Are you really richer?

2020 was a great year. That sounds a little counter-intuitive, mad even. How can a plague year — that’s how The New Yorker referred to 2020, which saw an estimated 1.7 million deaths worldwide attributed to coronavirus — be in any way great?

Well, despite Covid-19, total global wealth grew by 7.4% and wealth per adult rose by 6% in 2020, reaching “another record high” of almost $80,000, according to Credit Suisse. The Swiss bank also says, incredibly, that overall “the countries most affected by the pandemic have not fared worse in terms of wealth creation”. It defines wealth as the value of financial assets plus real assets, minus debts.

The initial impact on global household wealth from the pandemic and its associated lockdowns was diabolical. Credit Suisse calculates that $17.5 trillion in global wealth “was lost” between January and March 2020. Per adult it “declined by 4.7%”. More than 20 million Americans lost their jobs in April 2020 alone and US unemployment rose to 14.7%, the highest since 1945.

So how come we ended that horrendous year by being richer? Did we suddenly get loads of extra loot in our bank accounts?

Not quite.

The wealth increase has almost all been due to an increase in asset values. The MSCI all-country world index of global shares ended 2020 13% higher than at the start and two-thirds up from its low in March 2020.

There are many different reasons for this surge. One underlying factor is a recovery of confidence, partly because of the surprising speed of the vaccine development. Equities fell by 34% in early 2020 but bounced back on new-found optimism.

We all know by now what has happened to the value of what for most of us is the biggest asset investment we make — our home. In the US house prices have been going up in ‘value’ at the fastest rate in 30 years. In the UK the price rise rate has been much less; ‘only’ the fastest for about 17 years.

That surge in confidence was supported by governments and central banks vastly inflating their borrowing through a combination of monetary and fiscal measures. They shovelled trillions of Dollars into the global financial system. The Institute of International Finance (IIF) said that global debt in 2020 reached a new record of $281 trillion. In the US, the government has borrowed and sent out to all eligible adults $3,200 and every eligible child $2,500 in three rounds of stimulus money; this will cost the government an estimated $867 billion.

Keeping track of what this cash is being spent on is difficult. While many of the extreme poor have used the money to buy food and/or pay rent, the less financially-pressed have used the money to buy shares and other assets. According to a recent Deutsche Bank survey (of an admittedly small sample, just 430) who use online broker platforms half of respondents between 25 and 34 plan to spend 50% of their stimulus payments on stocks. The survey found that more than half of all respondents raised their investments in stocks over the past year, with just under half (45%) investing for the very first time. “Behind the recent surge in retail investing is a younger, often new-to-investing, and aggressive cohort not afraid to employ leverage”, according to the bank.

An impure ‘Cantillon effect’

While many Americans have been kept afloat by government emergency relief, the suspicion is that the mechanism for getting central-government money directly into the hands of those who need most it is flawed.

Enter Richard Cantillon. He was an Irish-French economist, murdered by a disgruntled employee in 1734. Cantillon’s most famous contribution to economic theory was his Essay on the Nature of Trade in General.

The ‘Cantillon Effect’ holds that relative prices change depending on how newly created money is distributed and spent. Perhaps Cantillon’s most relevant insight today is his assertion that recipients of ‘new’ money benefit more according to the position they already occupy vis-à-vis the social hierarchy. Cantillon argued that when governments create money, some people will end up with more purchasing power than others, because the “pipes” along which the money flows do not distribute it evenly across society; nor is it spent uniformly.

In the 18th century, the closer you were to the king and the wealthy, the more you benefitted. The further away you were, the less.

Today’s state largesse has benefitted more those in the fortunate position of not having to use ‘new’ money to buy essential goods and services.

The kinds of ‘stimulus’ programmes introduced by governments around the world have added to the money supply but the distribution and use of this ‘new’ money is uneven. Today we are experiencing what might be called an ‘impure’ Cantillon Effect. The US broad money supply (M2, which comprises currency, bank deposits and retail money market funds) has increased in the past 12 months by around $4 trillion, by far the largest expansion in US history. Central banks have created a lot of new money, but since that money is being used to directly replace the lost income of workers, their incomes have not increased. One group has benefitted tremendously — the already rich. Wealth inequality is nothing new in the US and elsewhere. Covid and its consequences have only widened a divide that started to become very obvious about 40 years ago. Between March 2020 and April 2021 the collective wealth of American billionaires went up by 55% to $4.56 trillion.

The coronavirus has thrown into stark relief the different ways different social groups spend the money they have. At the start of the pandemic there was a dramatic and worldwide collapse in spending. These spending reductions were not evenly spread across the economy. For large numbers of people, especially the poorest, most or even all of their spending is on essentials. Outgoings such as rent or mortgage payments or food take up a very large chunk of disposable income for most people. For these people, their spending barely dropped.

The huge falls in spending have come from richer people, for whom a much greater proportion of their spending is discretionary, non-essential items. Much of the normal spending of the wealthy and middle class, who have either been able to work from home (and thus protect their income) or who are able to live off investments, has been impossible during lockdowns, which have banned travel, dining out, or visiting stores and doing face-to-face shopping, and other ‘luxuries’. The work-from-home trend has enormously benefitted the share valuations of the likes of Amazon, Microsoft and Facebook.

Ruchir Sharma, the chief global strategist at Morgan Stanley Investment Management, follows the super-wealthy. He asserted in May this year that the Covid-19 pandemic has reinforced the trend towards inequality. In his words, “as the virus spread, central banks injected $9 trillion into economies worldwide, aiming to keep the world economy afloat. Much of that stimulus has gone into financial markets, and from there into the net worth of the ultra-rich. The total wealth of billionaires worldwide rose by $5 trillion to $13 trillion in 12 months… wealth inequality is likely to continue widening until the monetary spigots are turned off”.

With consumer price inflation now rising ahead of the targets set by many central banks around the world, we may be seeing the Cantillon Effect come to pass in its fullest sense — that all the “new” money now in circulation may create higher prices. Those with a cushion of wealth may turn out to be the unintended beneficiaries from higher asset prices across the board.

One consequence of the injection of trillions of Dollars into the world’s economy is that many of us may feel — and indeed actually be, in paper terms — more wealthy than we were.

But what will happen to the purchasing power behind that wealth? Even if the US Federal Reserve and the world’s other central banks start ending their loose monetary policies, there has been an irreversible inflation in the quantity of paper money. Unless governments drastically soak up all this newly created and/or borrowed money (through tax rises, maybe) it will further lose its value, its purchasing power.

The final chart gives a very clear picture of two compelling things: the first (the gray block) is the steady — relentless one might say — decline in the US Dollar’s purchasing power; the second (the yellow block) is the (erratic) rise in the gold price. What has happened of course is no guide to what will happen. But it could take a miracle to reverse the flood of fiat currency now at large.

Source: St Louis Federal Reserve and the Market Oracle

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