The rapidly rising wealth we have seen over the last decade or more is not
mainly a result of high income inequality or high savings, but of upward revaluations in wealth caused by the trend decline in real interest rates. Trends like this mean it makes little sense to talk about the old gaining at the expense of the young, and instead we should talk about the wealthy gaining at the expense of the asset poor.
Here is the ONS measure of total UK wealth.
Notes: 2020
refers to a survey spanning April 2018 to March 2020 and so on. There
is a break in the official data for 2016, and I have reduced data
before that based on the 2016 comparison. Source data here.
The ONS data
underestimates wealth, particularly at the top (see here),
but as I want to focus on trends rather than levels I will not
discuss the complex issue of wealth measurement in this post. The key
point is that the total value of wealth in the UK almost doubled over
a 12 year period, which is a much greater increase than nominal GDP
or earned incomes. Yet this itself is not mainly the result of any
dramatic accumulation of income by those earning a lot, but rather a
revaluation of people’s existing wealth.
The most obvious
example of this is housing, which made up just over 40% of total
wealth at the beginning of this period and a little over a third at
the end. The rise in housing wealth over this period is mainly a
result of higher house prices rather than more houses. But the same
point applies to another large category of total wealth, private
pensions, which was just over a third of total wealth at the
start of this period and over 40% at the end. Pensions are mainly
made up of shares and fixed income assets like government debt, and
their increase in value mainly reflects the upward revaluation of
these assets rather than their accumulation. For more on this see
this
useful piece by Ian Mulheirn.
Why have valuations
been going up? The main reason is the trend decline in real interest
rates (see the Mulheirn piece again) – what macroeconomists call secular
stagnation. I discuss why house prices rise when real interest rates
fall here,
but the reasons are the same for shares or government debt. In all
three cases these assets provide a nominal income stream largely
independent of short term interest rate changes (rent or housing
services for housing, dividends for shares and a fixed interest rate
for most government debt), but holding a short term variable interest
rate asset is always an alternative. If short term interest rates
fall, then if the price of these other assets did not rise they would
become more attractive, so their price will rise. Lower short term
interest rates leading to higher asset prices is financial arbitrage
at work.
This is why the
current debate over what will happen to interest rates once the
current burst in inflation is over is so important. If secular
stagnation is really over, then long term real interest rates will
rise over time and the price of many assets (including houses) will
fall. As a result, we will see the value of total wealth at least
stabilising, and perhaps even falling. On the other hand if secular
stagnation has not gone away, then these higher levels of wealth will
persist or increase further.
Which turns out to
be the case also influences how we think about higher wealth today.
It is often said that for most home owners higher prices don’t
really make them richer, because if they sell their house they are
likely to buy another. It’s also often
said that higher house prices benefit the old at the
expense of the young. I think this way of looking at current levels
of wealth only makes sense for erratic movements in real interest rates (and therefore the value of wealth) rather than sustained trends in real interest rates (and therefore wealth). To understand why we need to think intertemporarily.
Let’s take the
case where secular stagnation persists, so higher wealth also
persists. Consider two couples in the 40s, one of whom owns a house
and the other of whom rents. The couple that own their own house know
that at some point many years ahead they will no longer need their
house, and they can convert its value into money to spend in their
old age (on better care or more holidays), or perhaps as a gift to a
child. In either case they are substantially better off than the
couple that rents, who will not be able to do either. The case is
analogous to a couple that has a private pension and another that
does not. You don’t have to be old to feel better off when house
prices rise or the value of your pension increases. Instead you just
need to think ahead, and hope that higher house or asset prices last
until you downsize or retire.
But what, you may
ask, happens if all the pension or the money from downsizing goes to
buy an annuity? Because of lower real interest rates, annuity rates
will be low, so the income you receive from the pension or house sale
will be lower. Is what you gain in higher wealth lost in a lower
return from it? The answer is to some extent, but certainly not
completely. In particular if real interest rates are very low, you
will almost certainly be planning to spend some of your wealth in
retirement, so you still benefit from its additional value.
Your benefit is
someone else’s loss. As we should
all know, higher house prices have made it much more
difficult for first time buyers without wealthy parents to buy their
own house. More generally, persistent upward revaluations in wealth
relative to income reduces the possibility of social mobility, which
benefits the wealthy at the expense of the not so wealthy. This is I
think the basic reason why it’s wrong to think of higher wealth
through long lasting revaluations as benefiting the old
relative to the young. Instead it benefits the wealthy and
disadvantages the not wealthy. It’s one of the reasons why I think
those that advocate permanently low nominal interest rates as a
policy goal on distributional grounds are very mistaken.
Only when such
upward revaluations in wealth are short lived does it make sense to
talk about the current old versus the current young. In that case the
house owning couple in their 40s will never see the benefit of the current increase in house prices, because by the time they come to sell
their house and move into a retirement home or whatever prices will
have fallen again. Equally only would-be first time buyers right now
will be disadvantaged by unaffordable housing, because house prices
in 10 years time will be much more affordable.
Short lived movements in asset prices also influence pensions. Those taking their pension
can either get lucky (if real interest rates are temporarily low, so asset prices are high) or
unlucky (if the opposite is true). It is also why a pay as you go,
government run pension scheme can be a lot fairer than private
schemes because the value of pensions do not depend on short term
fluctuations in real interest rates and asset prices. (A failure to
think intertemporarily also bedevils discussion of the triple lock
for the UK state pension. If the state pension was gradually reduced
in value relative to the triple lock, those who would lose out most
are those currently in work, not current pensioners.)
Whatever happens
over the next decade, global real interest rates have been falling
since the 1980s, and so house prices and the value of existing
pensions have been rising. That counts as an upward shift in wealth
that has persisted or increased over decades, making the wealthier
more wealthy at the expense of those with no wealth at all. The last few decades have been a great time to be wealthy, and a
correspondingly bad time for the asset poor.
