News or Noise: Our Take on Capital in the Twenty-First Century
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: SignatureTHINKING
Asset Management
News or Noise: Our Take on Capital in
the Twenty-First Century
By David Fisher, Chief Investment Officer
Earlier this year, Capital in the Twenty-First Century, a new book by French economist Thomas
Piketty, set off passionate debate within both economic and political circles. Piketty’s argument
is that the global economy has entered a phase where the rate of return on capital could far
exceed the rate of economic growth. That could lead to widening wealth and income inequality,
similar to La Belle Époque in France and the Gilded Age in the U.S. (i.e., the period from the
1870s through World War I).
When the book was released in April, reviews and
endorsements by generally left-leaning politicians seemed to
come out daily. As the months ticked by, those opposed to
Piketty’s thesis started to push back. In a notable piece in The
Wall Street Journal, Dr. Jordan Ellenberg projected that, on
average, readers would make it through only the first 26 pages
of the 577-page tome. Generally speaking, there has been a
lot of confusion around the book. Even among economists,
more than 60% of those polled do not agree with Piketty’s
fundamental conclusions.1
As a public service for our clients and friends, I did read the
entire book. Below, I review 10 of Piketty’s key points so you
can impress your friends and family!
10 Questions About Piketty’s Book, Answered
“ The progressive tax
thus represents an
1. What is r>g? You may have seen the formula r>g
ideal compromise
mentioned somewhere recently. It seems unreasonable
to simplify a nearly 600-page book to a three-symbol between social
formula, but in many ways that is what has happened justice and individual
with Capital. Piketty defines “r” as the rate of return on freedom.”
capital, which includes profits, rents, interest, etc., while
—Thomas Piketty
“g” stands for the rate of growth in the overall economy,
which also becomes a proxy of wages for the majority
of the workforce. This simplification has been attacked
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by many of his critics. George Mason University professor Tyler Cowen says that Piketty
“sees capital as a growing, homogenous blob and fails to take account of the variation,
across time and investments, in the returns to wealth.”2 But Piketty himself seems fine with
the simplification. In the book’s introduction he writes, “This fundamental inequality, which
I will write as r>g ... will play a crucial role in this book. In a sense, it sums up the overall
logic of my conclusions.”3
2. Is inequality really happening? Much of Piketty’s book deals with inequality in Europe.
This is primarily due to the better data, but he also acknowledges that inequality has
been a larger problem in Europe than in the U.S. Much of this has to do with the historic
dynamism of the U.S. economy and especially the real growth witnessed in the U.S. over
the period Piketty examines. These general caveats aside, the evidence that inequality has
increased in recent decades, even in the U.S., is fairly convincing. After tumbling between
1910 and 1950 due to global depression and two world wars, the amount of capital started
growing again and from 1970 through the present has shown a tendency toward reverting
to pre-WWI levels. This accumulated capital is held in fewer hands. In Europe, the decline
in wealth from 1910 to 1950 is irrefutable as is the accumulation back toward pre-war
levels.
Though total wealth in the U.S. is less pronounced, it does appear to be accumulating in
fewer hands. For example, the wealth controlled by the top 0.1% is now above 20%—the
same level seen in the Gatsby era. The spread between the income earned by the top 1%
and the bottom 99% has become more pronounced. The ratio stood at 10:1 in 1973 and has
expanded to 29:1 today.4
The accumulation of wealth at the top is likely behind the general interest in Piketty’s
work. Take the fact that globally the number of individuals with a net worth greater than
$50 million grew from 98,700 to 128,200 in just the past year, according to Credit Suisse.
According to this 2014 report, “between 2008 and mid-2014, mean wealth per adult grew
by 26%; but the same period saw a 54% rise in the number of millionaires, a 106% increase
in the number with wealth above $100 million, and more than double the number of
billionaires.”5
3. What about Piketty’s data problems? The book has three primary goals: define and
document historical data on inequality, analyze the data to draw conclusions and
provide policy recommendations to minimize the impact of inequality. Data on inequality
that spans enough time to be useful has historically been limited. Piketty has made a
worthwhile contribution to economics by aggregating previous research and adding
new data sources to try to build models across multiple centuries. Because of the lack of
consistent records in most countries, the best data is limited to France, Britain and the U.S.
Some economists criticize the methodologies used by Piketty and argue that the results
“skew his findings.”6 In fact, the Financial Times found “mistakes and unexplained entries
in his spreadsheets.”7 When questioned about the data problems, he said, “I have no doubt
that my historical data series can be improved and will be improved ... but I would be very
surprised if any of the substantive conclusions ... was much affected.”8 The discovery of the
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errors did make his conclusions somewhat less credible, but the acceleration of the debate
about equality is not likely to be slowed as a result.
4. What are the forces for convergence and divergence? The first part of Capital reviews
several forces that drive inequality either higher or lower. Piketty calls these the forces
for convergence and divergence. He points out that the current system does have many
forces that are working toward convergence (i.e., less inequality). Examples of this include
globalization, which through the free flow of capital and competition should equalize
output, though he is less certain it will equalize income. The major force for convergence
is access to information. In theory, the Internet should be the biggest force for equalizing
wealth and income, and as the accessibility and cost of information declines rapidly, it
should operate as an equalizing force. But Piketty’s book is more focused on the forces of
divergence. Principally he argues that the slowing pace of both population and economic
growth is likely to cause wealth to accumulate in the hands of a few.
5. Does war serve as a big equalizer when it comes to economic inequality? According
to Piketty, World War I was the event that broke the period of extreme inequality that
existed from 1870 to 1910. The massive sums needed to pay for WWI led governments
into extreme debt, and after the war, countries resorted to monetary policies to reduce
these debts via inflation. Especially in Europe, this resulted in a full halving of accumulated
wealth. Interestingly, he provides evidence that the physical destruction of war was much
less than 50% of this amount. The bigger impact came from what he calls “budgetary and
political shocks.”—namely the massive reversal of globalized wealth, the very low savings
rates and the drop in real estate and equity values.
6. Does the book support Marxist policy? The book’s title echoes Karl Marx’s famous work,
also titled Capital, which many people took to mean that Piketty would further Marx’s
message. Though both works are concerned with inequality, Piketty’s conclusions are very
different from those of Marx. In fact, Piketty says that his “conclusions are less apocalyptic
than those implied by Marx’s principle of infinite accumulation and perpetual divergence.”9
In the end, he concludes that Marx was focused properly on equality, but his remedies
were incorrect. At one point he says, “Unfortunately for the people caught up in these
totalitarian experiments, the problem was that private property and the market economy
do not serve solely to ensure the domination of capital over those who have nothing to sell
but their labor power. They also play a useful role in coordinating the actions of millions
of individuals and it is not so easy to do without them. The human disasters caused by
Soviet-style centralized planning illustrate this quite clearly.”10
7. Is there a difference between inherited and created wealth? One of the biggest
faults many point to in the book is that it doesn’t necessarily differentiate between the
plutocratic systems that existed during the period before 1910 and the meritocratic
systems we have today. Much of the recent wealth creation has been by innovators that
have operated within a capitalistic system and enhanced the lives of millions. Individuals
such as Bill Gates, Warren Buffett, Sam Walton and Mark Zuckerberg earned their money,
and most would say they did so fairly. The book is focused on the inequality of wealth, and
this is much more prevalent in Europe than in the U.S. Even Piketty provides the data to
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support this, and as one book review points out, “The dramatic U curve in European wealth
is practically flat in America, where the capital-to-income ratio in 2010 was lower than it
had been in 1870–2000.”11 Piketty believes that the current trends will manifest themselves
in greater inherited wealth, but he provides little data to support this view.
8. What are Piketty’s views on progressive taxation? Piketty’s solutions focus on what he
calls “modernizing rather than dismantling” the current system. He focuses extensively on
the role of the state and especially taxation and public debt. In Chapter 14, Piketty turns
to taxation, arguing that extreme levels of progressive taxation are the most useful way to
reduce inequality. He states that “the evidence suggests that progressive taxation of very
high income and very large estates partly explains why the concentration of wealth never
regained its astronomic Belle Époque levels after the shocks of 1914–1945.”12 Specifically he
believes that the financial pressures coming out of WWI forced governments to implement
progressive taxes, which went as high as 97%. He concludes, “The progressive tax thus
represents an ideal compromise between social justice and individual freedom.”13
9. What solution does Piketty recommend? The first 500 pages of Capital lead up to the
policy recommendations Piketty makes in Chapter 15. His ultimate view is that the most
direct way to short-circuit the accumulation of wealth is to minimize the disparity in r>g.
Thus, he calls for a global tax on capital. He states, “The capital tax I am proposing is a
progressive annual tax on global wealth. The largest fortunes are to be taxed more heavily,
and all types of assets are to be included: real estate, financial assets, and business assets.”
In his view, the capital tax is not so much about the distributive powers it could have
(the tax would actually raise limited new revenue for the state) but about the diffusion of
wealth from the top few percent. Moreover, he believes the global tax should “promote
democratic and financial transparency.”14 In his view, the focus on income taxation after
WWI provided significant levels of transparency around wages and earnings and a new
tax on wealth would have similar benefits. But Piketty is a realist, and he concludes that
“a global tax on capital is a utopian idea. It is hard to imagine the nations of the world
agreeing on any such thing anytime soon.”15
10.What are Piketty’s views on public debt? The book’s final chapter focuses on public
debt. This is appropriate as debt and taxes are the two principal ways the state interacts
with the global financial system. As would also be expected, Piketty believes that “[in]
the general interest, it is normally preferable to tax the wealthy rather than borrow from
them.”16 Piketty recognizes a need for governments to incur debts over short periods of
time, but believes that over time debt is a negative in that it suppresses growth. Moreover,
it is critical to remember that debt has two sides—a lender and a borrower. To the extent
that government wealth goes down as a result of larger debts, the private wealth is likely
to go up. Given that private wealth is usually held by a concentrated few, the wealthy are
the ones that governments owe that money to. Piketty ultimately concludes that debt
has to be reduced over time and the only way to do that is inflate it away, repudiate it
or increase taxes to pay it down. He believes the third option is the best and inflation
the second best option. But in his view inflation is a less “transparent, just and efficient
method.”17
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Concluding Thoughts
Though a majority of commentators and investors are likely to disagree with Piketty’s
conclusions and, in reality, much of his analysis, he does place a spotlight on an important topic.
As the current phase of global economics has the tendency of pushing the lower 50% further
behind, the topic of inequality is only going to grow in importance in economic and political
circles. The challenge is that there is a vast gap in recognizing the existence of an issue and
understanding its causes and an even further distance in prescribing appropriate fixes. Capital
furthers the data analysis of long-term economic disparities, but robust data that confirms his
policy solutions is lacking.
Sources
1. IGM Forum. “Piketty on Inequality, Poll Results.” www.igmchicago.org/igm-economic-
experts-panel/poll-results?SurveyID=SV_5v7Rxbk8Z3k3F2t.
2. “Bigger than Marx.” The Economist. May 3, 2014.
3. Piketty, Thomas. Capital in the Twenty-First Century. Pg. 25.
4. Minack, Gerald. “Us Versus Them.” www.nakedcapitalism.com. October 23, 2013.
5. Credit Suisse. Global Wealth Report 2014. publications.credit-suisse.com/tasks/render/
file/?fileID=60931FDE-A2D2-F568-B041B58C5EA591A4
6. Giles, Chris. “Piketty findings undercut by errors.” The Financial Times. May 23, 2014.
7. Ibid.
8. Ibid.
9. Piketty, Thomas. Capital in the Twenty-First Century. Pg. 27.
10.Ibid. Page 532
11. McArdle, Megan. “Piketty’s Capital: An Economist’s Inequality Ideas are all the Rage.”
Bloomberg Businessweek. May 29, 2014.
12. Ibid. Page 495.
13. Ibid. Page 505.
14. Ibid. Page 518
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15. Ibid. Page 515.
16. Ibid. Page 540.
17. Ibid. Page 544.
What Is News or Noise?
Like most of you, we are inundated with information on our phones, in our email inboxes and on the Internet.
Clearly, the world doesn’t need another investing blog to reprocess stale information or reformat the day’s
useless headlines. Thus, in our investment blog, “News or Noise,” we’ve taken up the challenge of sorting through
the infinite bits of background noise and seeking the few truly newsworthy nuggets of information. What are the
stories today that are likely to be meaningful for investors in the future? A very small number of headlines are
important, and of those, many are immediately processed by investors. Only a tiny fraction of all the new data is
truly relevant and underappreciated.
Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment
strategy, or product (including the investments and/or investment strategies recommended or undertaken by SignatureFD, LLC), or any non-investment related
content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable
for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content
may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves
as the receipt of, or as a substitute for, personalized investment advice from SignatureFD, LLC. To the extent that a reader has any questions regarding the
applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.
SignatureFD, LLC is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice.
A copy of the SignatureFD, LLC’s current written disclosure statement discussing our advisory services and fees is available upon request.
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