A 'correction' for disparity

April 05, 2009|By Dan Rodricks | Dan Rodricks,dan.rodricks@baltsun.com

Ken Solow, chief investment officer for Pinnacle Advisory Group and a financial planner for some very wealthy clients, was struck by two charts on one of the many newsletters he receives at his office in Columbia. The newsletter came from Ned Davis Research, considered an authority on stock market data, and it addressed two historical factors central to understanding how we got into this mess and how long it might take the nation's economy to complete the severe "correction" it's going through: concentration of wealth and accumulation of debt.

The first chart shows income disparity in the United States over the last 90 years.

The chart looks like two soaring mountain peaks with a craggy but peaceful valley in between.

Mr. Davis' chart tracks the share of total income, including capital gains, of the top 10 percent of Americans from World War I through 2006. While the top tenth was doing quite well, with about 40 percent of total income by 1917, it darted further ahead of the middle class and poor for the next decade, until disparity peaked, north of 49 percent, in 1929. That, of course, was the year of the Wall Street crash.

The chart shows a sharp decline in wealth, with some spikes in the 1930s, followed by a fast drop in the 1940s, then into a deep crevice by the end of World War II.

From the 1950s through the 1970s, the rich started to get richer again, but disparity was not so wide - the Top 10's share of income ran over the low- to mid-30 percent range.

That is generally thought of as a period of relative prosperity, with a strong middle class, a stable industrial base and union membership at its peak.

By 1980, the year Ronald Reagan took office, income disparity started to grow quickly again, hitting nearly 41 percent in 1990, and soaring further during the Clinton years, dropping by about 3 percent after Sept. 11, 2001, and jumping to another peak, north of 49 percent, by 2006.

"It's this chicken-or-egg question," says Mr. Solow, looking at Mr. Davis' chart in his office at Pinnacle Advisory. "Which came first? Did the stock market go up, causing disparity, or did incomes go up first? The stock market probably went up first. Either way, disparity is not good for the market."

Not good for the nation.

Indeed, as Ned Davis' chart demonstrates, extreme disparity leads to bubbles - and bubbles burst. "Income inequality," he writes in his March 24 newsletter, "was more likely a result of the 'irrational exuberance' of the bubble and not a cause. So that still leaves me believing that income disparity is not a healthy sign, because it is just another indication that the stock market is in bubble territory."

It was former Federal Reserve Chairman Alan Greenspan who used the term "irrational exuberance" to describe the market in 1996, but he did nothing about it.

"Now, look at the other chart," says Mr. Solow, turning the page of Mr. Davis' newsletter for his calculations on personal debt. "We still have a whole lot of debt to unwind before things start moving again."

Mr. Davis' chart on this shows general debt service (mortgage and consumer credit payments as a percentage of Americans' disposable income) at close to 14 percent at the end of 2008. That needs to drop to 12 percent, Mr. Davis says, "to feel the debt bubble has been largely lifted from consumers' budgets."

Debt accelerated income disparity over the last two decades; while the rich were able to accumulate stocks, people stuck in the low- to middle-income brackets accumulated debt to offset stagnant wages. "And the 'magic' of compound interest," writes Mr. Davis, "[made] it easier for the rich to get richer and the poor to stay poor."

Now consumer spending is down and Americans are starting to save more. A correction is under way. "In fact," says Ken Solow, "it has already occurred."

Indeed. "There were, at the end of 2008, 37 percent fewer millionaires in this country than in 2007," Mr. Davis notes. "I think that is an astounding number and certainly indicates a severe 'correction.'"

Dan Rodricks' column appears Sundays on this page and Tuesdays in the news pages. He is host of the midday talk show on WYPR-FM.

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