive investment principal at cost ∑P and the accumulated saving ∑st are both numerically equal to nominal GDP as shown in Figures 4 and 5.
Both Piketty’s “st”
and Saving “s” must be after-tax figures
because government spending is already included in “total consumption” in the
national accounts. The principal repayments actually paid by firms are physical
monetary flows whereas the residual Saving recorded in the national accounts is
an accounting abstraction, despite the strenuous efforts made by statistical
authorities to generate an appropriate figure for “Consumption of Fixed
Capital”. For an example of those efforts see “Measuring Capital Stock in the
New Zealand Economy” 3rd Edition, published by Statistics New
Nobody pays anything called “consumption of fixed capital”. Instead, principal is repaid on capital items bought, in addition to interest. The repayments on productive assets must be funded from the gross operating surplus resulting from business activity in the productive sector. Payments of interest and capital relating to non-productive investments like housing must come from the work incomes of income earners: typically from wage increases generated by higher labour productivity.
Capital repayments in the productive sector must be more than the amount shown in the national accounts for the consumption of fixed capital. If that were not so, the banking system would have no residual security over the capital items they have funded as those assets approach the end of their useful life. For example, commercial vehicles have a scheduled life of around 7 years, but are typically paid off over 5 years or less. Residential buildings are allocated a 70 year life cycle, and are frequently paid off over 20 to 30 years. The “Savings” “s” in the SNA accounts, on the other hand, merely reflect post depreciation (amortisation) asset values which comprise tax-based accounting entries. Real residual monetary values are shown by the purchase price less actual repayments.
Once an appropriate correction to the consumption of fixed capital is made for those actual capital repayments, the SNA saving should equal the increase in productive capital (Gross capital formation less capital repayments) at current (typically inflated) prices. That is the basis of the Savings Myth [Manning 2011b]. SNA Saving “s” should be the net new capital creation and that must also equal nominal GDP growth as shown in Figures 4 and 5.
Theoretically at least, the productive economy is a closed circuit of financial flows where real financial surpluses are used to fund gross fixed capital formation at cost (Manning 2013a). That re-investment creates debt, either to the income earners and businesses who have produced the assets or to the banks. The resulting deposits attract interest that contributes to systemic inflation.
Further research is needed to confirm how the additional principal repayments (total principal repayments – consumption of fixed capital) added in Figure 5 to the figure for “consumption of fixed capital” could (or should) be shown in the national accounts. The total principal repayments would be recorded in the national income and outlay account (Table 3.2) where “consumption of fixed capital” is shown now, reducing national disposable income. The gross operating surplus (with GDP and gross fixed capital formation) may therefore be understated in the income and expenditure account of the national accounts (Table 3.1). The residual “Saving” “s” would then consequently increase by the same amount in the national income and outlay account to rebalance the accounts. Otherwise the additional capital repayments would suppress consumption as a percentage of GDP and mask the systemic inflation discussed in the source papers. Masking (from somewhere) seems to be a primary reason the observed CPI inflation as it is customarily reported in statistics is less than the systemic inflation discussed in the source papers. The suggested changes would not affect real economic growth. They would affect nominal reported GDP growth and the way inflation is reported.
accounts produced under the System of National Accounts (SNA) are only as
accurate as the data on which they are based and the data series are constantly
being reviewed. For example, the
Quite apart from required amendments to the data used in the national accounts, Saving in the national accounts is independently subject to wide margins of error because it is a small number resulting from subtracting much larger numbers each of which is itself subject to considerable error. That is especially the case when Saving “s” is small.
Compulsory savings and pension schemes add to
the “saving” problem because they reduce demand in the productive economy unless
all the withdrawal of purchasing power they cause is re-invested in new capital
goods. If that re-investment does not occur the withdrawals become part of
nominal “saving” that is diverted into investment sector inflation. This is
because the hoarded “saving” is either left in bank accounts at interest or is
added to the deposits used to trade existing assets in the non-productive
sector. Indeed, in the case of
Since the deposit investment pool (the total financial deposit base less the relatively small amount of deposits used in the physical production of goods and services) follows GDP (after substituting actual repayments for depreciation) [Manning 2012, Manning 2013a] a percentage increase in GDP (Piketty uses national income Y) tends to produce a similar percentage increase in wealth however that wealth is calculated. If the investment pool deposits increase by 10% all investment prices in aggregate, including the prices of non-produced capital, will also increase assuming the proportion of active investment in equities, property and bonds, remains constant. If, on the other hand, investors withdraw from active trading in existing assets thereby increasing the proportion of passive interest-bearing deposits, the circulating pool of active deposits used for investments will fall and so will investment prices. Shifts between the investment categories can also occur with changes in public policy, taxation, or external events.
Investment in the
productive economy, as it must do, creates nominal GDP growth derived from
multiplying price “P” and production “Q” in the Fisher equation (MV=PQ) where M
is the money supply and V is its speed of circulation. It does not separate out
inflation. The new debt used to purchase new capital assets determines wealth
growth. Figure 7, which refers to
The most extreme case of low growth and high saving in New Zealand was in 1980 when saving “s” was 16% of GDP and economic growth was -1.7%! During the high inflation period the gross operating surplus (and with it gross fixed capital formation) soared while “old dollar” principal repayments were being made in rapidly inflating currency. The high interest rates were bound to produce a very large national account “saving” figure that was obviously not all spent on creating real growth, especially in years like 1980. Instead “s” in those years represented productive sector inflation.
After replacing actual principal repayments for the existing “consumption of fixed assets” in the national accounts “SAVING” =NOMINAL GDP GROWTH in the productive economy.
External deficits occur in debtor countries when investment income and current transfers from the rest of the world are negative there. Their effect is to dynamically reduce the national disposable income (and ultimately domestic production and consumption) unless the loss of purchasing power in the debtor country is replaced by new debt. That is a primary reason why the domestic debt level in debtor countries like New Zealand (which runs a large and persistent current account deficit) is often much higher than the domestic deposit base.
Current account deficits reduce the Gross National Income in debtor countries and increase it in surplus countries. The deficits in debtor countries are funded from new domestic private debt there. In perfectly “free” capital markets the resulting deposits in creditor countries are returned to debtor countries as foreign capital investment (foreign ownership of the debtor nation’s businesses, property, land and resources). The net balance between domestic debt and domestic deposits at any time can be readily seen from the credit and monetary aggregate reconciliations published monthly by central banks the world over. Returning deposits must create an investment bubble (as discussed in section 8) to the extent they are invested outside of the debtor country’s productive economy in existing capital assets like housing and other property.
and consumption figures with capital outlays as the national accounts do in the
SNA system is also problematic because it obscures the underlying financial
system mechanisms. Production and consumption cycles in the real economy
require very little money (very roughly half of the monetary aggregate M1)
because, conceptually, the same money is recycled many times each year [Manning
2012]. On the other hand, new capital items have to be fully funded from
incomes and the gross operating surplus in the Gross domestic product and
expenditure account, (Table
In earlier times, under the “savings and loan” economic model, the debt to purchase new assets was provided by savers. That increased the debt base by the same amount as in the present system but not the deposit base. There were therefore relatively fewer new deposits available to inflate the investment sector. The extent of asset inflation then became a function of the speed of circulation of the available deposits as discussed below.
Asset “values” making up the total national wealth cannot be linked to the productive economy the way Piketty attempts to do.
For example, the
national capital accounts record changes in the net value of produced capital assets. Statistics departments
construct various tables for what they define as “capital stock”, such as Table
4.3 of the
If a broad net
national capital (wealth) figure for New Zealand made up of the net national
stock from the national accounts plus all the other excluded assets referred to
above is used, “β” for New Zealand in 2013 indeed comes out at about 6 as
Piketty suggests, but he fails to explain how the assets he has included
in the national capital are obtained from his aggregate saving “s”. In his
Piketty’s “second law” is therefore false. His “β” is not a function of (net saving st /real growth gt). It is instead a function of net saving.
Note: “β” for
In practical dollar terms, all price is inflation [Manning 2011a, Manning 2013a].
“Growth” is a representation of new production added by population and productivity increases. New production relates solely to the quantity of goods and services, not to their price [Manning 2011a].
Looking at the long
run, as Piketty says we must do, all production is derived from
growth because in the “beginning” there
were few people and little money and, apart from a few short interludes, no
inflation at least in England, over a period of some 600 years. The main
inflation interludes in England prior to WWI were first the plague that halved
the population there during the second half of the 14th century
thereby doubling the per capita money supply (though at that time the majority
of working people were still serfs), secondly the currency debasement of the
mid Tudor period 1546-1583, and thirdly during the Napoleonic wars at the end
of the 18th century. At those times most of the English economy was
still unmonetised. Even in 1800, 70% of
Figure 11 shows inflation for
The opposite argument applied during the depression
years and wartime period when wealth “values” were destroyed first through
business and bank collapse, then by wartime destruction and military
consumption. As prices rose during wartime, the purchasing power of (some of)
the rich declined because government imposed interest rates and
capital controls meant that the purchasing power and “wealth” of the
rich fell in nominal terms. Rapid inflation increased nominal incomes and
saving among workers without the corresponding relative capital growth accruing
to the rich. There is nothing magical about that and no “fundamental laws” are
needed to explain it. The phenomenon is clear from Figure 10 where “β” in
Stabilising “β” is simply a matter of ensuring (s=g), that is, that the money supply (domestic deposits) increases only in line with increased real production. At that point the domestic deposit base increases at the same rate as real GDP and other things being equal:
For stable investment prices inflation must be zero and, using Piketty’s terms, the rate of return “r” on total wealth must then be (r = g/ β)
Figure 11 : CPI (Consumer Price Index) England 1300-2000.
Inflation figures 1800-2000: O’Donoghue J, Goulding L (Office for National
Statistics Great Britain). Inflation figures 1300-1800 from Gregory
Clark “The Price History
of English Agriculture, 1209-1914” and Allen G, (House of Commons
Library) “Consumer Price Inflation since
6. RECONCILIATION OF GROWTH, SAVING AND INFLATION
The concepts of growth, saving and inflation will now be reconciled with each other.
Nominal GDP growth includes inflation. Production resulting from previous growth costs more each year in nominal terms as inflation increases. Each year after the growth first takes place (and when new assets are created) inflation “revalues” the current monetary worth of that growth. The revaluation is always positive except in recession and depression years.
In Figure 12 the
growth figures for
GDP measures present growth plus all past growth at current prices.
One primary reason there was so very little growth through the middle ages was that there was very little money. Much of what there was was physically hoarded and not invested because there was virtually no inflation and very little to invest in. As Piketty says, until the industrial revolution, most wealth was inherited not earned.
This is because according to the Fisher equation (M*V = P*Q) [see Fisher, I (1912) “Elementary Principles of Economics”] GDP relates to the quantity of goods and services Q the economy produces multiplied by its price P. (GDP = P*Q). “Q” is independent of “P” so that a smaller “Q” means lower GDP unless there is an offsetting rise in “P”. In the Fisher equation “M” is the money supply and “V” is its speed of circulation
While the Fisher equation is typically applied to the productive economy it can equally well be applied to the investment sector in relation to national capital where a subscript “i” is added to the Fisher parameters M,V,P,Q to indicate the investment sector as distinct from the productive economy.
The “value” of national capital is then determined by the available investment sector funding, being the deposit base excluding money needed for physical production of goods and services and its velocity of circulation “Vi” as required by the Fisher equation (PiQi=MiVi), where:
“PiQi” is the traded “output” or investment sector “GDP”, the “value” of national capital exchanged over a given period,
“Mi” is the available investment sector money supply and
“Vi” is the transaction velocity of that investment sector money.
That approach allows the change in net national capital to be calculated at any point in time as long as the asset elements and their respective prices are identified. For example, the cumulative traded “value” of tradable assets “PiQi” might be $100b, “Mi” about $200b and “Vi” about 0.5. If “Mi” increases by 10% while “Vi” remains constant, “MiVi” would increase by 10% to $110b and the national wealth (reflected by market prices) would also increase by 10%.
A similar approach applies to saving too. Nominal GDP appears to be the cumulative sum of past investment measured as the difference between gross capital formation and principal repayments, that is, the outstanding productive sector debt [Manning 2013a, Manning 2012]. In short, production increases with investment in the productive sector. No investment there means little or no monetised production. Even the servants and labourers in pre-industrial times used (expensive) tools and materials when they produced goods and services.
New Zealand GDP was NZ$ 211 billion in 2013 and accumulated SNA “saving”, was NZ$ 169 billion. As previously demonstrated in Figure 5, the difference of NZ$ 42 b between GDP (NZ$ 211 billion) and accumulated saving (NZ$ 169 billion) represents the additional capital repayments physically made over and above the “saving” figures, net of inflation, presently recorded in the national accounts.
productive investment principal is closely related to GDP is conceptually very
simple. Tools and equipment wear out and infrastructure and buildings have to
be replaced, so that past saving lives on in current capital expenditure (gross
capital formation). New investment
replaces old investment as recorded by “consumption of fixed capital” in the
national accounts. It may be qualitatively different but in principle it
produces the “same” amount of output Q. Since the value of new productive assets is included in GDP figures, the value
of the increase in new capital stock cannot exceed measured GDP growth. Investment
growth because it generates new production. If that were not so the investment
would not be made.
The “missing” 20% or so of GDP (see Figure 5, where a difference of 23% was assumed) referred to above is predominantly due to actual repayments involving amounts over and above the “age and efficiency profile” [depreciation or amortisation] statistics departments use to define the consumption of fixed capital (and therefore the residual “saving” figure “s” ) in the national accounts.
Housing is a problem the world over because once it is constructed it is usually economically unproductive. Servicing the debt and principal repayments on it can only come from productivity increases passed on as higher incomes to income earners or in the form of reduced consumption with all its consequences for growth.
Housing has become unaffordable for an ever increasing number of families because real disposable incomes have not kept pace with real productivity increases (or sometimes even with consumer price inflation) while at the same time inflation has increased asset prices. Moreover, consumption patterns have changed with relatively more disposable income spent on items that were previously “free” or un-monetised, or on transfer payments associated with structural unemployment and welfare caused by economic austerity policies.
The cost of living has changed in ways that the consumer price index CPI fails to include.
The change in
affordability is dominated by inflation, that is, by interest rates. One
exception in recent times was when US financial institutions distorted the
The monetary cost
of maintaining the established productive base created by historical investment
and growth is very high. Once the investment price of a capital asset at cost
has been repaid, (and the initial value of the asset is fully depleted) it is
usually replaced. The replacement programme vastly exceeds new productive
capital investment which is why the figures in
“savings” base to produce the current GDP output in
Cumulative historical savings calculated as outstanding principal on productive capital goods and cumulative historical growth at current prices are both equal to GDP. They are flipsides of the same orthodox economic coin:
(Saving=Investment) (S=I) where the investment is used to pay for the new capital goods the economy produces.
7. WHAT IS CAPITAL?
Table 4.3 “Net capital stock by asset type” found in the New Zealand Statistics Department publication “Measuring Capital Stock in the New Zealand Economy” edition 3, March 2013 indicates there is minimal net financial capital.
In the present debt-based financial system, financial assets are generally offset by counterpart liability. That is due to the double entry bookkeeping of the banking system whereby (domestic credit = deposits + net foreign currency holdings + bank equity + residuals). The secondary debt (on-lending) market follows the same pattern.
This does not mean financial assets in a debt-based financial system are evenly distributed among the population. The opposite is true: broadly speaking the rich have the assets while the poor have the debt.
National accounts only include non-financial, produced, fixed assets. Piketty has not shown how his national account-based factors “r”, “α” , “s”, “g” , that all relate to about half of the national capital, can be extrapolated to form “net national wealth” by way of his single multiplier “β”. Simple ratios such as Piketty’s short term indicators (β= α/r) and ( β = s/g) only confirm that the “value” of wealth is largely a function of inflation because the value of national wealth “β” obviously includes both new and past inflation.
At the same time,
In 2013, the present value of the portion of New Zealand’s national capital measured in Table 4.3 of the New Zealand national accounts was NZ$ 620b.
The material presented in this paper suggests that reflating the annual savings in the same way as was done for past growth in Figure 13 gives a present value of produced wealth that can be compared with the NZ$ 620b shown in the national accounts for 2013, assuming the national accounts data is rational.
The revaluation exercise for Saving gives a value of produced wealth in New Zealand from 1962-2013 of NZ$ 424.9b or 68.6% of the produced wealth figure shown in the national accounts. That agrees well with the 67.5% of GDP provisionally obtained for accumulated growth over the same period. The proportion would probably remain similar were Saving upgraded to take account of capital repayments as discussed in section 5 because the accumulated growth in Figure 12 would also be higher.
Total produced wealth is the accumulated present value of past Saving.
As a corollary, the “value” of “all wealth” in the absence of bubble debt (section 8) appears to be the present value of past Saving proportionately extended on the basis of supply and demand through market transactions to apply to intangible and non-produced assets.
8. INEQUALITY AND BUBBLES
The previous sections of this paper describe the physical accounting relationships between growth, nominal GDP, saving and wealth.
Using a similar approach to the one already used above for past growth, produced capital (wealth) appears to be the present value of past increases in nominal GDP as set out in section 7 above.
That produced capital is owned by households and businesses that collectively make up the private sector, and the government. In New Zealand (from National Accounts Table 4.3) about half the produced capital (about NZ$ 300b of the total of NZ$ 620b in 2013) is in the form of residential buildings while the rest is non-residential buildings, other construction, transport equipment, plant, machinery and associated equipment and some less tangible assets.
The total net financial
wealth owned by households in
Where there is
practically no longer interest paid on deposits, as in the world’s major
economies like the US, Japan and much of the EU, inflation is very low and
wealth there is expanding slowly if at all.
There is still some
inflation in the
When deposit interest rates are zero there is no financial transfer from borrowers to deposit holders and therefore no systemic inflation (Manning, 2012). Paying interest to deposit holders means deposit holders literally get something for nothing. That is the biblical definition of usury. The rationale for offering interest on most deposits is twofold: first to protect holders from inflation and secondly to pay deposit holders for “risk” even though there should be little or none in a stable modern banking system. Protecting deposits from inflation through interest rates is a myth because the source papers (Manning 2012, Manning 2013a) show that the interest itself is the cause of systemic inflation. The higher the interest rate, the higher the inflation, as is obvious from a cursory glance at any developed country data set from the time US President Nixon abandoned the US$ gold peg (August 15, 1971) through the resulting 1970’s oil shocks until the Basel I accords were implemented in the late 1980’s. In recent decades, banks have paid competitive interest rates to depositors so as to maintain central bank reserves (liquidity) as required under international banking rules. If they do not pay enough interest their deposits will shift to other banks that pay more. This would create a liquidity crisis because they would not be maintaining enough reserves at the central bank to cover perceived banking risk.
Figure 14 shows how wealth and inequality develop (in the absence of Quantitative Easing provided to financial institutions). The difference between the systemic inflation after tax and CPI inflation shown in Figure 14 seems to be the combined effect of orthodox non-productive saving as described in Section 6.
Central banks set the floor for interest rates by (arguably, arbitrarily) establishing a base rate at which they will lend fresh liquidity to their participating commercial banks. Raising or lowering that rate effectively controls lending rates to borrowers because, when the price for new money rises, borrowers are unable to borrow as much as they could before, and, overall, new lending falls.
The fundamental issue is that, in aggregate, the borrowers are not the same group as deposit holders. If borrowers already had deposits, they would not typically be borrowing more because it costs much more to borrow than it does to use their existing deposits. Interest rates for borrowing are always higher than deposit rates by an amount equal to the bank spread (the difference between the borrowing or “claims” rate and the “funding” or deposit interest rate).
Inequality increases in proportion to the debt held by an ever-increasing number of poor people relative to the corresponding deposits held by an ever-decreasing number of rich people.
The process of the
concentration of deposits in ever fewer hands is gradual. That is why Piketty
says inequality has to be viewed over the long term. Just as there is a close
association between growth, savings, GDP and “wealth” there is an equally close
association in debt –based financial systems between domestic credit
(debt), the money supply M3 (excluding inter-institutional lending or “repos”)
and GDP. The relationship has become clearer as the influence of cash
transactions in generating economic activity has fallen to very low levels in
industrialised countries. When cash was “king” some investments could be made
from hoarded cash outside the debt-based banking system. That is why from 1900
or earlier until 1990, the ratio (GDP/M3) in
The increase in MONEY relative to GDP has directly caused asset inflation and that increase is itself caused by deposit interest together with (some) bubble debt.
This gives practical substance to Fulbrook’s profound observations (Fullbrook,2014 p7) That “any increase in the market value of either K [capital] or Y [income] decreases by an equal amount the market value of the other and vice versa …… It is not an accumulation that takes place when capital-2 increases, but rather an appropriation [His emphasis]. While this paper suggests that his “K” would be limited to produced capital, it establishes his notion of transfer or appropriation through saving and inflation from the productive economy by the investment sector.
The two kinds of saving Fullbrook refers to (Fullbrook, 2014 p8) are inflation, his “sv”, the percent of savings going into existing assets, and growth, his “sr”, the percent of savings invested in the productive economy.
As an example,
consider the monetary figures for
The M1 monetary aggregate was: NZ$ 36.8 billion
M3 excluding repos was: NZ$ 256.1 billion.
The GDP was: NZ$ 211.6 billion
Subtracting GDP from M3 left a residual of NZ$ 44.5 billion.
If that residual were reduced by the non-interest-bearing transaction account total M1 (including cash in circulation), which was NZ$36.8 billion in 2013, only NZ$7.7 billion (just 3.6% of GDP) would remain unaccounted for in systemic inflation. That sum unaccounted for represents “bubble” debt, being new debt and its corresponding deposits generated by the banking system outside the productive economy, for example, to pay the outflows resulting from current account deficits when a country is importing too much and living “beyond its means”.
Much (but far from
The real “bubble”
Further research is needed to accurately identify the true “bubble” balance but the M1 balance shown in the New Zealand Reserve Bank data for 2013 should probably be reduced by:
a) Most cash in circulation (say NZ$ 3 billion of a total of NZ$ 4b), which is mostly hoarded in the informal economy (in the drug trade and other illegal activities)
b) The deposits used in productive transaction accounts to physically generate GDP that the author estimates at about 5.5% of GDP or NZ$ 11.6 billion
c) The transaction deposits used in the investment sector to physically generate the transfer of existing assets (say 2.5% of GDP or NZ$ 5.3 billion)
The total of (a),
(b) and (c) is NZ$ 19.9 billion which is much less than the M1 monetary
aggregate of NZ$ 36.8 billion shown in the example above for
therefore, bearing in mind the relationships between GDP, savings, and
“wealth”, that the entire wealth base in
That is not the end
of the story, either, because
The reverse applies
to surplus countries like
Plainly, in the case of “bubble” deposits, deposit interest accrues to those who sold their domestic assets in return for their bank deposit. From that point on, they miss out on subsequent capital gains from the increase in the price of the asset they have sold, but they retain the capacity to buy another asset, while the deposit remains permanently in the financial system unless or until the corresponding original debt has been repaid. On the other hand, as far as foreign investment goes, the accumulated net foreign asset imbalance can only be rectified by reducing the debtor country’s current account deficits. As long as the current account debt keeps growing, so does the investment “bubble” it has created, leaving the debtor country at constant financial risk.
Over time, the investment sector (taking New Zealand as an example) has expanded beyond the economic growth rate by an amount equal to the inflation represented by the difference between real economic growth on the one hand and (nominal GDP plus the added impact of “bubble” debt as described) on the other.
The amount of
interest transferred from borrowers to subsequent deposit holders from the two
sources described above is an accounting identity that can be quantified at any
point in time. Its direct result in
That is why so many
economists and officials in debtor countries like
Piketty among others observes that unequal wealth distribution is also growing from absurdly high “earned” incomes. While that is true and those “earned” incomes further distort the distribution of wealth and increase inequality, they are not themselves the cause of wealth “generation”. They are a “normal” part of productive sector GDP and their effect on wealth inequality can be addressed by more appropriate progressive taxation .
Piketty’s “golden rule” and his “laws” do not
withstand scrutiny. His own data
The heart of Piketty’s book and his “laws” is that the percentage (r-g) gives rise to a capital-based unearned income that is surplus to the monetary requirements of the productive economy. That surplus income is created through inflationary deposit expansion that forms part of Saving “s” in the SNA system of national accounts.
Contrary to Piketty’s claims, wealth is transferred upward through the deposit interest rate mechanism whereby the net interest paid by original debt holders under their debt contracts finds it way as unearned income to current deposit holders’ accounts. That unearned income is funded from nominal GDP growth and directly confers higher values on all traded national capital in both the productive economy and the non-productive investment sector.
Inflation coupled with interest rate controls and high taxation caused the “U” shapes in the “β” graphs (national capital/national income) shown in Chapter 3 of Piketty’s book. Neither of his “fundamental laws” explains the historical events he refers to in his book.
After replacing principal repayments for the existing “consumption of fixed economy assets” in the national accounts “SAVING” =NOMINAL GROWTH in the productive sector.
GDP = the sum of existing outstanding productive investment principal.
GDP =the accumulated present value of all past real GDP growth in the productive economy.
Produced capital (wealth) = the accumulated present value of all past saving.
National capital (total wealth as defined by Piketty) = the value of produced capital extended to include produced intangible and non-produced assets. It is determined directly by the size of the domestic deposit base (including deposits resulting from bubbles).
In the absence of bubbles, asset inflation will cease when deposit interest is zero.
In the absence of bubbles (and only then ), using Piketty’s terminology, when deposit interest rates are zero the rate of return “r” on the national capital will be the economic growth rate (gt/ β). At that point, using Piketty’s typical figures for “β” of 6 and “g” of 2%, “r” would be just 0.33%, not the 5% Piketty refers to throughout his book.
Many developed countries with low interest rates referred to in Piketty’s book may already have a rate of return “r” on national capital of less than 1% because national capital is a function of deposits and saving, not “growth”.
(All the papers by Manning L are published at www.integrateddevelopment.org)
Manning L 2011a,August 2011)“The Interest-Bearing debt System and its Economic Impacts”v. 5 Interest-bearing debt system and its economic impacts. (Revised edition).
Manning L 2011b (September 2011) “The Savings Myth” v. 7
Manning L (October 2012) “The Missing Links Between Growth, Saving, Deposits and GDP” v.3
Manning L 2013a (February 2013) “The DNA of the Debt-Based Economy” v.3
Manning L 2013b (April 2013) “Capital is Debt”
Manning L 2013c (September 2013) “The End of Capitalism: Systemic Collapse” v.2
Piketty Thomas, “ Capital in the Twenty-First Century” English translation by Arthur Goldhammer, Belknap Press of Harvard University Press, 2014
Fulbrook Edward, “Capital and capital: the second most fundamental confusion”, Real World Economics review, issue no 69, pages 149-160, 2014.
A. ORIGINAL PAPERS IN ALPHABETICAL ORDER.
General summary of all papers published.(Revised edition).
(The following items have not been revised. They show the historic development of the work. )
Analysis of Jackson, A., Dyson, B., Hodgson, G. The Positive Money
Proposal – Plan for Monetary Reform, Positive Money,
Analysis of the New Zealand Initiative (NZI) paper by B. Wilkinson : New Zealand’s Global Links : Foreign Ownership and the Status of New Zealand’s Net International Investment. (Posted 11 May, 2013.)
Chicago Plan Revisited Version II: An insufficient response to financial system failure. (Posted 11 May, 2013.)
Comments on the original IMF (Benes and Kumhof) paper “The Chicago Plan Revisited”. (Posted 20 August, 2012.)
The end of capitalism : Systemic collapse. (24 August, 2013).
Increases in export income from price rises abroad are not growth. (26 August, 2013).
There’s no such thing as affordable housing. (15 June, 2013).
What about a tax cut for the poor? (16 May, 2013).
W.K.; Sapinksi, J.P., International
Sociology, Vol. 25 no. 4 pp. 501-538, Sage Publications,
The Transnational Insitute (TNI),
For the domination of the financial lobby in European decision making see Wolff, M. and others, The Fire Power of the Financial Lobby : A Survey of the Size of the Financial Lobby at EU Level, Corporate European Observatory (CEO) with the Austrian Federal Chamber of Labour and the Austrian Trade Union Federation IÖGB), Brussels, April 2014. Understating reality by using minimal salaries and excluding event organisation, travel costs and taxation, some 1700 financial lobbyists working for 700 organisations (450 of which are unregistered) spend € 123 million a year on lobbying EU institutions, 30 times more than NGOs, Trade Unions and Consumer Associations together. They account for more than 70% of lobby meetings with EU institutions and have dominated with up to a 94% participation 15 out of the 17 “Expert Groups” on financial topics, the exceptions being the two “users” groups.
Super-secret negotiations are under way which would still further expand the almost unlimited dominating power of the finance industry. See Wikileaks Secret Trade in Services Agreement, under negotiation, Annex 10. For preliminary comments on it see Kelsey J, Memorandum on the Leaked [Secret] TISA [Trade in Services] Financial Services Text which is also published by Wikileaks.
By every measure, the big banks are [37%] bigger [than in 2008], S.Gandel, fortune.com, Time Inc, 13 September, 2013.
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