Interest Income and the Upper Class

I don’t think Paul Krugman is very convincing in his argument that repeated calls for higher interest rates derive from class interest:

You’re living in a fantasy world if you don’t think this has something to do with the diatribes against currency debasement and all that.

Krugman’s argument is simple, and fair at first approximation: the rich earn a disproportionate share of their income from interest-bearing assets and have the most to loose from “artificially low” interest rates.

Similarly, to the extent low interest rates create inflationary pressures, the rich have more to loose given a net surplus position in nominal assets. However, as I remember the story, the economists making this argument made a fundamental error in assuming simple asset swaps (i.e. QE) could somehow cause hyperinflation. Arguing against hyperinflation may be a straw man, but it’s still a fair worry (for rich and poor alike). I don’t think you had many rich people militate in favor of deflation.

But that’s not the most puzzling part of this argument. A side-effect of the Fed’s stimulus have been elevated asset prices. There’s no voodoo behind this: the price of an asset is the discounted value of its future cash flows, and this necessarily increases as the interest rate falls. Since the rich own a disproportionate share of real assets across the country – primarily real estate and equities – they stand to benefit from this program. Indeed the stock market has been setting record highs for the past few years.

Krugman’s tandem argument that high interest rates/low inflation portend a redistribution from the young to the old is also tenuous. (Sure, if there was a long-term increase in expectations this would act like a one-off capital levy. But that hasn’t been the case.) Note that wealth is just a claim on future income, and since Fed policy has increased asset prices and therefore P/E ratios, capital gains will fall in the future, ceteris paribus. To think about it another way, the Fed has moved future returns into the present to stimulate consumption. Or, equivalently, low interest rates increase asset prices redistributing consumption from the future to the present. (Or young to the old, contra Krugman).

Magnitudes matter. Nothing Krugman is saying is inherently false, but seems to be guided more by intuition than data. I’m just pointing out a number of other effects. His primary source indicates that the ratio of interest-bearing income to debt increases as we move up the income distribution. But even at the latter end, debt is twice as important. Krugman is probably right that were the last group to be spliced further, those at the tippy-top may have more even portfolios.

But at the tippy-top you also have a diverse group of people without homogenous incentives. For example, the private equity industry has made a killing financing large, leveraged buyouts at throwaway prices. This similarly stimulates demand for mergers and acquisitions which is one of the few profit centers left for investment banks. These people surely fall among the rich.

On this note, observe that to the extent the data Krugman presents holds to any significant magnitude, we’re talking about 0.01% of the population. Sure, class interests matter for this group, but more effective avenues (even if low interest rates were a huge problem for them) would include lobbying for specific subsidies and tax breaks, which actually works, rather than have discredited economists spill ink in the Wall Street Journal.

Another overlooked consideration is that the United States is somewhat unique. Despite a large current account deficit and soaring obligations, we earn more in foreign income than foreigners earn here. And in fact, the ratio of GNP/GDP has only been increasing. This derives from a large long position by (rich) American investors in emerging markets. To the extent the the dollar is debased (something Krugman suggests the rich are very worried about), the US claim on the rest of the world’s future income increases. (And, conversely, foreign reserves across the world would plummet).

None of this is to say that any of the noisemakers clamoring about money printing and debasement are right. I’m just suggesting that class interest may not be nearly as relevant as Krugman suggests. Occam’s Razor would demand a simpler explanation: these people are simply ignorant or want to sound serious.

But hey, which one percenter among us hasn’t dumped our net worth into the money market.