The Rich Get Richer and Then Go Broke

Do you have your eyes open? Well, look carefully, because what you are seeing is one helluva show.

Unfortunately, it is likely that we are only in the middle of it, and it is almost surely a tragedy. When the fat lady finally sings, there are going to be a lot of people with tears in their eyes.

But we are getting ahead of ourselves.

Every great public spectacle turns mass man into a chump...a patsy...and a stooge. He gets sent off to fight and die in wars that are of no real importance to him. He gets caught up in the delusions of politics...joins a lynch mob...or watches TV and wonders what Paris eats for breakfast. Or, he is ruined in market crash, inflation, or depression.

It is all very well for wealthy speculators to be ruined. They usually gamble with money they can afford to lose. But in this last go-round, the average fellow put everything he had on the table. Without realizing it, he speculated with the family home.

There is more to it than that, of course. What we are seeing is really a massive transfer of wealth...the biggest transfer ever.

You see, what drew the average man into the mortgage market was the allure of getting something for nothing. Without lifting a finger, his house rose in price. He looked...and thought he saw free money. He could 'take out' this extra wealth...and still have as much equity in his house as he began with. He felt he was actually getting richer...so why not spend a little more? 

The catch is that he wasn't really getting richer at all. That is the curious thing about a boom fueled by asset price increases. In general, they do not really make people richer. Instead, they make SOME people richer.

You already know who those people are, don't you? We have mentioned them often in these pages. They are the lucky 1% of the population who have substantial assets...and the few hundred thousand who work in the financial industry. Hedge fund managers, investment bankers, substantial property owners, people who own art and antiques...even people who own stocks. Most U.S. stocks are less valuable, in real terms, than they were seven or eight years ago. But they are a lot more valuable than they were 20 years ago.

For the first time in history, the rich really are getting richer at a rapid pace. Here's how it works. The world's central banks, led by the U.S. Federal Reserve, and other financial intermediaries, create new forms of 'wealth' - paper dollars, securitized debt, derivatives, etc. Bond issuance, for example, has doubled in the last six years. Derivative creation has soared over $300 trillion. This 'wealth' never seems to reach the hands of the masses.

Instead, it stays with the investing classes - bidding up prices on financial assets and other forms of wealth favored by the rich (such as London houses and works of art by people without talent). In other words, a new form of 'inflation' has been loosed upon the world, one that everyone seems to love. It boosts the wealth of the wealthy, spectacularly.

According to a new study by McKinsey and Co., the value of all the world's stocks, bonds and other assets has ballooned to $140 trillion. These assets are traded across international borders; and they are growing much faster than the real economy that supports them. There you have the fundamental difference...and the theme that runs through this whole farce. A company may produce $10 in profits, growing at a rate of maybe 5% per year. But the loans, stocks, bonds, and derivative positions based on this company's output are growing at twice the speed.

The average person works in the real economy. If he is lucky, he could see his wealth grow along with the growth of the real economy. But the people who own financial assets are watching their wealth grow much faster.

Wait, how is this possible? The real wealth of the economy depends on the real output of its real businesses. That is where the goods and services are produced. Trading, speculating, lending, acquiring, buying-back, refinancing - these are just peripheral activities that have no direct bearing on real output. So, how can it be that one segment of the society, a very small segment at that, is getting so much richer than the growth of real output?

Ah...there's the slick, tragic, disastrous side to this performance. It is as if the central banks had printed up huge quantities of additional dollars, and instead of distributing these to the economy at large, it gave them only to the rich. Thus, the rich gain the benefit of the inflation; their purchasing power rises dramatically. But the rest of the population suffers because of it; their own purchasing power declines. They have no more income, while they have higher living expenses; health care, housing, energy and education have all gone up sharply. And to make matters worse, they now have to pay off the money they borrowed when they thought they were getting rich.

Stay tuned... this spectacle is bound to get even more interesting.

Bill Bonner

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