Time to consider your vote

One of the best gifts anyone give me is a book voucher which offers me an excuse to involve myself in a favourite pursuit which is to take myself to our local Exclusive Books shop to spend a contented half hour selecting a pile of new books and then to repair to the attached coffee shop for a bottomless flagon of coffee, a sandwich and an afternoon of enjoyable reading.

My rule is to choose one book for myself, another for my wife and a third for a friend with an up-coming birthday or anniversary. If I can finesse this properly, I will get the latter early enough to be able to at least skim read it before it is gift wrapped. And of course the book for my wife will soon become available to me as well.

Now, ordinarily I am not a political person. As a rule I am inclined to side with the average Briton who, in a recent survey ranked politicians as lower down their least favourite persons pecking order list than second-hand car salesmen. However, on this latest occasion I was surprised to find that two of the three books I selected were  commentaries on the contemporary political scene.

Then I remembered talking over tea with two very distinguished black women of my acquaintance whom I had always assumed were staunch ANC supporters. They were bemoaning the fact that there were no credible leaders in South Africa today who could offer moral and upright examples for our youth.

And so there I was paging through a book entitled “We Need to Talk”by Prof Jonathan Jansen, rector of the University of the Free State, and my eye fell on a single paragraph which for me encapsulated the current South African dilemma: the issue which has diverted the attention of everyone in this wonderful country of ours away from the really important things to a sordid daily contemplation of the corruption of  our society.

Prof Jansen wrote of his youthful heroes who offered up their lives to liberate millions of South Africans from a tyrannical political system and thus paved the way for an ANC leadership which in its turn had recently denied the Dalai Lama the right to visit this country; which at the United Nations had sided with oppressive regimes in Mynmar and closer to home provided moral and material support for despotic leadership for Robert Mugabe’s Zimbabwe!

What, one might ask, has happened to those who inherited the mantle of leadership?

Writing of his travels up and down this country talking to people in every walk of life as he sought guidance for the future of his university, Prof Jansen wrote that the people he had come to most respect were mothers who, often without the support of a husband, were single-handedly bringing up families of young people whose clothes, though patched and mended, were always neat and clean; Children who were always in school and in church and most importantly who knew right from wrong.

These mothers, he had grown to realise, were the real heroes of modern South Africa!

And so, I wondered whether people like President Jacob Zuma, smugly ensconced in his R220-million homestead at Inkandla, together with the gravy train coterie that surrounds him, had mothers like those and why  they failed to teach their children the difference between right and wrong.

Pressed in a television interview on news channel eNCA to resign over the Nkandla scandal on a recent Sunday evening, President Zuma was defiant that he had done nothing wrong. Neither, apparently, was he concerned at the misplaced priorities that saw two minor roads to his homestead tarred and upgraded to the tune of R582-million.

Neither, it seems, has he been concerned by public reaction whenever someone close to him is released from jail without serving out their allotted sentences, nor to my knowledge has he done anything to clamp down on the annual R30-billion that the then head of the Special Investigating Unit, Willie Hofmeyr claimed was being stolen annually from the Government’s annual procurement budget.

When one appreciates that South Africa’s high crime rate and excessive violence are directly linked to the fact that we have one of the highest unemployment rates in the world, and that every cent stolen from the government is a cent less available for the causes of economic growth, ending  unemployment and uplifting the poor, it is clearly time for ordinary citizens to use their votes with care.

Need I also remind readers about the latest horror that President Zuma is about to unleash upon an apparently slumbering South Africa:  a fleet of nuclear power stations likely to cost at least ten times more than the R60-billion arms deal that will deliver electricity at an infinitely higher cost to the consumer that the projected inflated costs of the new Medupi and Kusile power stations at a time when clean non-polluting solar power is coming on stream at a lower cost than these coal-fired giants.

There has been no public consultation, yet Zuma announced it in his State of the Nation Address as a done deal for the provision of 9 600 MW of nuclear power! You can understand the unseemly haste when you appreciate that any significant further increase in South Africa’s energy costs will totally destroy any competitive edge that this country’s industry still possesses. If proper consultation took place this contract would have to be canned. So who is getting a pay-off this time?

There is an ancient adage in politics which argues that power corrupts and absolute power corrupts absolutely. It follows then that if South Africans are concerned about these things they should use their votes to ensure that the ANC’s parliamentary majority is significantly reduced.

Do bear in mind also, that in South Africa not voting is as bad as casting a vote in favour of crooked government because then all those unused votes get allocated pro rata to the parties that glean the most votes.

We begin a new series in The Investor

by Richard Cluver

Investors have been teased for decades by the idea that you can convert the seemingly hectic hysteria of the share market trading floor into an easily understood pattern of graphs and accordingly predict where the “Smart Money” is flowing. More than that, in recent years it has become clear that these graph patterns can enable astute observers to piece together the likely future of individual share prices.

More art than science in its early stages and regarded with great suspicion by orthodox analysts for much of its early history, it is probably fair to say that Technical Analysis – to give charting its formal title – has in recent years come to be accepted as a valuable tool which few modern analysts would comfortably do without.

Indeed, having in the 1980s distilled the best concepts from the work of early technical analysts and combined these into a series of my own indicators which I have since been able to observe for over 30 years, I have been able to conclusively prove that prediction accuracy rates of more than 90 percent are consistently possible: rates which absolutely guarantee that profitable share market trading is now a reality.

In its simplest form, Technical Analysis appears as line graphs which enable the investor to form a picture of the trend of a market and make a few simple assumptions. My opening chart is beguilingly simple, seemingly depicting a market rising endlessly into the future with barely a hiccup: a long-term investors dream. Of course it is far from simple, but then the best indicators appear disarmingly simple, belying the complex mathematics that has made them possible. It is an example constructed by my own ShareFinder 6 computer programme of the ShareFinder Blue Chip Index which is an index that represents the day-to-day price performance of all Johannesburg Stock Exchange shares that conform to a basic rule that the companies of which they are a part have paid constantly-rising dividends for not less than ten years.

It is, furthermore plotted as a logarithm; in other words the daily price changes are effectively plotted as percentage movements which is why they can be overlain with a straight “Trend” line which allows us to see that the index rose at a compound annual average rate of 27.7 percent annually during the five years from November 2008 to November 2013. Were it not for this simple plotting variation the graph would have appeared in the form below: not particularly different over this comparatively short period.

But note what happens when we display it as an ultra long-term graph over a 27-year period. The curvature is the consequence of a market phenomenon known as exponentiation which I will explain at a later stage in this study:

Patently, without the disarmingly simple device of logarithmic charting, it would have been a great deal more difficult trying to determine a measurable price trend.

This, and dozens of other simple constructs are what makes Technical Analysis such a useful science to master. So come with me on a voyage of exploration as I attempt to do away with the mysteries and offer you some simple explanations of how you can make charting such a useful adjunct to your investment understanding.

CPI update: The upward trajectory in CPI inflation will be reversed in the second half of 2014, the breach in the target proving very temporary

By Annabel Bishop, Investec Group’s chief economist

January 2014’s CPI inflation rate came out at 5.8% y/y, slightly above consensus of 5.7% y/y. A key driver, the 0.2% m/m rise in petrol prices will repeat in the February inflation print, and potentially the 0.2% m/m contribution from food prices as the effects from the drought feed through. Nevertheless, CPI inflation is likely to remain within target for the majority of this year.

A small 0.1% m/m increase was recorded from miscellaneous goods and services, which include financial services, and it is normal for these premiums to rise annually. There was no clear evidence of any second round, pass through effects from the rand’s depreciation on the CPI. The residual was larger than normal, at 0.2% y/y, accounting for inflation pressures too minor to be captured by the categories. This fails to demonstrate any clear second round effects of rand weakness.

The rise in the CPI should not be misinterpreted to read that demand is rising, or that higher prices at the tills are being absorbed by the consumer, and so higher inflation will become entrenched. Retailers have been battling sharply escalating state controlled prices such as water, electricity and property rates and taxes. Labour costs are rising rapidly too because of this escalation in administered prices and resultant strike action. Retailers passing these costs through are seeing that consumers are not necessarily absorbing them.

March will see significant price pressure come through from state administered prices, as the taxes on tobacco products and alcohol, and the fuel levy all rise significantly. However, the petrol price increase in March should be more modest, coming off a higher base and likely only 33c/litre, as opposed to the 81c/litre recorded in March 2013. March 2014 could see a CPI inflation rate of 5.6% y/y consequently.

We expect CPI inflation to average 5.9% y/y in 2014. CPI inflation is being bolstered by the high administered price inflation rate, of 9.3% y/y, without it CPI inflation would be 5.0% y/y. Core inflation is unchanged at 5.3% y/y.
The expected, upward trajectory in CPI inflation this year is not likely to be as steep as many forecast, including the SARB, and so should not give cause to hike interest rates substantially. We expect another 50bp increase in July.

Any more than this would be excessive given that consumers are highly indebted, at 76% of disposable income, well above the 50-60% ratio of the late 1990s and early 2000s. There is greater sensitivity to higher interest rates currently, and fewer interest rate hikes will be needed to curb demand-led inflation.

Food inflation accelerated to 4.3% y/y, from 3.5% y/y in December, driven by the impact of the rand’s weakness and the drought.

The 38c/litre petrol price hike in January pushed up the targeted measure of inflation and the petrol price rose by 39c/litre in February, and is on course for a 33c/litre increase in March. However, the m/m impact of the March petrol price increase will be lower as it comes off a higher base.

The core inflation rate came out lower than the headline rate, at 5.3% y/y. If all state administered prices are excluded only demand led inflation results, at 5.0% y/y.

The gambling industry: No ordinary industry

By Brian Kantor

The casino industry, and the established gambling industry in general, face threats from new sources.

Gambling is no ordinary industry. Nowhere can anyone with simply the will and the capital to do so offer an open opportunity to the public to play games of chance for money.

To enter the gambling business, investors typically have to cross very high barriers to entry set by regulation. They will need to acquire a special licence and, much harder perhaps, a prescribed suitable venue to play the games. They will also have to satisfy strict instructions as to what particular games of chance and prizes they can offer.

The reason why societies intervene in the gambling market has much to do with a religious, essentially paternalistic, objection to gambling, or rather perhaps a visceral objection to the sometimes large gambling losses that may be suffered by particular gamblers they know or have heard about. The best practical argument for tolerating and legalising gambling services is that what inevitably follows prohibition or the imposition of onerous taxes: illegal gambling, which is even worse for the community.

This argument applies also to how society can best manage all of what are broadly regarded as the popular “vices”. Driving consumption underground is not good public policy.

Furthermore, if enthusiastic gamblers are prevented from gambling near where they live they will travel to jurisdictions near and far to do so. The opportunity to tax the activity for useful local purposes – perhaps to reduce the burden of other taxes or to provide employment at home rather than elsewhere – may well win the political arguments for and against licensing gambling.

The opportunity to tax gambling activity as an alternative to imposing other taxes, may well win the political arguments for and against licensing gambling. The prospect of employment at nearby casinos or race tracks, rather than far away, will be an additional argument for local or provincial authorities to license gambling venues.

The history of casinos in SA

The history of the large entertainment casinos in SA with their banks of slot machines and a variety of table games that attract many players, provides a good case study of the practical and political forces at work when dispensations for gambling are imposed or relieved. Casinos were illegal in SA before the so called “homelands” were allowed to license them. The customers would travel from SA to gamble and for other pleasures or vices not legally available closer to home. The homeland authorities would tax these activities and relieve the SA taxpayer of some of their burdens. In SA, consequently, there had also grown up a large, illegal, unregulated and untaxed, local casino industry.

With the re-unification of a democratic SA and the demise of the homeland authorities, it was sensibly decided to legitimise the casino industry in SA, to place it under the authority of the respective provinces and most important, to strictly limit the number of casino licenses nationally and by the province. Only up to forty casino licences in all could be issued and provinces were able to license their operation within the urban areas close to their potential customers. The distant, previously homeland casinos, while they retained their licenses, lost their competitiveness. Why travel further than to a convenient casino close to home?

The success of these newly established SA urban casinos in attracting custom soon became apparent. Their success in attracting a larger share of the household budgets for gambling became immediately and painfully obvious to the horse racing clubs and their dependents on the tracks and farms. Horse racing had benefitted from something close to a legal gambling monopoly in SA. The revenues from gambling on horses, shared with the private bookmakers and with the provinces as taxes, had helped support a thriving, labour intensive, industry. Horses are not easily groomed by robots. Casinos too provide employment and income earning opportunities for local business to supply their needs.

But the gains of the owners, workers, suppliers and the players at the new SA casinos, at the expense, in part, of the racing clubs and their extended network, help illustrate an important point.

The different gambling offers compete with each other for a fairly predictable share of domestic household disposable incomes, in SA equivalent to between one and one and a half per cent of disposable income on average, though the share does vary by province and by city. The demand for gambling services can also be shown to depend in part on the disposable incomes of households and also on the traveling time taken to access gambling venues. Both the poor and the rich tend to spend a lower than average proportion of their incomes on gambling than the middle income earners.

The role played by the archetypal foreign travelling high roller in the typical casino, outside of the special cases of Las Vegas and more lately Macau (casinos are still illegal in mainland China), has been shown to be minimally important to the large urban casino in South Africa and elsewhere. The SA casino business caters to a local customer base. Online gambling opportunities may be about to change all this – if allowed to do so.

But while the casinos compete with each other and with the tote, the lottery and the private bookmakers, the limits to entry have proved valuable to the licensed casino operators.

For these reasons, a partial casino monopoly in one urban area can prove so valuable – and something the operators are prepared to pay for (in cash or kind).

A turn around the Cape

On this basis the Western Cape Government in the late 1990s was persuaded to grant an exclusive 10 year right to operate only one casino within the Cape Town metropolitan region (as well as on the basis of a more decentralised economic development that would come with allocating a limited number of new licenses outside of the city).

The exclusive license was then determined by way of a competition, a beauty contest between different potential operators, who were asked to compete for the licence by offering a variety of additional benefits to the province as well as the new casino itself in exchange for this exclusivity. Sun International and its partners won a closely contested bidding process with an offer of a themed casino in Goodwood plus other benefits to the province of a major financial and organisational contribution to help found the Cape Town International Convention Centre.

This exclusivity agreement has run its course and the province could exercise a further opportunity to extend the exclusivity agreement for upfront benefits in cash and kind in the broad public interest. Sun International, with a well established and well preserved casino complex in operation, would be in an especially strong position to compete financially for a new exclusive license and to offer significant benefits to the province and its citizens for a renewed exclusivity agreement.

Unlike its potential competitors it would largely save the cost of building a new casino. Yet judging by recent public commentary or rather the absence of it, the province seems inclined to forgo these potential benefits and seems inclined to allow the transfer of one of the rural casino licenses to the city.

The people of the province, as far as I am aware, have not been widely consulted on or informed about such a choice – of two casinos or one (with all the upfront payments in cash and kind that might be offered for continued exclusivity). It is a choice deserving of very serious consideration by the citizens of the Province and its elected representatives.

The upshot of any decision to permit two casinos would be likely to divide the market roughly between the two operators as well as to reduce the market for casino-like services in one of the rural areas, with the indirect knock-on effects on local employees and suppliers the loss of casino business would bring. Unless the total casino market in the Western Cape would grow significantly in response to an additional casino offering in Cape Town (an unlikely outcome) there would not be meaningfully more tax revenues for the province to collect nor any additional employment or ongoing economic activity. The rural area losing its casino would suffer obvious economic losses. The established Cape Town operator might well offer, in its bid for renewed exclusivity, additional benefits to the city or province in exchange for an extension of exclusivity.

Any additional hotel or entertainment facilities that might accompany any additional casino cannot be regarded as among the additional benefits provided by a new urban casino in Cape Town. There is no shortage of hotels, restaurants or entertainment amenities in Cape Town. Such additional entertainment facilities would very likely displace activity in restaurants and entertainment venues generally.

New threats

There is however a more serious threat to legitimate gambling interests in SA. It comes in the form of still more competition for the gambling rand from the proliferation of limited payout slot machines and electronic bingo terminals (EBTs) that are slot machines in practice. The latter offer an additional competitive advantage to the gambler in that they can promise effectively unlimited pay outs, unlike the limited payout slot machines previously licensed. Limiting pay outs restricts the competition of conventional casino-based slot machines for gambling revenue with casinos, the tote and the National Lottery. Unlimited, or less limited payouts, have an attraction to many casino or horse racing gamblers whose objective is the big win, even when the odds of doing so are very long shots.

The slot machines, masquerading as bingo machines, overcome this disadvantage of limited pay outs and may well become increasingly ubiquitous and competitive against the established providers.

A still bigger threat to established gambling enterprises is surely the online gambling opportunities that modern technology makes available. The cost of providing a gambling opportunity on the internet or participating in one, from home anywhere in the world, is close to zero. The offering therefore is infinitely scalable. By comparison running a casino or a racing club is a very costly enterprise because they employ people and require a physical structure and presence.

Lower costs of production of any good or service usually means lower prices as firms compete for a larger market share with better terms – and in the case of gambling this might well mean better terms or bigger potential prizes for the serious gambler.

This provides online gambling with a great competitive advantage over conventional gambling providers. The online sites that can attract many customers from all over the world, at very low cost, are likely to offer the better odds or the most commanding big payouts – especially if internet gambling pays very little tax!

The value of any casino or racing club is therefore under threat of the potential proliferation of EBTs and legal access to internet gambling. The threat from new technology and the great uncertainty about what the gambling landscape in SA will look like over the foreseeable future is currently influencing the value attached to Casinos and their licenses in SA. Therefore the case for establishing an additional casino in Cape Town, or the price the established casino might pay to keep it out, must now be subject to unusual uncertainty.

It is in the interests of the wider community that as much certainty as possible about the gambling landscape be created. The objective should be to maximise as far as possible the domestic SA public interest in the gambling industry for taxpayers, employers or employees and investors in addition to those of gamblers themselves. The possible migration to a highly competitive SA gambling industry dominated by offshore providers, with the interest of the serious gambler in effect treated as paramount, should surely not be allowed to happen by default, but only rather after careful consideration of its full economic and social consequences .

The North American view

by John Mauldin

The Worst Ten-Letter Word

“Inequality has emerged as a major issue in the US and beyond. A generation ago it could reasonably have been asserted that the overall growth rate of the economy was the main influence on the growth in middle-class incomes and progress in reducing poverty. This is no longer a plausible claim.

“The share of income going to the top 1 per cent of earners has increased sharply. A rising share of output is going to profits. Real wages are stagnant. Family incomes have not risen as fast as productivity. The cumulative effect of all these developments is that the US may well be on the way to becoming a Downton Abbey economy. It is very likely that these issues will be with us long after the cyclical conditions have normalized and budget deficits have at last been addressed.”

– Lawrence Summers (in the Financial Times)

“Cyberpunk is a postmodern science fiction genre noted for its focus on ‘high tech and low life.’ It features advanced science, such as information technology and cybernetics, coupled with a degree of breakdown or radical change in the social order. ‘Classic cyberpunk characters were marginalized, alienated loners who lived on the edge of society in generally dystopic futures where daily life was impacted by rapid technological change, an ubiquitous datasphere of computerized information, and invasive modification of the human body.’”

– Lawrence Person (Wikipedia)

A new word is achieving ubiquity. The word has always been with us and at times has been a beacon to attract the friends of liberty and opportunity. But now I’m afraid it is beginning to be used as a justification for social and economic policies that will limit the expansion of both liberty and opportunity. The word? Inequality. More specifically, the word has become problematic when used in close proximity to the word income. There are those who believe that income inequality is the proximate cause of the Great Recession, if not the imminent demise of Western Civilization, pushing us into a dystopian world that will come to resemble the one depicted in the movie Blade Runner.

(Note: Blade Runner exemplifies a genre of science fiction called cyberpunk, defined above.)

This week we begin what will probably be a multi-week series on the subject of income inequality. Over the years, I’ve written many times about the lack of income growth for the middle class in the developed world. We have also looked at the growing spread between the top 1% or 5% or 10% and those further down the income scale. The widening spread is an undeniable fact. But what should be done about it? Do we take money from the more well-off, or do we increase opportunities for all? How do we increase opportunity without social expenditures for education and healthcare, and where will the money come from? What trade-offs do we get for the lost productivity and reduced savings that result from increased taxes? What institutional and policy barriers are there? These are all fundamentally important questions.

What spurred me to start this series was a recent paper from two economists (one from the St. Louis Federal Reserve) who are utterly remarkable in their ability to combine more bad economic ideas and research techniques into one paper than anyone in recent memory. Their even more remarkable conclusion is that income inequality was the cause of the Great Recession and subsequent lacklustre growth. “Redistributive tax policy” is suggested approvingly. If direct redistribution is not politically possible, then other methods should be tried, the authors say.

So what is this notorious document? It’s “Inequality, the Great Recession, and Slow Recovery,” by Barry Z. Cynamon and Steven M. Fazzari. One could ask whether this is not just another bad economic paper among many. If so, why should we waste our time on it? And this week we’re actually not going to lay the paper out on the slab and dissect it; we’re just going to prepare for the post-mortem by getting up to speed on the issues it tries to address.

The problem is that the subject of income inequality has now permeated the national dialogue not just in the United States but throughout the entire developed world. It will shape the coming political contests in the United States. How we describe income inequality and determine its proximate causes will define the boundaries of future economic and social policy. In discussing the multiple problems with the paper, we have the opportunity to think about how we should actually address income inequality. And hopefully we’ll steer away from simplistic answers that conveniently mesh with our political biases.

I am pretty certain that by the end of the series I will have been able to offend nearly every reader, and some of you multiply. That’s OK – it means we’re thinking outside our boxes. I will admit to having been forced, of late, to change some of my more reflexively conservative positions with regard to the structural causes of income distribution trends and, even more importantly, the distribution of opportunity. It is the latter concept that should command our particular attention, and a fair distribution of opportunity should appeal to both libertarians (I more or less think of myself as one) and progressives.

The unfair distribution of opportunity is not an injustice that can be redressed simply by composing erudite paeans to free markets or social justice, even though politicians will try. The problem is far more complex than that. Are we in fact, as Larry Summers suggests, on the road to a Downton Abbey economy – or, even worse, a Blade Runner-like dystopia?

I should note that Professor Summers’ op-ed is a not entirely uneven discussion of the problem. “Given the widespread frustration with stagnant incomes, and an increasing body of evidence suggesting that the worst-off have few opportunities to improve their lot, demands for action are hardly unreasonable. The challenge is knowing what to do.” We will address Summers’ conclusions later in this series, but for now let’s think about how to approach the challenge of income inequality.

A quick search for the word inequality in Google Trends reveals that the general public is starting to take a lot more interest in the concept. Monthly searches for the word inequality have more than doubled in the past year or so. (Odd trivia fact: Indiana is the state with the highest search interest in inequality, ahead of college liberal Massachusetts.)

Of the underlying or related searches, income inequality is the most frequently searched term. It spiked to all-time highs after President Obama’s State of the Union address in January.

We have to take this data with a grain of salt, but it clearly shows that inequality is becoming a more popular search term. And if it is becoming a more popular search, that is clearly because people are thinking and talking about it a lot more. And if people are thinking and talking about the subject of income inequality a lot more, then my readers, who are by and large thought leaders in their respective worlds, have a serious responsibility to inform that discussion.

The fact that incomes of various segments of our society are diverging is not really disputable. There are many ways to sort for the reasons for income differentials, but one of the ways is by education level, where the income differences have become rather stark over the last 40 years. Note in the chart below that incomes for all segments of the population generally rose in tandem up until the beginning of the Information Age in the early ’70s, and then the disparity began to grow. Those with more education saw their incomes increase while those with less education saw their incomes fall.

As Summers noted, a rising share of GDP is going to profits as opposed to wages. This is a trend that started at the beginning of the last decade.

One other odd bit of information that I came across while researching this topic is that between 1979 and 2002 the frequency of long work hours (more than 50 hours a week) increased by 14.4 percent among the top quintile of wage earners but fell by 6.7 percent for the lowest quintile. And those extra hours translate into extra income. (You can see the NBER study here.) I don’t know about you, but my hours have significantly increased since 2002. Not sure that is relevant, but just saying.

Robber Barons

Let’s take a somewhat philosophical and less databased approach to income inequality. Mainstream economists and policy makers are still thinking of inequality through the lens of 19th and early 20th century experience, when robber barons like Carnegie, Rockefeller, and Vanderbilt supposedly lined their pockets by withholding reasonable wages from the working poor.

This is precisely what Larry Summers was getting at in this week’s Financial Times op-ed:

The share of income going to the top 1 percent of earners has increased sharply. A rising share of output is going to profits. Real wages are stagnant. Family incomes have not risen as fast as productivity. The cumulative effect of all these developments is that the US may well be on the way to becoming a Downton Abbey economy.

That thinking assumes that if income inequality is rising, the top 1% is getting richer at the expense of the working class, because it assumes production still heavily exploits the relatively unskilled labour that most Americans can provide through hard work. It does not discriminate between value-added labour and value-added information and innovation.

The gains from the Information Age have been unevenly distributed throughout the economy. This is a structural problem in the sense that the productivity gains from the first two Industrial Revolutions are essentially thoroughly distributed through the economy. All workers saw their incomes increase along with increasing productivity for the 200 years of the Industrial Revolutions. Yes, entrepreneurs, innovators, and knowledge workers saw their incomes rise faster, but a rising tide of productivity lifted all boats.

The same phenomenon is playing out now in developing markets, where much of the basic infrastructure of industrial revolution is still being built. I would expect that the same income inequality issues would develop in those markets in conjunction with the full rollout of industrial revolution and the shift to a knowledge-based economy.

Another observation that I have come to embrace is that knowledge workers have indeed seen their incomes increase because of their ability to put their knowledge to work more productively. Goods-producing workers have by and large not seen much rising productivity in the last 30 years due solely to their work and thus have not seen an increase in their incomes. To the extent that workers have skills, their incomes rise.

(Please. I get that it is more complicated than this. Increased foreign competition for lower-skilled jobs and the bursting of two major bubbles have also put a dent in US incomes.)

That being said, the top 1% is getting richer either by (1) allocating capital to the right places (which all right-thinking people want to see happen), or (2) by employing skills that most of the American work force does not have – because production increasingly depends on the hard work of creative workers with hard-earned skills gained through education and experience.

Today, a much smaller percentage of our labour force is responsible for a much greater percentage of economic output. Their wages are rising because their productivity is rising.

The trouble with conventional wisdom about income inequality is that it is so fails to factor in productivity and the sources of productivity.

While populist politicians, mainstream economists, and envious market watchers would like to brand billionaire inventors like Tesla CEO and PayPal Founder Elon Musk, Facebook CEO Mark Zuckerberg, or eBay cofounder Pierre Omidyar as modern-day robber barons, they haven’t really robbed anyone. The emerging class of billionaires is creating value that did not exist before they arrived, and they’re doing it with relatively small teams of highly skilled knowledge workers. And they deserve every penny they earn.

On the flip side, a growing majority of our labour force is responsible for a much smaller percentage of economic output. Their wages are stagnant because more people are competing for a shrinking number of jobs.

The World’s First Trillionaire

I have brought to your attention before a very important book by Mark Buchanan called Ubiquity, Why Catastrophes Happen. I HIGHLY recommend it to those of you who, like me, are trying to understand the complexity of the markets. It’s not directly about investing, although he touches on that subject. Rather, it’s about chaos theory, complexity theory, and critical states. It is written in a manner any thoughtful layman can understand. There are no equations, just easy-to-grasp, well-written stories and analogies.

Buchanan talks about power laws and critical states. He wraps up his opening chapter like this:

There are many subtleties and twists in the story … but the basic message, roughly speaking, is simple: The peculiar and exceptionally unstable organization of the critical state does indeed seem to be ubiquitous in our world. Researchers in the past few years have found its mathematical fingerprints in the workings of all the upheavals I’ve mentioned so far [earthquakes, eco-disasters, market crashes], as well as in the spreading of epidemics, the flaring of traffic jams, the patterns by which instructions trickle down from managers to workers in the office, and in many other things. At the heart of our story, then, lies the discovery that networks of things of all kinds – atoms, molecules, species, people, and even ideas – have a marked tendency to organize themselves along similar lines. On the basis of this insight, scientists are finally beginning to fathom what lies behind tumultuous events of all sorts, and to see patterns at work where they have never seen them before.

Now, let’s think about this for a moment. I’ve written about the sand pile game where researchers created a computer simulation of the sand piles that we built as kids at the beach. In their simulation of the sand pile, they found that as the number of grains of sand involved in an avalanche doubled, the likelihood of an avalanche was reduced by 2.14 times. We find something similar with earthquakes. In terms of energy, the data indicate that earthquakes become four times less likely each time the energy they release is doubled. Mathematicians refer to this as a “power law,” a special mathematical pattern that stands out in contrast to the overall complexity of the earthquake process.

We are indisputably living through the greatest era in human history. Humanity is immeasurably richer than it was 100 or 50 or even 20 years ago. And along with everyone getting richer, we’ve seen a rising number of super-rich. But as the Huffington Post noted a few weeks ago, even the super-rich are getting left behind by the uber-rich.

Eighty-five people have as much money as do the poorest 3.5 billion. The top 1% have almost half the liquid wealth that has been accumulated in the world. There are 1,426 known billionaires, and gods know how many additional kleptocrats and people who have managed to maintain some semblance of privacy.

I’ll bet you a great dinner at your favorite restaurant that the distribution of the world’s wealth very clearly follows a power law similar to the one that describes the distribution of earthquakes and other phenomena. (There is an economics paper in there somewhere. Send it to me when you’ve written it!)

Thought experiment: if world GDP grows at 3% compounded for the next 100 years, world gross domestic product will be 16 times greater than it is today. That’s simple math. But if the future is anything like the past, the distribution of that enormous increase will not be even throughout the population. Not everybody will be 16 times richer, and some people will be fabulously richer. Unbelievably richer. Off-the-charts and mind-bendingly richer.

Someday, and with the real possibility of its happening in our lifetimes, we will see the world’s first trillionaire. This week we awakened to the fascinating story of WhatsApp cofounder Jan Koum selling his company to yet another of the elitist uber-rich, Mark Zuckerberg, founder of Facebook. Theoretically, the 37-year-old Koum walks away with about $6.9 billion – after starting out as a refugee from Kiev some 20 years ago, living on food stamps. He created this fabulous wealth with a partner and less than 70 employees in just a few years on the strength of an idea, a lot of chutzpah, and venture capital from the very firm that Zuckerberg spurned less than 10 years ago (Sequoia Capital – and that in itself is a great side story you can learn about on Google).

Of course that is not yet $1 trillion, but that is not how we get to the world’s first trillionaire. Many of the young men and women who are billionaires today are going to be living to the end of this century. What if a few of them are able to compound their wealth at 6%, 8%, or even 10% a year? Below is a chart of what Jan Koum might see his wealth become if he were inclined to continue the chase.

Zoum has almost as much net worth today as Elon Musk, founder of PayPal and Tesla Motors ($10 billion). As noted above, there may be as many as 2,000 billionaires in the world, with more being created every day. I can think of half a dozen ideas that could generate more than $10 billion for their creators. A cure for cancer could easily be worth $100 billion. A new, clean, localized energy source could create multiples of that. There are already five family groups with over $50 billion each. At 6% compound returns they could top $1 trillion within 50 years, although several are giving away most of their wealth.

The point? It is not a matter of whether someone will be worth $1 trillion or whether they even deserve it. It is simply going to happen at some point. Quite frankly, I don’t care. I hope they take their capital and put it to productive uses that make the world richer and a better place to live while they themselves are getting fabulously rich. As long as they do it on an even playing field, “good on them.”

Income inequality is not going away. Visually, and given the realities of the unfolding Age of Transformation, we may even see greater disparities.

I do agree with Summers on one point: “It is very likely that these issues will be with us long after the cyclical conditions have normalized and budget deficits have at last been addressed.”

What else can we expect as long as we continue to rely on a 20th century education system to equip 21st century workers? When we allow crony capitalism to create an unequal playing field with special benefits for some? When businesses successfully lobby to create barriers to entry for future competition so that they can maintain their profits without having to compete? When we give tax benefits that help a relative few so that we are forced to tax those who are productive at ever higher rates?

Instead of obsessing over the rising income inequality that has always accompanied great periods of innovation (it took decades for the first and second Industrial Revolutions to be reflected in productivity numbers as well as overall wages), Larry Summers, Paul Krugman, and other “big league” mainstream economists should be advising President Obama, the House, the Senate, and every voter who will listen about the importance of aggressive reforms in education, entitlements, and tax/regulatory policy.

They should be asking why knowledge workers are moving ahead, while more of the labour force is left behind. And they should be formulating policies that can empower and encourage more unskilled workers (or workers with out-dated skills) to become highly skilled knowledge workers in the coming decades. But such questions don’t suit their political agendas. These are not questions with easy answers. They demand hard work not only on the part of politicians, but also from the people wanting the benefits. The Age of Transformation will require constant education and updating of skills.

There is no way for a government to protect its citizens from increasingly accelerating change without ultimately destroying the benefits delivered by that change. The focus has to become on how to help people adapt and prosper in an environment of unremitting change. What sort of government and what economic policies will foster an environment that increases productivity and income for everyone?

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