Northwest Indiana Discussion

Excerpted from: Citigroup Equity Strategy re Plutonomy
Part 1 Oct 16, 2005
BY Ajay Kapur, CFA, CITIGROUP

[plutonomy - n. An economy that is driven by or that disproportionately benefits wealthy people, or one where the creation of wealth is the principal goal. [Blend of pluto- (wealth) and economy.]

- The World is dividing into two blocs - the Plutonomy and the rest.

- The U.S., UK, and Canada are the key Plutonomies - economies powered by the wealthy. Continental Europe (ex-Italy) and Japan are in the egalitarian bloc.

- Equity risk premium embedded in "global imbalances" are unwarranted.

In plutonomies the rich absorb a disproportionate chunk of the economy and have a massive impact on reported aggregate numbers like savings rates, current account deficits, consumption levels, etc.

This imbalance in inequality expresses itself in the standard scary "global imbalances". We worry less.

What are the common drivers of Plutonomy?

- Disruptive technology-driven productivity gains,
- creative financial innovation,
- capitalist-friendly cooperative governments,
- an international dimension of immigrants and
- overseas conquests invigorating wealth creation,
- the rule of law, and
- patenting inventions.

Plutonomies have occurred before in sixteenth century Spain, in seventeenth century Holland, the Gilded Age and the Roaring Twenties in the U.S.

Often these wealth waves involve great complexity, exploited best by the rich and educated of the time.

2) We project that the plutonomies (the U.S., UK, and Canada) will likely see even more income inequality, disproportionately feeding off a further rise in the profit share in their economies, capitalist-friendly governments, more technology-driven productivity, and globalization.

4) In a plutonomy there is no such animal as "the U.S. consumer" or "the UK consumer", or indeed the "Russian consumer".

There are rich consumers, few in number, but disproportionate in the gigantic slice of income and consumption they take. There are the rest, the "non-rich", the multitudinous many, but only accounting for surprisingly small bites of the national pie. [...] i.e., focus on the "average" consumer are flawed from the start.

At the heart of plutonomy, is income inequality. Societies that are willing to tolerate/endorse income inequality, are willing to tolerate/endorse plutonomy. We make the assumption that the technology revolution, and financial innovation, are likely to continue. So an examination of what might disrupt Plutonomy - or worse, reverse it - falls to societal analysis: will electorates continue to endorse it, or will they end it [as they did with the New Deal], and why.

Organized societies have two ways of expropriating wealth - through the revocation of
property rights or through the tax system. The more likely means of expropriation is through the tax system. Corporate tax rates could rise, choking off returns to the private sector, and personal taxation rates could rise - dividend, capital-gains, and inheritance tax rises would hurt the plutonomy.

Capital markets, like human beings, generally strive for certainty and stability. The pricing of assets is easier, projections more comfortable, etc. For this reason, in developed capital markets, governments have learnt the lessons of level playing fields, regulatory certainty, and the sanctity of property rights.

WHERE DO WE STAND TODAY?

In the plutonomies, there seems little threat from the first of these challenges: blatant
expropriation of property by governments. There are few examples of governments
changing the rules in the plutonomies and engaging in widespread nationalization, or
asset re-distribution.

Likewise, if anything, the trends of taxation are positive for corporates, with fiscal
competition in Europe forcing rates lower, year by year. Ironically, this is happening
most in non-plutonomy countries, like Germany. This is good for the profit share, of
which the mega-rich, through their holdings of equity, are “long”.

However, even if the profit share is rising, the fruits of those profits could be taxed
before ending up in the pockets of the rich. In other words, dividend, capital gains and
estate taxes could all rise. However, we struggle to find examples of this happening.

Indeed, in the U.S., the current (Bush) administration’s attempts to change the estate tax code
and make permanent dividend tax cuts, plays directly into the hands of the plutonomy.

While such Pluto-friendly policies are not widely being copied around the world, we
have not found examples of the opposite occurring elsewhere.

Protectionism or regulation. Here, we believe lies a cornerstone of the current wave of
plutonomy, and with it, the potential for capitalists around the world to profit. The wave
of globalization that the world is currently surfing, is clearly to the benefit of global
capitalists, as we have highlighted. But it is also to the disadvantage of developed
market labor, especially at the lower end of the food-chain.

There are periodic attempts by countries to redress this balance - Jospin’s introduction of
the 35 hour working week in France to the anticipated benefit of labor being one
example. But in general, on-going globalization is making it easier for companies to
either outsource manufacturing (source from cheap emerging markets like China and
India) or “offshore” manufacturing (move production to lower cost countries).

Brunswick, the recreational services company, is typical of the “globalized” world we
now live in. We were intrigued to see in the company’s September 27 presentation, that
in 2000, the company had 17 manufacturing/procurement centers globally, 14 of them in
North America, high cost European countries or Japan. Today, five years later, they have
40 manufacturing/sourcing /engineering centers. Of these half are in low-cost countries.
Such examples abound in today’s globalized world.

The final option for countries willing to consider it, is to in-source labor. For example,
in the UK, between May 2004 accession of the 10 new countries into the EU, and March
2005, 176,000 workers have moved from the accession countries to the UK and joined
the workforce. Leaving aside any demand benefits they might bring, this does, in theory
keep the price of labor contained. It interests us that the Plutonomy countries (U.S.A,
UK, Australia, and Canada) all have - generally - a welcoming attitude to skilled
immigration. Of the pre-accession EU 15 countries, only a handful, the UK and Ireland
included allow full and free labor movement from the new EU 10 countries into their
labor markets. The vast majority, Germany, Austria, Italy etc., are refusing to allow
accession countries full freedom of movement until 2009-11.

So, property rights look as if they are being protected, tax policies helpful, and the profit
share should continue to rise, through globalization and the productivity/technology
wave.

Our conclusion? The three levers governments and societies could pull on to end
plutonomy are benign. Property rights are generally still intact, taxation policies neutral
to favorable, and globalization is keeping the supply of labor in surplus, acting as a
brake on wage inflation.

There are rich consumers, and there are the rest. The rich are getting richer, we have
contended, and they dominate consumption.

Check out Citigroup's second memo on plutonomy:

Excerpt from Citigroup Equity Strategy memo
by Ajay Kapur, CFA, Citigroup.
March 5, 2006 - Revisiting Plutonomy: The Rich Getting Richer

The latest Survey of Consumer Finance data was released Friday 24th of February (2006). It shows that the rich in the US continue to be in great shape.We thought this was good time to bang the drum on plutonomy

Despite being in great shape, we think that global capitalists are going to be getting an even greater share of the wealth pie over the next few years, as capitalists benefit disproportionately from globalization and the productivity boom, at the relative expense of labor. As we believe plutonomy explains away some of the conundrums we highlighted above, we are very relaxed about these issues.

We believe that the plutonomy thesis helps explain some of the conundrums that vex so many equity investors, such as why high oil prices haven’t slowed the global economy, why consumer confidence might be low yet consumption remains robust in the US, why savings rates are low, and why the dollar depreciation hasn’t done much for the US trade deficit.

By contrast, in other countries such as Japan, France and the Netherlands (read much of continental Europe), egalitarianism has kept the rich to a similar share of income and wealth that they accounted for in the 1980s – in other words, they haven’t really gotten any richer, in relative terms. Indeed, if the rich keep getting richer, as we suggest, savings rates might get even worse in the plutonomy countries. If plutonomy explains away many conundrums that our equity clients worry about, then this suggests the risk premia ascribed to equities might be too high.

Furthermore, if the rich will be getting even richer in the coming years, this bodes extremely well for businesses selling to or servicing the rich, be it for example luxury goods stocks or private banks. The rich are a growing and captive market, who have the nice habit of relatively little price elasticity. The plutonomy basket of luxury goods stocks, private banks etc. has handsomely outperformed the S&P500 index since 1986, and we expect similar outperformance from these types of stocks in the years to come. In the last 3 months alone, these stocks have outperformed the MSCIAC World index by 7%.

For these reasons, the recently released US Survey of Consumer Finances, which confirms that the rich continue to get wealthier and account for a disproportionate share of income and wealth in the US, is important. It confirms that the dynamics of plutonomy are still intact.

Why is being rich considered to be like a crime? Ever hear the story of the Little Red Hen? Oh I guess that's been banned from schools today because it's too capitalistic and paints socialism and Markism in a bad light.

Gee, I don't know. Maybe you can justify it:

Excerpted from: Citigroup Equity Strategy re Plutonomy
Part 1 Oct 16, 2005
BY Ajay Kapur, CFA, CITIGROUP

"[plutonomy - n. An economy that is driven by or that disproportionately benefits wealthy people, or one where the creation of wealth is the principal goal. [Blend of pluto- (wealth) and economy.]

- The World is dividing into two blocs - the Plutonomy and the rest.

- The U.S., UK, and Canada are the key Plutonomies - economies powered by the wealthy. Continental Europe (ex-Italy) and Japan are in the egalitarian bloc.

In plutonomies the rich absorb a disproportionate chunk of the economy and have a massive impact on reported aggregate numbers like savings rates, current account deficits, consumption levels, etc.

At the heart of plutonomy, is income inequality. Societies that are willing to tolerate/endorse income inequality, are willing to tolerate/endorse plutonomy. We make the assumption that the technology revolution, and financial innovation, are likely to continue. So an examination of what might disrupt Plutonomy - or worse, reverse it - falls to societal analysis: will electorates continue to endorse it, or will they end it [as they did with the New Deal], and why."

Maybe...just maybe, it has something to with the promise of our constitution, to wit:

"We the People of the United States, in Order to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity, do ordain and establish this Constitution for the United States of America."

But hey, i could be wrong. Maybe the founding fathers were just having a good laugh on us.

If that's the case you wanna make then why did the Dem Congress pay all this corporate bailout money? I thought they were looking out for the little guy? Instead it looks like the little guy is gonna be picking up the tab.

Obviously, you're having trouble connecting the growth of plutonomic disproportionality and a system of finance controlled by private banks/brokerage firms literally too big to fail - the very epitome of plutocracy.

Consider Mr. Kapur's definition of the situation. From his March 2006 memo:

"PLUTONOMY: TAKE ANOTHER LOOK

The latest Survey of Consumer Finance data was released Friday 24th of February. It shows
that the rich in the US continue to be in great shape.We thought this was good time to bang
the drum on plutonomy.

Back in October, we coined the term ‘Plutonomy’ (The Global Investigator, Plutonomy:
Buying Luxury, Explaining Global Imbalances, October 14 2005). Our thesis is that the rich
are the dominant drivers of demand in many economies around the world (the US, UK,
Canada and Australia). These economies have seen the rich take an increasing share of
income and wealth over the last 20 years, to the extent that the rich now dominate income,
wealth and spending in these countries. Asset booms, a rising profit share and favorable
treatment by market-friendly governments have allowed the rich to prosper and become a
greater share of the economy in the plutonomy countries. Also, new media dissemination
technologies like internet downloading, cable and satellite TV, have disproportionately
increased the audiences, and hence gains to “superstars” – think golf, soccer, and baseball
players, music/TV and movie icons, fashion models, designers, celebrity chefs etc.

These “content” providers, the tech whizzes who own the pipes and distribution, the lawyers and
bankers who intermediate globalization and productivity, the CEOs who lead the charge in
converting globalization and technology to increase the profit share of the economy at the
expense of labor, all contribute to plutonomy. Indeed, David Gordon and Ian Dew-Becker of
the NBER demonstrate that the top 10%, particularly the top 1% of the US – the
plutonomists in our parlance – have benefited disproportionately from the recent
productivity surge in the US. ( See “Where did the Productivity Growth Go? Inflation
Dynamics and the Distribution of Income”, NBERWorking Paper 11842, December 2005)."

Writes MATT TAIBBI of Rolling Stone: By now, most people who have followed the financial crisis know that the 2008 bailout of AIG was actually a bailout of AIG's "counterparties" — the big banks like Goldman to whom the insurance giant owed billions when it went belly up.

What is less understood is that the bailout of AIG counter-parties like Goldman and Société Générale, a French bank, actually began before the collapse of AIG, before the Federal Reserve paid them so much as a dollar. Nor is it understood that these counterparties actually accelerated the wreck of AIG in what was, ironically, something very like the old insurance scam known as "Swoop and Squat," in which a target car is trapped between two perpetrator vehicles and wrecked, with the mark in the game being the target's insurance company — in this case, the government.

This may sound far-fetched, but the financial crisis of 2008 was very much caused by a perverse series of legal incentives that often made failed investments worth more than thriving ones. Our economy was like a town where everyone has juicy insurance policies on their neighbors' cars and houses. In such a town, the driving will be suspiciously bad, and there will be a lot of fires.

AIG was the ultimate example of this dynamic. At the height of the housing boom, Goldman was selling billions in bundled mortgage-backed securities — often toxic crap of the no-money-down, no-identification-needed variety of home loan — to various institutional suckers like pensions and insurance companies, who frequently thought they were buying investment-grade instruments.

At the same time, in a glaring example of the perverse incentives that existed and still exist, Goldman was also betting against those same sorts of securities — a practice that one government investigator compared to "selling a car with faulty brakes and then buying an insurance policy on the buyer of those cars."

Goldman often "insured" some of this garbage with AIG, using a virtually unregulated form of pseudo-insurance called credit-default swaps. Thanks in large part to deregulation pushed by Bob Rubin, former chairman of Goldman, and Treasury secretary under Bill Clinton, AIG wasn't required to actually have the capital to pay off the deals. As a result, banks like Goldman bought more than $440 billion worth of this bogus insurance from AIG, a huge blind bet that the taxpayer ended up having to eat.

Thus, when the housing bubble went crazy, Goldman made money coming and going. They made money selling the crap mortgages, and they made money by collecting on the bogus insurance from AIG when the crap mortgages flopped.

Still, the trick for Goldman was: how to collect the insurance money. As AIG headed into a tailspin that fateful summer of 2008, it looked like the beleaguered firm wasn't going to have the money to pay off the bogus insurance. So Goldman and other banks began demanding that AIG provide them with cash collateral. In the 15 months leading up to the collapse of AIG, Goldman received $5.9 billion in collateral. Société Générale, a bank holding lots of mortgage-backed crap originally underwritten by Goldman, received $5.5 billion. These collateral demands squeezing AIG from two sides were the "Swoop and Squat" that ultimately crashed the firm. "It put the company into a liquidity crisis," says Eric Dinallo, who was intimately involved in the AIG bailout as head of the New York State Insurance Department.

It was a brilliant move. When a company like AIG is about to die, it isn't supposed to hand over big hunks of assets to a single creditor like Goldman; it's supposed to equitably distribute whatever assets it has left among all its creditors. Had AIG gone bankrupt, Goldman would have likely lost much of the $5.9 billion that it pocketed as collateral. "Any bankruptcy court that saw those collateral payments would have declined that transaction as a fraudulent conveyance," says Barry Ritholtz, the author of Bailout Nation. Instead, Goldman and the other counterparties got their money out in advance — putting a torch to what was left of AIG. Fans of the movie Goodfellas will recall Henry Hill and Tommy DeVito taking the same approach to the Bamboo Lounge nightclub they'd been gouging. Roll the Ray Liotta narration: "Finally, when there's nothing left, when you can't borrow another buck . . . you bust the joint out. You light a match."

And why not? After all, according to the terms of the bailout deal struck when AIG was taken over by the state in September 2008, Goldman was paid 100 cents on the dollar on an additional $12.9 billion it was owed by AIG — again, money it almost certainly would not have seen a fraction of had AIG proceeded to a normal bankruptcy. Along with the collateral it pocketed, that's $19 billion in pure cash that Goldman would not have "earned" without massive state intervention. How's that $13.4 billion in 2009 profits looking now? And that doesn't even include the direct bailouts of Goldman Sachs and other big banks, which began in earnest after the collapse of AIG.

Sounds like the 2010 version of muckrakers.

Here's the thing. In the old days the liberals, or progressives if you will, would try to break up "too big to fail" companies. Example, Standard Oil Corp. But it looks to me like the current government wants to merge everything or turn it over to the government. So instead of breaking banks up that are "too big to fail" we may be soon looking at just a few super-banks (even fewer than now) with no more little guys or possibly even a conversion to 1 mega-bank that's quasi-government like the Post Office now is.

So what you're saying is we need to bring back the mom & pop businesses and bust up huge corporations. Unfortunately I don't see this President or this Congress willing to make that happen.

That is because there is no difference between the political parties. They are both bought and paid for by corporate interests. The Democrats took HUGE amounts of money from the financial industry before the 2008 elections and it has paid off well for them.

That is the ridiculousness of the arguments of political partisans. The policies and the actions of both parties are more similar than different.

Actually that's where I was getting to. Both that and the President's march towards Marxism. And not necessarily to single this particular President out. Glenn Beck makes a case that under the name of progressive Presidents back to Wilson and both Teddy & Franklin Roosevelt have been subtle about pushing us in the direction. I would maintain that even W. Bush pushed a few questionable items along including bailouts.

BTW I see the GOP is supposed to be drafting something like the Contract for America. On another board I said they'd need something just like that for the Fall campaign. I wonder if the leaders read that post from me?

I don't disagree that one party name today is almost as bad as the other. That said yes one side actually is a little worse than the other. Of the 2 parties the Dems have no desire to change. The Republicans are at least paying lip service to the Tea Party concerns and others. If the Fall election provides the opportunity we may see if the Republicans are willing to be reborn or not. But I don't have a problem with consideration of voting for a Tea Party endorsed candidate against either or both party candidates and let the chips fall where they may.

So should the "rich" strive to be less rich? Should Citi have tried to make their clients less rich?

Not unless that wealth is transferred from everyone else to the rich. The actions of the big banks stole large amounts of money from you and I to bailout the banks.

When the playing field becomes unfair and the majority stand no chance of bettering themselves, because of the self interests of the elite. Then yes ..... it is wrong to allow the rich to get richer, while the middle class and poor suffer.

That reminds me. So you think all that money from the bank bailout fixed the whole home loan foreclosure problem? Doesn't look like it. And I heard someone make the comment that in the next go around we will have to address repos of the multi $mil homes. It's looking like the bank bailout is the scam that just keeps taking. One might even call it legalized bank robbery.

No ... it transferred our money to the banks. It allowed them to hide the problem a bit longer. Every program that has come out so far has helped the banks instead of the people that have their homes underwater or in foreclosure because of the actions of those very banks.

The banks should have taken their lumps and be forced to reduce the values of those loans. But that is never going to happen .....

Yup