Shifting Shares and Price Targeted Policy

by: Max Fraad Wolff

Over the last few decades, several trends have shaped the macro environmental backdrop of investment flow and return. In the developed world we have seen a historically rare and nearly uninterrupted upward redistribution of income and wealth.

The EU and the US have seen the income shares of their most affluent rise spectacularly. The top 1% of US income earners now receives more than 20% of individual income. The EU average is measured and reported as the S80/S20 ratio. This measure compares the share of total income earned by the top 20% of income earners against the income share of the bottom 20% of income earners. For the EU-15 Nations this has risen consistently and in 2009 the top 20% of income earners received about 4.9 times as much income as the bottom quintile of income earners.

The GINI coefficients of most OECD countries- notably the US, UK, France, Italy, and Germany- have increased. The Luxembourg Income Study, OECD research and various national studies all point in the same direction [i]. Wealth has been more pronounced in its upward redistribution than income. The Luxembourg Wealth Study and the Federal Reserve’s Survey of Consumer Finances document rising concentrations.

Financial assets are luxury goods. Like most luxury goods, they tend to experience increases in price as higher incomes grow disproportionally. We have just lived through 20 years of rapid global financial integration and a real blossoming of financial markets and assets. This has been attracting leading talent, massive attention and altered the size and geography of financial asset demand. More money, in absolute and relative terms, is chasing more assets over greater ranges of product and geography.

Upward redistribution of income and wealth has occurred as new products and investment opportunities abound. Demographic trends have lent a hand as well. Aging populations have been saving and speculating ahead of historically early retirements and record life expectancies.

There have been rising in faith in and fury over monetary policy. Fiscal policy has been used, even abused over the last decades. However, comfort with notions of the primacy and range of monetary policy action has outstripped fiscal policy development. Taxes and regulations were stagnant to declining from the 1980s through 2007. This is true with or without factoring in the demise of the USSR and state directed economies in the old Soviet orbit. India and China have rising inequalities of wealth and income among their combined 30% of global population and growing shares of world GDP.

The rise of monetary policy has marched in lock step with rising centrality and policy importance for financial markets and firms. Central banks and finance ministries have enjoyed unusual power and prestige. Large banks and non-bank financial intermediaries have ballooned in size, influence and social regard. The surge in hatred for and obsession with leading financial firms, speaks to this process. Monetary policy, foreign exchange and asset markets have been more powerful and more central in policy making and policy targeting.

Thus, the recent past was been an unusually good period for the demand for and supply of financial assets. Speculative assets are widely ascribed magical powers of wealth creation and impoverishment. Demand flourished with deregulation and upward income/wealth distribution. New communication possibilities and deregulation opened grand vistas for gathering funds and making allocations. As the inflows and development of financial assets have grown, there has been a rising attention and focus on policy interventions that “stabilize” speculative markets and increase asset prices. From bans on shorting to rising regulation of futures and options, there is an asset price inflating bias to policy.

At the same, increasingly dramatic monetary policy interventions target upward pressure on asset prices during crises and price swoons. Quantitative easing, strategically important private firm bailouts and emergency plunge protection teams, have emerged in governments around the world. Dramatic nationalization of private liabilities has moved public treasuries into support of private securities and loans. Looming and implemented capital controls, limits on short duration purchase and taxes on hot money seek to keep floods of inward capital from moving outward. This too can be seen as seeking an upward bias from investment flows.

I mention this because the odds are overwhelming that this is not part of how you see the events in global macro and investment strategy over years past. It should be. We are in the midst of finding the hard constraints - political and economic- for upward income/wealth redistribution and asset price targeted monetary policy intervention. Publics, politicians and stability conditions will not abide significantly greater redistributions or policies favoring asset owners. The Federal Reserve’s QEII decision of 03 November 2010 is only days old.

Already global asset prices are being dramatically pushed and angry calls are ringing out. As we move through the G20 meetings in South Korea, many nations are raising cries over downward US Dollar pressure from QEII. Quantitative easing will likely take the Federal Reserve’s balance sheet from $2.25trillion up to nearly $3trillion. US Treasuries, developed and developing world corporate and sovereign bonds, are priced very dear. Interest rates are very, very low. On the eve of Lehman Brothers’ decline and the US Treasury action to nationalize the liabilities of Fannie Mae and Freddie Mac, the Fed sat atop a $950billion balance sheet. A tripling of the direct asset price support of Fed policy has dramatically pushed up prices. US wages and home prices have stagnated and fallen; unemployment remains higher throughout the developed world.

Thus, we are seeing massive asset price support amid flat prices and economic weakness. In 5 of the last 7 quarters US unit labor costs fell as productivity increased with flat to declining real wages. Developed economies are generating outright deflation. Monetary policy and asset inflation is keeping general price levels from rising. This is what asset price targeted monetary policy with redistribution looks like.

All major asset strategies should factor the roles of upward income/wealth redistribution and explicit asset price targeting monetary policy. The room for further actions on both fronts is seriously constricted going forward. Chinese authorities have increasingly come to recognize the need for inequality targeted policy and economic growth. Latin American nations have been attempting such policies for nearly a decade. Growing and increasingly angry crowds are demanding a social welfare inflected version of the same in the streets of continental Europe. UK welfare and public spending reform and the American Tea Party, appear to be counter instances.

We are far from confident that this will continue to be the case. Recent demonstrations by university students in the UK and reaction to the Obama Administration’s Budget Council suggest trouble coming in the US and UK. Even if declining fiscal policy interventions are forthcoming in the US and the UK, quantitative easing has little more room to run beyond the next 6-12 months. Further significant upward income/wealth redistribution in the developed world will couple with deleveraging household balance sheets to severely constrict demand.

Developed and developing economies will see bouts of asset price pressure as quantitative easing efforts peak and trail off. Monetary policy actions will increasingly be seen and contested as attempts to manipulate currencies toward beggar thy neighbor import and export response. Hard constraints are looming for upward redistribution tax and regulatory policy within the next 12 months. Headwinds here will be the norm in developed and developing countries alike. Struggling middle classes in the developed world will not fade quietly into history. Rising middle classes in developing countries will agitate in response to the inevitable business cycles and long deferred promises of secure and comfortable material lives.

Income/wealth shares and asset price targeted monetary policy winds will not fill the sails of investors for very much longer. Assets that do not require monetary policy support and rising inequality will likely outperform. Demand, demographic and policy support will be less and uneven in the coming years. Investors will face general pressure in the coming environment and there is every reason to favor global middle class consumer defensive products. Even if the global economy weathers deleveraging and stubborn refusals to rebalance, redistribution and targeted monetary policy cannot proceed without creating significant economic and political tail risk.

[i] The Luxembourg Income and Wealth Studies offer a wealth of information (here). The OCED (here) and the Survey of Consumer Finances offer valuable statistics (here).

Disclosure: No specific shares mentioned, long consumer defensive US, China, Brazil.