So here you are one of those one-percenters controlling 30% of the US wealth. You have way more money than you would ever really want to spend, so what do you do with it. You use it to buy stocks or bonds, in hopes that it will get you even more money. Now you also have a tax advisor who advises you to engage in the “Buy, Borrow and Die” investment strategy, so you never actually sell any of your stock.
But you keep making money. So you need to find new stock to buy. But you and your fellow one-percenters now own 54% of the stock market and are all doing the same thing, looking to buy but unwilling to sell. You get the occasional retiree cashing in their nest egg from the remaining 46% to pay for chemo, but that isn’t nearly enough to satisfy the demands of the giant pile of cash that needs to find something to buy.
So with limited supply and high demand, prices of that equity go up. So if a company is has next to no earnings, or a loan is a bit risky for not much return, you buy it and spend top dollar because what else are you going to do with your money, feed the homeless?
Disclaimer: I’ve never taken a class in economics, so I may be totally off base, and will accept or even welcome those who will say that this is complete and total BS.
It’s not nuts. But if equity is over-priced as you argue, there must be some other asset that is underpriced. Relative to equity.
Also, some stocks pay dividends, some do not. Most do AFAIK. Most stock portfolios will pay dividends, providing a flow of cash that can either be consumed or invested in the most underpriced asset. Which may or may not be stocks.
Are asset markets prone to bubbles? Opinions vary: I think they are.
I was using too narrow a term when I said “equity” since my argument was meant to really apply all investment vehicles, such as bonds, crypto, real estate and certain commodities (e.g. gold) whose value is tied mostly to speculation rather than utility.
Basically with a larger and larger portion of the wealth being controlled by the investing class, and there being only a limited amount of blood from the remaining turnips, the price of root vegetable exsanguination machines is going to go up.
Well, if stocks, bonds, and real estate are all over-valued, then cash deposits (or money market funds or treasury bills) are undervalued. Relatively.
It’s true that late-bull markets underprice risk. I think it’s also true that stocks were systematically undervalued prior to the 1980s due to the trauma of the Great Depression and a crude understanding of financial markets before the 1960s.
As for the thread title, you can substitute in “Asset markets”, for “Equity markets”, nix the word inflation, and ask whether the concentration of wealth inherently produces asset bubbles. I tentatively doubt it, but I’m not going to rule it out without thinking harder about it. One key question: if asset prices are driven up, will there be an adequate supply response in the form of higher investment (creation of assets)? There are other questions.
Good point. What we are discussing is the “Lock-in effect.” Taxpayers can choose when and whether to pay capital gains taxes. From the Penn Warton Budget model website:
The lock-in effect arises for two reasons. First, due to the time value of money, taxpayers can reduce the net present value of tax liability by choosing to defer realizations. Second, asset basis is “stepped up” to its market value at the time of death or charitable donation, so those who plan to leave an asset in an estate to their children can avoid capital gains tax entirely.
All else equal, the tax benefit of deferral is economically inefficient: it encourages investors to make portfolio allocation decisions based on tax considerations unrelated to real production. Scholars and lawmakers have proposed reforms aimed at limiting the tax benefit of capital gains deferral, ranging from reforming stepped-up basis at death to taxing all gains on an accrual basis.
Balcer and Judd (1987) show that differential taxation of interest and capital gains and investor’s individual horizons will affect optimal portfolio composition. Kovenock and Rothschild (1987) compare the net returns of different portfolio strategies when capital gains are taxed upon realization. Auerbach (1991) illustrates the lock-in effect “leads investors to accept a lower rate of return before tax than they would for new investments without accrued gains”. More recently, Landsman and Shackelford (1995) find evidence that investors require higher prices to sell shares with large accrued capital gains.1
Those are all policy incentives though: they do not address the combined effects with wealth inequality. But the last underlined point implies I think that this tax policy tends to support asset prices by removing potential sellers from the market. Until their heirs sell the assets, at least.
But the issue is generational. If tax policy is designed so that you minimize (or eliminate) any taxes by following this financial plan and then pass on your assets to your heir, why should your heir sell those assets? They are looking at the same tax policy and will presumably follow the same financial plan to avoid paying their taxes.
That seems to me to be the key question. If there is suddenly a sweet potato pie craze, farmers will see the increased demand and grow more sweet potatoes. But it seems to me that its not so easy to come up with new investment opportunities to satisfy demand. Particularly since the money companies make generally comes from consumers and the amount of the money in the hands of consumers is not growing as fast as the amount of money looking for a place to invest.
With the step-up in cost basis, there’s no big reason why the heirs shouldn’t sell the assets. Once assets appreciate, then there’s an incentive to pay interest on borrowed money to avoid large capital gains. But early on, this tax planning trick doesn’t apply.
As for adequate supply response, lower interest rates tend to increase investment by making borrowing money cheaper. Similarly, higher stock prices stimulate investment by making it cheaper to raise money. How much this applies is an empirical question. Citing from memory, one study I read concluded that the effects of stock prices on corporate investment are statistically significant but… small. As @Buck_Godot intuits, corporate investors are far more concerned with anticipated product demand. The authors of the piece concluded that stock prices weren’t quite a side-show when considering investment decisions, but they didn’t play a central role either.
I’m somewhat concerned about heirs having no feasible way to precisely peg the value of appreciated assets decades after the deceased originally purchased the property. But somehow they make this process work in other countries, so I view this problem as solvable. I would hope it would be addressed somehow in legislation. It’s certainly worth thinking through a little.
This is already proving to be a problem. Berkshire-Hathaway is sitting on more than $300 billion in cash and Tbills. Apple has at least half that amount. Extrapolating, trillions of dollars are awaiting a better return than what investors see now.
I remember four decades ago when Kodak created a little incubator farm to come up with its next big idea. One of the people involved said their big roadblock was that any product had to be literally a billion dollar new field to make it worth the company’s time and effort. Very ironic, I know. Kodak already had that in digital cameras but those would sink the at-the time infinitely more valuable film market. The point remains. When a firm like B-H or Apple has a market cap of a million million any lesser number in the mere billions doesn’t move the needle at all. That’s why so many firms stick to cash cows long after the world changes. Or make minor changes and ride short-term novelty effects.
All investors can do now is hope that some little firm will take the chance and grow into a giant. The AI mania is built on that hope.
“Wealth” is kind of nebulous, though. Trillions of dollars simply do not exist but are merely abstractions. The numbers are not even on paper, just in computers somewhere. A dedicated team of hackers, being thorough, could make a large fraction of wealth vanish like a fart in a haboob and not much would change. Some billionaires would become millionaires, and ordinary people would gain access to markets in ways they could not before, but the country would move along barely perturbed. All that “wealth” has minimal real meaning.
I’ve seen this argument before and I don’t buy it as more than a half truth. Half in that the market collapse after “Liberation Day” took away what some say was $10 trillion in value and for most people, including the 1%, nothing really changed.
However, wealth does certainly correlate with power. If ordinary people gained equal or even higher relative access to the markets, the power flow would be significant. Look to the 1950s for an example.
For another thread is whether the hacker vanishing act is the pure nonsense I think it is. The number of stocks times the market price is as real as a house address. Ripping the number plate off the front door changes nothing.
You have a lot of money.
You put that money into the stock market or bond market (which are two different things).
Predictably, you hope the value of those financial instruments would increase.
How is it “inflation for rich people” unless you constantly buy stocks and/or bonds that decrease in value?
Are you under the assumption that you will run out of stocks to buy at some point? The total market cap of the NYSE is like $28 trillion. The richest man in the world (Elon Musk) is worth like $400 billion.
Why would you pay top dollar for a shitty stock for a company with no earnings or risky bonds with no return?
I’m not sure how “buy, borrow, die” using an SBL loan fits into this.
Are you asking where someone might want to invest large sums of money in a bear market to avoid inflation?
The richest, in this view, are not only gaining wealth by appreciating assets, but huge flows of income as well, that they need to invest (the huge demand) and there is not, in this story, any good place to invest it. But there is literally a whole world out there of assets to choose to invest in. A huge supply of assets of great variety in many markets. And as has been pointed out, the annual incomes of the wealthiest are still very small compared to the value of that.
In the US, companies have almost 7 trillion in cash at this point.
While most Americans have spent down their pandemic savings, non-banking U.S. firms have increased their hoards of cash, reaching $6.9 trillion, an amount larger than the GDP of all but two countries. Even as interest rates have risen, cash now represents $1 out of every $5 of total assets held by non-banking U.S. firms, according to our research.
Why would U.S. firms hold so much in an asset class that yields far lower returns than their cost of borrowing? Researchers have offered multiple explanations, including flexibility and taxes, which we review below. But our work adds another explanation that we call “precautionary cash holdings.”
In short, companies hold cash because it helps them avoid premature failures that decimate shareholder value.
Its my understanding that technology companies tend to have more cash than non-technology companies, in large part because the tech companies need reserves to invest in the next innovation so they can remain competitive.