Economics

The continued wealth divide

Luxury carmaker Rolls-Royce’s 2012 financial results must have brought new worries to those concerned with the growing wealth divide.

Rolls-Royce reported a third consecutive annual sales record, the best results in its 108-year history. Priced at £170,000 for its cheapest model, it is safe to say that these sales were reserved for a small subsection of the wealthiest, perhaps the 0.01 percent. While the ongoing recession has left the masses paying off their debts and enjoying less consumption than before, the so-called one percent continue reaching for new heights and excesses.

What explains this growing divide, especially concentrated in the hands of a very few?

One place to look could be in the successes of businessmen, earning large profits by serving customers especially well. While there may be a handful of entrepreneurs weathering the financial storm well, the recession is wearing on the majority of the business community. It also doesn’t appear that these lavish displays of wealth are being made by the astute business community.

Another place to look is whether there is a privileged position or relationship that is enabling some to succeed at the expense of others. Such a cause would have the markings of some people earning large profits with seemingly little conventional work at the expense of the well-being of the masses (in contrast to the normal way of earning profits – hard work aimed to make the masses better off).

Last year the Bank of England increased the supply of notes and coins by about 4%. This increase provided a buyer for UK gilts that might not otherwise exist, reducing borrowing costs for the government. Yet while some politicians might be living the high life, the real culprit is found within the banking system.

With that increase in base money, the banking system was able to increase its supply of credit – issued in the form of loans to borrowers against the deposit base. It was able to do this by a legal privilege bestowed on it by the government, in the form of fractional-reserve banking. By issuing loans in excess of the amount of their assets, banks are able to effectively create something from nothing. These loans are used by borrowers, and have the result of pushing up prices. Inflation harms savers – those whose hard work was rewarded in the past but is now compromised as rising prices reduce the purchasing power of these funds. On the other hand, borrowers are able to use these newly created funds for purchases. Since they gain access to funding at one set of prices and then, through their spending, raise these prices, borrowers of this fractional-reserve created money relatively impoverish the rest of us.

Instead of earning profits the old-fashioned way, it is now advantageous for people to borrow money from the banking system and spend it as quickly as possible. The only problem is that most of us cannot do this. Since the bank is concerned with getting paid back, it will only loan money to the credit-worthy, or connected. The one percent, relatively unaffected by the recession compared to Main Street, is able to gain access to new exclusive profits.

That these profits should be funneled into displays of wealth like luxury autos should come as no surprise.

Yet Rolls-Royce is not alone in this growing wealth divide. Last year I discussed how high-end art and real estate markets are flourishing. BMW (Rolls-Royce’s parent company), Audi, Mercedes-Benz and Jaguar Land Rover also all reported record luxury sales in 2012. Automotive research consultancy JATO Dynamics reports that premium and luxury car sales have grown by 13% over the past four years, despite talks of austerity and recession filling the financial press. Bently recently announced that its 2012 sales increased 22% compared to the year before.

The mass-market automotive brands are in a much starker position. Battling over price points to attract price-sensitive customers, high taxes and rising unemployment are endangering sales. Indeed, “[t]here is a disconnect between the mega-rich and the rest of us” according to Rim Urquhart, an analyst at IHS Automotive. With the forthcoming introduction of Roll-Royce’s ultra-luxury model, the trend shows no sign of abating. Aimed at just hundreds of units of sales instead of the thousands for its current model, Rolls-Royce is aiming clearly at a different segment of the market than it is accustomed to – one geared toward the one percent of the one percent.

For those upset at these ostentatious displays of wealth and the growing divide they signify, blame should be properly placed. In some cases these purchases and lifestyles are the result of hard work and the reward of sacrifice. For many, however, the growing divide is a “reward” for being in a privileged position within the financial industry. The fractional reserve system enables undue profits to some at the expense of others. Scrutiny over the Bank of England (and other central banks) and their continued inflationary gifts to the financial system would do much to rectify this growing imbalance.

5 comments to The continued wealth divide

  • Paul Marks Paul Marks

    Yes of course.

    Even back in the 1700s Richard Cantillon (John Law partner in “legal” crime) understood that the effect of a monetary inflation (regardless of whether prices went up in the shops or not) is to benefit some, normally rich, people at the expense of many, normally poor, people.

    Even after the boom-bust event has taken place – some people (normally rich people) are better off than they otherwise would have been, and other people (normally poor people) are worse off than they otherwise would have been. It is not even a “zero sum game” as the economy as a whole is WORSE off than it otherwise would have been (without the monetary expansion).

    People who claim to care about extreme inequality yet who support a policy of monetary expansion (inflation – regardless of whether prices go up in the shops or not) are revoltingly dishonest, utterly vile.

    They are, for example, the primary reason that most of Latin America is as it is.

  • Howden is apparently describing a sequence that begins with fractional reserve banking and culminates with ostentatious luxury consumption and then inflation. I don’t know the statistics on Rolls-Royce automobile sales, who buys them and where they’re sold, but it’s evident that they’re not all sold to bankers and financiers in the UK. There’s probably a sheik or two with control over a beyt stuffed with petrodollars that’s using his Rolls to ferry his hunting falcons from one oasis to the next. Be that as it may, there are some intermediate steps between fractional reserve banking and overstuffed emirs. The hated symbolic Rolls is sold by a company composed of shareholders, management and employees. Sure the shareholders could move their investments to windmills that no one wants and the executives could seek employment with non-profits and the craftsmen that assemble the Rolls could stay home in front of the telly and swill beer. Would that make more sense?

    Actually, the L170,000 Rolls is startling insignificant next to a $35,000,000 fighter jet or a $6 billion aircraft carrier, but it must be just fine for the state to be able to finance stuff that makes a Rolls look disposable.

  • Paul Marks Paul Marks

    Good point chuck martel – I apologise if anything I wrote implied that I have something against people buying these cars, or against wealth generally.

  • Mr Ed

    Paul, whether or not these people are dishonest is interesting, some might simply be ignorant and unprincipled, or be (foolishly) content to let the ‘experts’ decide, and assume that this is how things are in the World into which they were born.

    There are those who know that they have to keep fiat money going to keep the banks going, the senior bankers and central bankers, and the economic cranks, and choose that it be so, but there are also those who cannot imagine cause and effect or are simply confused.

    For one, I do not associate Rolls-Royce cars with central bankers and bankers, new ones are rarely seen on the roads, older, classic ones are used for weddings, ceremonies etc. But certainly, in a competitive, level market, rising ahead of your competitors is very difficult, as constant innovation and speculation is needed, rather than connections to the Money Tree/Soup Dragon, or ‘blat’ as they used to say in Moscow (and probably still do).

  • Paul Marks Paul Marks

    Mr Ed – agreed.