Plutonomy: The Spending of the Wealthy

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The term plutonomy has been around for a long time as an alternate term—a somewhat derogatory one—for economics and economy.  The word’s root is the Greek word for wealth.  The term plutocracy is more firmly recognized by the general public as describing a society that is dominated by the wealthy.  The term plutonomy would be resurrected and given a more specific and relevant meaning by a series of articles that emerged from Citigroup analysts beginning in 2005.  Oliver Bullough discusses the issues that were raised then in Moneyland: The Inside Story of the Crooks and Kleptocrats Who Rule the World.

In 2005, Ajay Kapur was director of Global Strategy Research for Citigroup.  He was responsible for identifying investment strategies for Citigroup customers.  At about that time, oil prices were climbing rather steadily, enough to cause pain in the economy.  He was observing that the equity markets were not responding to what should have been bad news in the way expected.  The attempt to understand this phenomenon would lead to the publication of a report entitled “Plutonomy, Buying Luxury, Explaining Global Imbalances.”

“The report’s message was a simple one: the rich are getting richer, and that can make you rich.”

“Kapur’s insight was that, if a majority of a country is owned by a very few people, it doesn’t necessarily matter what the oil price does.  The oil price is important to people who are on a budget.”

“According to the Citigroup analysts’ research, the top million households in the United States had approximately the same wealth as the bottom 60 million households.  And rich people have relatively little of their wealth tied up in their homes, meaning that a far higher proportion of that wealth is disposable.  If you looked at just financial assets, and exclude housing from the calculation, the top million households held more of the sum total of American wealth than the bottom 95 million households put together.  This was a new phenomenon, and one with lucrative possibilities for a canny investor.”

If the rich are going to continue to get richer then they will put ever more money into the kind of products that only they can afford.  What would any smart investor do in this situation?  They would buy shares in the companies making those products.

“He identified a basket of stocks that have benefited from the kind of purchases favored by Moneylanders: companies like Julius Baer, Bulgari, Burberry, Richemont, Kuoni and Toll Brothers.  His report traced the prices of the shares of the companies in the basket back to 1985, and showed that they cumulatively yielded an annual rate of return of 17.8 percent, far higher than the stock market as a whole.  That outsized return had only accelerated with time, particularly since 1994, when wealthy Russians and others began to develop their taste for Western luxuries.”

The interest here is not in such an investment strategy, but in Kapur’s use of the term plutonomy to recognize a change in the investment paradigm caused by the increasing concentration of wealth.  A stock’s price, in the past, was based on an evaluation by investors of the company’s growth and earnings potential.  This is the path taken by investors worried about losing their money.  Kapur’s conclusion was that the markets were behaving as though that approach no longer seemed determinative.  It was as if the investor class began using a different set of ground rules.

Let us fast forward to July, 2020.  The Covid-19 pandemic in the United States is out of control.  Workers are losing jobs at a record rate.  Many businesses have already failed as the virus has restricted economic activity, and many more are teetering on the brink.  Major components of the economy may have to be recreated for a new reality going forward.  It is not clear when or if the situation will ever return to a pre-pandemic state.  Competent political leadership at both state and federal levels is almost nonexistent.  How much worse could the situation possibly get?  And how has the investor community responded? 

After a brief fall when the emergency struck, the markets have generally been returning to near previous highs.  It appears that the investor class believes everything is going well and it is a good time to invest!  How can that be?  Perhaps returning to the notion of wealth concentration and plutonomy can provide an answer.  The fraction of wealth captured by the investor class has only grown larger since 2005.

Consider a situation where the investor class has sufficient wealth that its economic status is little threatened by major economic disruptions.  Such events hurt the little people who will no longer consume products at the same level, eliminating any investments in production capacity.  The investor class has more money to spend than places to spend it.  Conspicuous consumption can only eat up a small fraction of the wealth available, so what does one do with the remainder?  It must be invested somewhere, and the logical place to place large sums of money is in the financial markets.  The nature of a plutonomy appears to require an excess of funds to invest over traditional investment opportunities.  The result is an inevitable increase in asset prices.  Stock markets are flooded with funds beyond the level justified by the economic situation, driving share prices up no matter what.  And as long as the prices keep going up, why not keep throwing more money in?  If this is in fact what is occurring, we are observing an economic trend somewhere between casino gambling and a Ponzi scheme.  Gamblers usually will lose, and Ponzi schemes always collapse.

Extreme economic inequality creates a diverse set of problems.  The discussion above adds one more.  This cannot end well.