Monday, 28 April 2014

Thomas Piketty on Inequality and Capital

Thomas Piketty has written a popular economics book. In 1936, a difficult-to-read academic book appeared that seemed to tell politicians they could do what they wanted. This was Keynes’s General Theory. In today's Guest Post, Hunter Lewis argues Piketty’s book does the same in 2014, and serves the same short-sighted, destructive policies.

Thomas Piketty’s Sensational New Book
By Hunter Lewis

Thomas Piketty, a 42-year-old economist from French academe has written a hot new book: Capital in the Twenty-First Century. If you haven't already heard of it, you will. Indeed, your 'masters' already have.
    The U.S. edition has been published by Harvard University Press and, remarkably, is leading the best seller list; the first time that a Harvard book has done so. A recent review describes Piketty as the man “who exposed capitalism’s fatal flaw.”
    So what is this flaw? Supposedly under capitalism the rich get steadily richer in relation to everyone else; inequality gets worse and worse. It is all baked into the cake, unavoidable.
    To support this, Piketty offers some dubious and unsupported financial logic, but also what he calls “a spectacular graph” of historical data. What does the graph actually show?

    The amount of U.S. income controlled by the top 10 percent of earners starts at about 40 percent in 1910, rises to about 50 percent before the Crash of 1929, falls thereafter, returns to about 40 percent in 1995, and thereafter again rises to about 50 percent before falling somewhat after the Crash of 2008.
    Let’s think about what this really means. Relative income of the top 10 percent did not rise inexorably over this period. Instead it peaked at two times: just before the great crashes of 1929 and 2008. In other words, inequality rose during the great economic bubble eras and fell thereafter.
    And what caused and characterized these bubble eras? They were principally caused by the U.S. Federal Reserve and other central banks creating far too much new money and debt. They were characterized by an explosion of cronyism as some rich people exploited all the new money, both on Wall Street and through connections with the government in Washington.
    We can learn a great deal about cronyism by studying the period between the end of WWI and the Great Depression and also the last 20 years, but we won’t learn much about capitalism. Crony capitalism is the opposite of capitalism.    
    It is not the result of free prices and free markets, instead it is a perversion of markets. Not capitalism at all. [You can blame cronyism on government, not on business. -Ed.]
    One can see why the White House and other big government fans likes Piketty. He supports their narrative that government is the cure for inequality, when in reality government has been the principal cause of growing inequality.
    The White House and IMF also love Piketty’s proposal, not only for high income taxes, but also for substantial wealth taxes. The IMF in particular has been beating a drum for wealth taxes as a way to restore government finances around the world and also reduce economic inequality.
    Expect to hear more and more about wealth taxes. Expect to hear that they will be a “one time” event that won’t be repeated, but that will actually help economic growth by reducing economic inequality.
    This is all complete nonsense. Economic growth is produced when a society saves money and invests the savings wisely. It is not quantity of investment that matters most, but quality. Government is capable neither of saving nor investing, much less investing wisely.
    Nor should anyone imagine that a wealth tax program would be a “one time” event. No tax is ever a one time event. Once established, it would not only persist; it would steadily grow over the years.
Piketty should also ask himself a question. What will happen when investors have to liquidate their stocks, bonds, real estate, or other assets in order to pay the wealth tax? How will markets absorb all the selling? Who will be the buyers? And how will it help economic growth for markets and asset values to collapse under the selling pressure?
    In 1936, a dense, difficult-to-read academic book appeared that seemed to tell politicians they could do exactly what they wanted to do. This was Keynes’s General Theory. Piketty’s book serves the same purpose in 2014, and serves the same short-sighted, destructive policies.
    If the Obama White House, the IMF, the European and the world's central banks -- and people like Piketty --would just let the economy alone, it could recover. As it is, they keep inventing new ways to destroy it.

Hunter Lewis is author of nine books, including two new books, Free Prices Now! and Crony Capitalism in America: 2008-2012.Lewis is cofounder of Against Crony as well as co-founder and former CEO of Cambridge Associates, a global investment firm. He has served on boards and committees of 15 not-for-profit organizations, including environmental, teaching, research, and cultural organizations, as well as the World Bank. This post first appeared at the Mises Daily. It has been lightly edited.


  1. Wealth taxes will bring the house down.

    Most people have a strange idea about wealth and what it actually is, believing rich people have some sort of kiddies piggy bank; in fact the vast majority of wealth is simply the 'goodwill' part of a company (ie: you multiply the annual profits by a certain figure - usually about 5 - and come up with a number).

    Goodwill based wealth is simply all part of the game; the businessman pays 1/3 of his profits to the State in the form of taxes, and in return his Accountant tell him how rich and incredibly clever he is - for example, he makes $1 million in profits, he pays $280,000 in company taxes leaving $720,000 net; his Accountant simply multiplies that by 5 to get $3.6 million in 'goodwill' and everyone is happy.

    It is not actually 'money' unless the businessman sells everything up, much like the house you bought for $300,000 a decade ago, and is 'worth' twice that today, is not actual 'money in your pocket'.

    To tax something which is little more than an Accountant giving an opinion - (so the businessman can 'feel' richer rather than realising he has been right royally shafted by the taxman and quit and take his net profits and live the high life in the Bahamas) - is just silly.

    It will lead to vast numbers of seminars and books encouraging businessmen to tell everyone to get stuffed and do an Atlas Shrugged - and rightly so - for a very good reason that few businessman can afford to actually pay the wealth taxes, as proposed, because there is no kiddies piggy bank.

    As the sole person in the world who didn't 'swallow it whole' from Obama I think this is further proof he is a Manchurian Candidate.

  2. "...his Accountant simply multiplies that by 5 to get $3.6 million in 'goodwill' and everyone is happy."

    If anyone is foolish enough to value a company in this manner or to accept such a valuation, then they deserve entirely the ruination that likely as not is a-coming their way. This is not the correct way to value a company. It never has been. Let's see what can go wrong with this sort of silliness. Here is one possibility (there are plenty of others).

    This makes the after tax profit as above mentioned. The company is a stainless steel fabrication business. It is engaged in the dairy industry. The owner supervises and runs the business in all aspects including quotation, sales, marketing, hands-on work, product development, production scheduling, staff supervision, apprentice training, professional development of staff, general managementm, pricing, response to RFPs and industry visits. His wife does the day to day book-keeping and the accountant does the rest. The owner has been doing all these tasks since he started the company some 20 years ago. There are now 15 employees on the floor.

    This makes $590,000 after tax profit. It is in the same business sector as COMPANY A. There are 17 employees. Two of the employees join the owner of COMPANY B undertaking many of the tasks that the owner of COMPANY A 100% does alone. It can be said of this company that it has a management team of three- the owner and two of the staff. These two extra staff relieve much of the time of the owner. They have specialist skill and knowledge every bit as good as the owner's but neither is presently interested in starting up his own business from scratch. Both, however, are long standing employees of honesty and professionalism. It is known that both intend to stay on and are satisfied with their conditions and situation. The owner has been in the business for 20 years since he started this company. He committs somewhat less time to his business than does the owner of COMPANY A. He acknowledges that he will eventually need on-sell his company and has been aware of this for some 5 years.

    Which of these companies would most likely be worth the greater? All else being equal the answer is most liley to be B. Point of the story is that you can never rely on an abitrary multiplier when valuing a company like this.

    But the bigger point is this. Just as valutions by multiple are made on an arbitrary basis and rely on fictious assumptions, so too wealth taxes. They are theft, as all taxation actually is. Governments are the conveyances that enable such thefts on the grandest of scales possible. Once the wealth is cleaned out and the economy and standard of living tanks, then expect the wars. They are always a good excuse.

    Dinner calls and so one last question. Does any one of you believe that US equities and indexes are falling due to the instability and violence in the Ukraine?


  3. Amit - not surprised to hear everyone in the world is silly apart from you, apparently.

    Your "never has been" contention is not only wrong, but sharemarkets value companies like that every single day (and have done so for about 2 centuries!) it is known as the p/e ratio - price to earnings ratio HAHAHAHA!!

    One further point I should make is that New Zealand businessmen are notorious (by world standards) for selling their businesses at very low 'multiples', usually only 1 or 2.

    The 5 X annual profits rule of thumb I mentioned is universal in Britain, the US and Australia for valuing private companies.

  4. Ahh, tricoteuse and tumbrils under a hot sun.

  5. Amit
    The value of a company is decided by the buyer, not the seller. When you buy a company you want to know how long it is going to take to recoup your investment and begin to make money on it. Therefore, as Lineberry notes, you define how many years you can accept being in the red on the investment and try and make a ballpark figure on the value... hence the p/e ratio. It isn't rocket science. It might not seem "fair" but this isn't socialism. Of course other factors of goodwill, planned efficiencies, immaterial rights, etc will modify the value during a due diligence, but the ballpark is usually defined by the p/e ratio.

  6. Mr Lineberry

    You've missed the point. Oh well.

    In the meantime try to get it right, just for once. A p/e ratio is just that, a ratio.

    And sharemarkets are not in the business of valuing anything. They are a marketplace, a venue for transaction and that is all they are. They are not conscious, let alone cogniscant. They are a venue for transaction, not a valuer. Valuations are made by individual buyers and sellers. Sure, they are strongly influenced by regulation and by various attempts to game and to fix. Sure the conditions under which they make transaction are hyper sensitive to the machinations of central banks. Nevertheless, the buyers and sellers, those who make the decision to transact, when and why to transact or not to as the case may be, they are the ones who are doing the valuing, not the marketplace within which they transact.

    While it has been the case for some to use simple mulipliers to indicate a value for a company as "a rule of thumb", the multipliers are about as useful in revealing the value of a company as are economic aggregates in determining the financial health of specific individuals in a population. In other words, not seriously useful at all. For example, using your 5x multiplier for the two companies in the example provided would report a higher "value" for the COMPANY A whereas real experience demonstrates it is likely that the COMPANY B would be more profitable after sale, hence is more valuable. This sort of occurance is not uncommon. Indeed some of the largest equities transactions undertaken demonstrate exactly that point. Do the research. Go find out about them.

    Some helpful questions for you to ponder: Have you heard the term "due diligence"? Do you know what that is? Have you any idea why they are done? Have you ever done one?

    Done properly, valuation requires the valuer to undertake significant and rigorous efforts to obtain real and specific information pertaining to the condition of a company, the market it operates within, the nature of the management, internal structure, competitors, customers, suppliers and so on. This is the polar opposite of grabbing a random multipler and applying it to somewhat dubious numbers reported in a public venue (do you even know how those profit numbers were generated, on what basis they were calculated, on who did the books and what their instructions were?). Here again we encounter the difference between knowing and blowing (again).

    Valuation of a private company, have you ever undertaken that exercise? I don't mean simply going 5x profit equals some number you call the "value". I mean valuing a company? (see questions about due-diligence above)

    Again it seems you prefer the blowing to the knowing. Well, that's your funeral. Your bragging and puffing demonstrates an abiding insecurity. If you really knew as much as you pretend, if you really were as successful in life as you'd prefer, then you'd not be puffing and blowing and bragging and posing in the manner you have been on these pages for some time. You'd not need to blow. You'd not be worried what others thought of your person or condition. Hence no need to brag in vain attempts to proclaim to other people how you are a man of successes and greatness.

    Finally, NZ companies sell at the prices they do for several reasons. One of them is inherent to the example of COMPANY A and COMPANY B provided above. Ponder on it.


  7. ...And sharemarkets are not in the business of valuing anything.. - is this some sort of hoax?

    I made a few points and shall recapitulate them here -

    1. Wealth taxes are in response to the claim "Mr X, the businessman, is worth $20 million" (or whatever)

    2. Most of that $20 million is simply 'goodwill' or a p/e ratio, not actual cash in some kiddies piggybank

    3. Mr X almost certainly doesn't have $200,000 lying around to pay a 2% wealth tax

    4. Mr X will have to start sacking some people to get the money to pay such a tax, thereby making unemployment worse, thereby making 'inequality' worse.

    5. Back in the bad old days of high marginal tax rates a game was played; Mr X (or his granddad) paid high marginal taxes, in return his accountant was encouraged - (it was actually in the rules of the Chartered Accountants industry body to do so!) - to give a 5X the net profits valuation each year for Mr X's company (usually on embossed parchment in old fashioned writing to make it more impressive), thereby making him feel richer (and to take his mind off the shafting the Government gave him) - it was all a game.

    6. A part of the 'game' was the understanding that there was no capital gains or wealth taxes (ie: Mr X was told "this is all tax free!") if he felt like selling up at retirement.

    7. The reason the game was played was so Mr X would not 'do and Atlas Shrugged' and quit.

    8. Wealth taxes take away the remaining fig leaf that there is some point to engaging in free enterprise activities in Western nations (some point from the businessman's perspective, that is)

  8. Corrigendum: that should have read '$400,000 to pay a 2% wealth tax', not $200,000.

  9. Mr Lineberry

    Selective quotation followed by this sort of silliness, "is this some sort of hoax?", is your dishonesty on display. Read the passage in its entirety. Are you truely unable to comprehend the difference between a venue and a conscious decsion making individual? Come now. Don't insult your own intelligence so.

    As to the rest of what you report, some of it corresponds to reality, some not so much, by and large modest triviality produced from uncertain assumption. To make the point proceed directly to it. The salient point is that just as valutions by multiple are made on an arbitrary basis and rely on fictious assumptions, so too wealth taxes.

    I add, wealth taxes are theft, as ALL taxation actually is, and that governments are the conveyances that enable thefts on the grandest of scale.

    Also, item number 7 is quite an ambitious claim. Are you really certain this was THE reason? It'd be interesting to know.


  10. Yes Amit, I am sure.

    Several prominent politicians in NZ during this period, Sir John Marshall and Sir Robert Muldoon, mentioned it in their autobiographies; several prominent businessmen during this period also mentioned it in theirs.
    There are also a couple of other, general history, books detailing NZ business in the 3 decades or so prior to Rogernomics which say the same thing.

    One reason for this concern about high marginal tax rates was that in America after WW2 various prominent families - Rockerfeller, Mellon, Vanderbilt, Kennedy, Cabot, Astor being some examples - simply stopped engaging in active business.

    What they did was focus (solely) on tax minimisation and managing their already large fortunes, rather than adding to those fortunes, because the income tax rate was 90% (if you did any work), the capital gains tax rate was 25% (for doing nothing).

    So what do you think they did?

    One of the reasons President Kennedy in 1963 pushed for large income tax cuts (implemented by his successor) was because he knew from his father and all his friends, that lots of rich people were not bothering anymore (why pay 90% when you can pay 25%?)

    In New Zealand the most notable example of this (there were plenty of others, by the way) was Sir Robert Jones who made a large amount of money in the early 1960s in the publishing business and then quit to manage his investments.

    There is a lot of evidence that NZ governments were a bit worried about Jones and his loud mouth, pointing out what fools businessmen were by continuing to be businessmen, and the effect it may have.


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