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The Super-Rich: The REAL Explanation

By Shlomo  Maital

    Roger Martin

Roger Martin

 

  Want to know the real story behind the super-rich – those who pull enormous inflated salaries?  The Dean of Univ. of Toronto’s Rotman School of Management, Roger Martin, a former McKinsey principal, tells us the story in the latest issue of Harvard Business Review:

    The rich are getting richer in the United States, surely, but the real problem, says this former business school dean, is who exactly is getting mega-rich and how. It’s not the capitalists (that is, the shareholders and investors). It’s the speculators (the people who manage their money). The top 25 hedge fund managers in 2010 raked in four times the earnings of all the CEOs of the Fortune 500 combined. How come?

Here is the explanation.

Through a once-obscure mechanism called the “2&20 formula.” Derived from a 2,000-year-old practice whereby Phoenician ship captains took 20% of the value of a cargo successfully delivered, it’s the formula that governs how hedge fund managers are compensated — a 20% cut of the profits generated (taxed at the 15% capital gains rate) on top of a 2% asset management fee. And what are those 25 people doing? They’re borrowing stock, holding it for sometimes less than five minutes, and creating and profiting from the resulting volatility.

And – the solution? Pretty simple, according to Roger Martin:

 This problem can be fixed with tax laws that penalize high-frequency trading and require the profits to be taxed as income, and concerted efforts among pension and endowment funds to stop lending the overpriced hedge fund managers the stock they’re playing with.

   What are the chances the U.S. Congress will fix the problem?  With obstructionist Republicans calling the tune, and with November elections upcoming, with the Democrats  in danger of  losing control of the Senate – less than zero. 

2013:  Tough Year for Workers, Great Year for HNWI’s

By Shlomo Maital

                      rich

                 Illustration by Avi Katz

  For most of us, 2013 was yet another hard year.  The U.S. and EU economies were either in recession or barely growing.  Unemployment remains high;  the job market, weak.   China faces slowing export growth and a housing bubble. 

  But it was a super-great year for HNWI’s, the Wall St. euphemism for the rich and super rich (High Net Worth Individuals), who are the focus of a huge and profitable industry known as ‘wealth management’.  And wow, is there ever a lot of wealth to manage.

    According to the Boston Consulting Group’s Global Wealth 2014 report, global private financial wealth grew by nearly 15 per cent last year and now totals $152 trillion, more than double world Gross Domestic Product.  Wealth multiplies with ease, even when the rich do not actively work at it.  Microsoft founder Bill Gates, 58, is the world’s wealthiest person, with net worth of $78 b., even though he has spent most of the past few years giving his money away.  His Microsoft shares continue to generate more and more billions in wealth for him, even though he resigned as Microsoft Board Chair in February.  

Capital has boomed because of urbanization and rising real estate prices,  rising share prices,  vast amounts of new money printed by central banks everywhere and loaned at low interest,  and new capital markets in emerging nations, creating assets where none existed before.  Global private wealth boomed last year because investors put money into the stock market and stock markets rose sharply.  Wall Street broke all records and closed the year 23.8 per cent higher.

    The wealthy have capital and so quickly accumulate more of it;  the poor do not. The capital of the rich grows exponentially. The income of the poor stagnates.  This is inherently unfair.   

       But can’t the poor rise to wealth, by hard work and saving?  

       The American “Horatio Alger” rags-to-riches myth is just that, according to the Equality of Opportunity Project, led by Harvard and Berkeley economists.  This study found that an American child born in 1971 to parents in the poorest fifth of the income distribution had an 8.4% chance of making it to the top quintile. For a child born in 1986 the odds were 9%, basically the same.  In other words, in the U.S. you have less than a one in 10 chance of rising from poverty to wealth, and it’s been that way for nearly two generations.  You need to be fairly rich to go to good schools and to be accepted to good universities.  In contrast, in Denmark, the probability of climbing from the bottom quintile to the top one is double that of America.  If you want rags to riches, you’d better be born in Scandinavia.

     If the democratic system cannot repair itself, because the super-rich control the system through high-paid lobbyists and donations to politicians —  what other solution is there?  The French Revolution, 1788-1804, used the guillotine; that did not work out too well for anyone and ultimately brought a dictator-emperor named Napoleon, who destroyed Europe.        

   The rich are different.  They have money, and when they invest it, it multiplies rapidly.  At 8 per cent compound interest, wealth doubles every nine years.  There is nothing wrong with being rich.   But when extreme wealth perpetuates itself in the manner now occurring worldwide,   poverty perpetuates itself too.  Trickle down?  It’s a myth, too. 

    The rich use their wealth to make a whole lot more of it, with ease.  That process does not seem to help working people much.   

    Unless people of good will everywhere, rich, middle-class and poor, get together to resolve this dilemma,  society is simply going to fracture, perhaps violently.  And that won’t be good for anyone, rich or poor.  

Piketty: The Super-Rich Will Own Us

By Shlomo  Maital

Piketty

Thomas Piketty’s new book Capital in the 21st C. (Harvard/Belknap) should get him the Nobel Prize. It won’t because it is basically just carefully-built data.  But the data are shocking. And it took a French economist to do it; except for Paul Krugman it seems that the collective brains of the American economic establishment have shut down for good. 

  Piketty’s book is 700 pages long. Few will actually read it.  But the fierce and growing inequality he documents has already drawn huge media attention, and even the IMF is in on the act, with Christiane Lagarde (IMF Director-General) announcing that the IMF believes inequality is bad for growth, and pro-equality policies can actually stimulate economic growth.

    I will save my readers the time and effort of reading this huge book, by summarizing it.  Piketty says, there is “an oligarchic type of divergence, in which the rich countries would come to be owned by their own billionaires…or in which ALL countries would come to be owned by the planet’s multi-millionaires and billionaires…. All the ingredients are in place for the top centile and thousandth of the global wealth distribution to pull farther and farther ahead of the rest.”

    This has already happened, to a large degree.  Oligarchs run Russia.  They own the media in my country, Israel. They are powerful in America.  They are powerful in China.

     Why is this happening? Simple.  If you have great wealth, you can earn on average 6.8 per cent annual return (above inflation).  This doubles your wealth every decade, without your having to really do anything.  And you can keep the profits, because the wealthy easily find tax havens.  If you have little wealth, you earn maybe 1 per cent, and then you get taxed.    When the wealthy double their wealth every decade, in 30 years it is 8 times what it was at the start.  Great wealth confers huge political power. You can buy the media, you can buy lobbyists, and you can, yes, you can buy politicians. 

     Karl Marx got one thing right, and one thing wrong. He said that wealth would become more and more concentrated, under capitalism.  Right.  He said that the people (the government) should confiscate national assets and run them.  Wrong. Governments can’t run businesses.  

  Piketty’s solution is very French – perfect, optimal and utterly impractical. Impose a global wealth tax.  What are the chances this will happen, when the oligarchs already wield immense political power?  If one country does it, the money will flee to another, happy to welcome it by offering tax havens. 

   Either there will be enormous social upheaval, to bring the oligarchic wealth back to where it belongs, and decades of suffering and instability,  or we the people will find some clever way to deal with this ‘doom loop’, which is leading us to destruction.    The current situation cannot continue.  And Occupy Wall Street was largely ineffective, like the Arab Spring, because it brought passionate protest, it brought attention to a critical problem – but offered no creative solutions. 

     The solution?   To be presented in a future blog.  

     

Blog entries written by Prof. Shlomo Maital

Shlomo Maital

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