What is Wealth - Where has it Gone?

But, before one can discuss the effects of wealth one needs to decide what wealth really is. This brings up the issues of price and value. Price is the simplest concept to define, the price of something is what it costs at the moment when a transaction takes place. Many people find this definition unsatisfactory, however. We frequently hear that something is a "bargain" or overpriced. What is really meant is that the current price differs from what we feel a fair price should be. This gets us to value, a much trickier concept.

People have been trying since the invention of money to define value. For most of the period rare metals were given a value and then everything was priced in relation to this. This mindset still exists as the current gold rush indicates. Gold has risen in price because many people think it has some inherent value and is a safe investment. However, the real market for goal (aside from hoarding) is quite small. It consists mostly of electronics and medical applications and is about 12% of the total. Jewelery is by far the biggest use, but this is a form of hoarding. If people stopped being emotional about gold then demand would only be a tenth of the present amount and the price would drop accordingly. In other words, gold is valuable only because people say it is.

Before the industrial age much wealth was held in the form of land. The value of the land was proportional to its productivity. Farmland or forest could yield a certain amount of product which could be sold. The price of the land was a multiple of this. The seller expected to be paid for a certain number of years of future, foregone, revenue when the land was sold. These days this type of valuation is also found in the pricing of common stock. We hear about the price/earnings ratio and stocks which are selling at a low multiple are considered cheaper than those selling at a higher multiple (assuming the future earnings prospects for both firms are similarly stable). But the average P/E value changes with gross economic conditions, during periods of a downturn it tends to fall as prospects dim. So, once again, the yardstick of value turns out not to be a reliable measure.

In many industrialized countries we have seen a large rise in wealth disparity in the past 40 years. What forms has this wealth taken? The biggest growth in wealth has been in the rise in financial instruments held by the wealthy. If an individual owns shares in a company and the stock rises in price the person is said to have gotten wealthier. But, as I just mentioned, share prices depend upon expected future economic activity. So this is only paper wealth. There have been efforts to diversify and many wealthy people have bought multiple homes, antiques and art work, and other tokens of conspicuous consumption. Once again a value built upon expectations. There are now several multi-million dollar homes for sale in my area with no buyers. This is not related to the current mortgage mess, but to the fact that the pool of wealthy investors has shrunk (in the US) and international purchasers are looking elsewhere. How much is a $10 million home worth if there are no buyers?

More prudent wealthy individuals buy into commercial and rent producing real estate. As with land the price is related to the income stream generated. In an economic downturn tenants leave and the income stream declines. Wealth tied to the imputed value declines as well.

What this means is that those countries which have seen the greatest increase in "wealth" are now at the highest risk of a wealth collapse. This was first seen over a decade ago in Japan when the commercial real estate bubble popped. It is now being seen in the US, the UK and in several other countries whose economy is tied to finance (like Switzerland). The new measure of wealth is shifting towards vital commodities. The most dramatic rise has been in the oil states where the sharp rise in the price of oil has led to a wealth boom. States like Abu Dhabi and Dubai are using the new income stream in a building frenzy as well as buying up assets in other parts of the world. The foolish oil states are devoting too much of this current wealth to internal growth, while the most prudent are trying to diversify so that they will own income producing assets elsewhere that will allow them to maintain their wealth when the oil revenues decline. This won't work. The US has been able to maintain investments in the rest of world by the use of gunboat diplomacy, although this is changing in South America. Dubai can't do anything if in ten years the US decides to expropriate foreign owned assets as it did during WWII.

Where is this all leading? First it must be understood that the "stagnation" of the middle class in the developed world is going to become the norm. The middle class saw it standard of living increase after WWII for a number of reasons. The growth had been inhibited for over a decade by the depression and war. The burst of technological innovation led to higher productivity which enabled workers to generate more output for the same labor. This enabled them to bargain for a bigger share of the economic pie. Raw materials were at unnaturally low prices making profits higher in the developed countries and thus shifting the wealth from the weaker states to the stronger.

The natural standard of living of the working class is that which allows them to live and work. If they have "excess" wealth then prices will rise to absorb this. We have seen this at work in the US already. Non-discretionary items like housing, health care, child care and education have risen in price much faster than income and now take an unprecedented proportion of family spending. Efforts by the government to compensate by subsidizing the cost of these items are self-defeating. If the amount of college tuition grants goes up, then families are more able to afford the cost and the price will rise because of increased demand. In the end college will just be as unaffordable as before. The alternative is for governments to set prices or remove cost as a factor by nationalizing the service. This technique is in use in some Scandinavian countries and is being tried in parts of South America. It is not under consideration in the US or UK where privatization is the ruling philosophy.

As much of the paper wealth accumulation of the past several decades evaporates we can expect to see dramatic social dislocation. One possibility is for a country to sink into plutocracy where the wealthy take over the levers of power and keep their wealth maximized at the expense of the overall health of the nation. So far this type of behavior has been restricted to poor countries like Haiti and parts of Africa, but undemocratic trends in the US have increased dramatically in the past 40 years and what will happen next is an open question. Another possibility is that the country as a whole will lose its economic standing and become less wealthy overall. The wealthy who can move their assets abroad will do so, and leave as well and those who are left behind will just be poorer. The details differ, but this can be seen in the histories of many of the former colonial empires. Nobody regards Spain, Portugal or the Netherlands the same way now as they were during their heydays.

Can this happen to the US? Well for the time being, the plan is to use military superiority to prevent such a development. This option seems to become less effective as time goes on. The US failed in its objectives with Korea, Vietnam, and now Iraq. The rise of an Asian block which can trade internally also means that efforts to influence policies in China and India will not be as effective as they were in the days of the banana republics.

What the American public will do when it discovers that it is the former "world's only superpower" remains to be seen. So far the government and the media have conspired to prevent the information about the decline of stature and competitiveness from becoming widely known. People still think (incorrectly) that the US has the best health care, best educational system, best telecommunications infrastructure, and best mass transit system. Information about the level of social services provided elsewhere (especially in the EU) is not understood either. Perhaps the public is just being conditioned to accept second class status. Things were much worse during the depression and rather than public outrage their was mostly resigned acceptance.

There may be some shifting in the wealth inequality, but this will mostly be due to the decline in the price of the inflated assets I discussed above. Efforts to redistribute wealth will fail, the libertarian spokesmen for the wealthy have nothing to fear. There may also be some modest changes to regulations which control such markets and this will hold down future bubbles for a generation or so. Those who are intent on making money will just move their investments to where the action is. General Motors is now betting on growth in China, but why should the government there wish to allow GM to move the profits to the US? After awhile these foreign investments will be taken over by local enterprises - a trend which has already started.

Can anything be done to maintain the US type of lifestyle in the developed countries? I would say no, but the willingness of the government to totally destroy a society to get at its natural resources may forestall change, at least until the resources run out globally.

There are too many people, chasing after too few resources and there is a lack of effort to adapt to a sustainable level of consumption and population. If the transition is not planned, it will happen anyway, it just won't be pleasant and who the big losers will be can't be anticipated.