Inflation isn’t new, but price rises can still shock. I recently holidayed in the Hamptons, a tony beach area outside New York, where I was stunned to pay $800 for a single shopping cart of groceries. This wasn’t at some foodie emporium, but rather at the IGA, which is the American equivalent of the UK’s Tesco. Food prices are up everywhere, but in places like this, they have reached nosebleed levels.
Wealthy locals and vacation shoppers notice, but seem not to curb their spending. Everyone else is travelling an hour or more to get groceries outside the resort areas, ordering dry goods from Costco and growing their own produce.
This story is extreme, but by no means a one-off. To the extent that the wealthy in the US are not yet cutting back on spending, they may be an important and under-explored factor driving the inflation felt by all.
The top two-fifths of income distribution in the US accounts for 60 per cent of consumer spending, while the bottom two-fifths accounts for a mere 22 per cent, according to 2020 BLS statistics.
Income inequality is not the same as wealth inequality. But the two can go hand in hand. People who make higher incomes tend to receive a greater percentage of compensation in stock. They also have vastly more home equity (which tends to encourage more consumption spending, according to IMF research).
The American Enterprise Institute, a right-leaning think-tank, estimated in February that the wealth effect of both asset gains and cash extraction from the refinancing of property (which hasn’t corrected yet, like stocks) represented $900bn, with a consumption impact that started last year and will continue through 2022.
Amazon’s Jeff Bezos can build a half-billion-dollar yacht, and it doesn’t change life for anyone but him. But when the top quintile of Americans as a whole enjoy 80 per cent of the wealth effect from rising stock and home values (the AEI’s estimate), I suspect it starts to have a real impact on inflation, and on the overall structure of our economy, which over the course of the past 30 years of real falling interest rates has become highly financialised.
Gavekal founder Charles Gave explained the underlying dynamics of all this in a recent piece for clients. “If the market rate [of interest] is too low versus the natural rate, then financial engineering pays off . . . borrowing to capture the spread will lead to a rise in the value of those assets which yield more than the market rate, but also to a rise in indebtedness.”
The issue is that fewer new assets will be created — why invest in a factory or workforce training when you can buy back stock? One practical result of this unfortunate Wall Street-Main Street arbitrage is lower productivity. Falling productivity and artificially low rates often equal inflationary recovery periods — just as in the 1970s.
The only way out is through the pain of higher interest rates. The market cost of capital must be normalised to reduce financialisation, and the unproductive allocation of resources and inequality that comes with it.
Unfortunately, the pain of that paradigm shift (like the benefits of the previous one) won’t be shared equally. Rising rates hit the poor hardest, raising the cost of non-expendable items such as food, housing and payment of credit cards and other loans. The rich can keep spending, while others have to make tougher economic choices.
The US housing market is the best example of the economic and social downsides of extremely financialised growth. Historically, high home prices — which are in part a result of more cash buyers and investors in the market, as well as zoning restrictions and financing trends that favour the rich — mean more people are renting. Rents today are rising not just in big cities, but across most of the country.
But the people who tend to rent are those least likely to be able to pay the higher prices. According to 2021 Pew Data, 60 per cent of renters are in the lower quartile of American income. If you look at net worth, including asset wealth, that number rises to 87.6 per cent. As more discretionary income goes on basics, the consumption picture is further skewed towards the rich.
Of course, no economic paradigm lasts forever. Higher interest rates will eventually bring down artificially inflated asset values.
Meanwhile, the Biden White House is doing what it can to buffer inflationary pain for working people. It has been releasing strategic petroleum reserves in a partly successful effort to lower prices at the pump, extending pandemic-era caps on some student loan payments and pushing for antitrust action in areas where corporate concentration (which has grown hand in hand with financialisation) may be responsible for some inflationary pressure.
But more changes are needed. The success of corporate lobbyists in overturning efforts to roll back carried interest loopholes are shameful. Student debt forgiveness — no matter how generous it is — will not change the fact that the cost of four years of private university in the US (an elastic cost that can be bid up indefinitely by the global rich) is nearly double the median family income. Housing markets continue to cry out for major reform.
I suspect it will take a younger generation to push through these sorts of systemic changes. They simply don’t have as much asset wealth to protect.