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What is Wealth, part II

Yesterday's NYT had an article about wealth that fell into several of the usual traps of this discussion. To his credit, David Leonhardt looked at a few aspects of the question. He did not manage to avoid two of the major traps when it comes to this discussion -- the two sided nature of any temporal argument, and relative aspect of wealth as a concept.

Long time readers will recall we looked at the question What is wealth? back in 2004.

The Times uses Snow Blowers as an example, but any modern device or service would suffice:

"Yet the benefits of the snow blower, namely more free time and less health risk, are largely missing from the government’s attempts to determine Americans’ economic well-being. The same goes for dozens of other inventions, be they air-conditioners, cellphones or medical devices. The reasons are a little technical — they involve the measurement of inflation — but they’re important to understand, because the implications are so large."

As we noted last time out, all temporal arguments are two-sided. The lowest economic strata -- with their indoor plumbing and their color TVs -- are "wealthier" today than long dead royalty of long ago. Thanks to Human ingenuity and the relentless progress of technology, the wealthy amongst us are inevitably poorer than people from the lower economic rungs 100 years from now.

Sure, we may have Snowblowers, but we don't go to Mars for vacations, or have nano-tech cholesterol bots keep our arteries clean, or the ability to carry the entire library of congress, every film, book or musical recording ever made in a device the size of a quarter. Hey, we don't even have robotic servants to operate those snowblowers! Why, we are practically impoverished compred with people born merely 100 years from now.

Of course, that's just as absurd an argument. Nobody today thinks to themselves: "Huzzah! I am wealthier than King Henry!", nor do they lament "Alas! I have less wealth than the poorest schlump to be born in the year 2200. . . woe is me.".

It is the nature of mankind is to relentlessly raise his standard of living, generation after generation. This has been especially true throughout history, with progress accellerating at an ever quickening pace. The overall trend has been upwards for a long, long time, and there's no reason to think this will end anytime soon. This is a given of the human condition. Claiming this as proof of wealth merely reveals a fundamental lack of understanding as to the very nature of human existence.

Other than that minor shortcoming . . .

~~~

Regardless of the 2 sided nature of the historical/future argument, many observers have a fundamental misunderstanding about the conception of financial well being: Wealth is a relative concept.

Some people define wealth as having $100 more than what their brother-in-law has. We try to "keep up with the Jones" because they are our contemporaneous, geographical peers. We Americans neither try to keep up with the Sultan of Brunei nor with a Chinese factory worker. 

We instead compare ourselves vis a vis local contemporaries.

This is why the price of Real Estate in Manhattan or La Jolla, CA. does not impact the price of Real Estate in Chicago or Nebraska. Its why Larry Ellison and Steve Jobs compare themselves with Bill Gates and the Google boys.

~~~

Tainting the overall discussion is the old economic saw, courtesy of the Boskin Commission, that claims the government's measure of inflation overstates the case. This is one economic's greatest absurdity, about on par with cold fusion and OJ's trial. (The chart below pursues this absurd line of thought).
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click for larger graphic

Graphic courtesy of the NYT

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In the past, we have beaten the inflation issue to death. If you believe the CPI -- the core CPI, seasonally adjusted, hedonically altered, substituting chop meat for steak and removing energy and food -- accurately reflects the cost of living, well, then you simply have not been paying attention. We are not the first to mention this;  John Williams created the Shadow Government Statistics to track actual inflation and GDP (See also this discussion by Martin Weiss);

~~~

Let's all agree on two things: First, Human progress is inevitable, with each generation benefitting from improvements in medical care, technology, etc.; Second, there is a systemic bias built into the government reporting machinary that understates the declining purchasing power of the US dollar.

The more the Fed prints, the less its worth -- that's basic law of supply and demand at work. That's something I would hope "one of the country’s leading macroeconomists" would understand.

Apparently not . . .

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Sources:
Life Is Better; It Isn’t Better. Which Is It?
DAVID LEONHARDT
Economix
NYT, September 20, 2006
http://www.nytimes.com/2006/09/20/business/20leonhardt.html

What is wealth?
Saturday, May 22, 2004
http://bigpicture.typepad.com/comments/2004/05/what_is_wealth.html

The Boskin Commission Report and its Aftermath
Robert J. Gordon
Northwestern University and NBER, September 1, 1999
http://faculty-web.at.northwestern.edu/economics/gordon/346.html

Thursday, September 21, 2006 | 06:47 AM | Permalink | Comments (41) | TrackBack (1)
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Comments

futures this AM at 11725 ... hope you have all been long since 10700 ..... no for anyone to be negative just yet ! this is crazy.

Posted by: christopherrobin | Sep 21, 2006 8:03:20 AM

If the CPI shows no change in earnings, then the hedonic adjustments are correct for what they are supposed to be doing. They are supposed to remove improvements to quality of life from the inflation measure. Assuming the middle class is roughly a constant percentage of the population, the best measure of inflation after removing quality of life changes is median wages. The cost of a middle-class lifestyle will be the same as the earnings of middle-class workers for the most part. Periods of growing and shrinking debt are the only exceptions. So I guess that if median real wages are constant with debt growing, inflation is being overstated.

An irrelevant technical point: people will not be taking many vacations on Mars until we have fusion working. The energy required to get there means that without fusion, it is a 6-9 month trip in each direction. Which means it isn't worth going for less than about 2-3 years of time away from Earth. That's a once in a lifetime trip, sort of like sailing around the world.

Posted by: jkw | Sep 21, 2006 8:50:06 AM

“The more the Fed prints, the less its worth -- that's basic law of supply and demand at work.”

The basic problem here is, you’re only looking at one side of the supply-demand balance. The Fed prints more money: that’s one side. The economy becomes more productive: that’s the other side. Which side wins? That’s an empirical question.

(Just to make this point clear, though: if the Fed didn’t print any more money, we would definitely have deflation, because you would have the same amount of money chasing more and more goods.)

Posted by: knzn | Sep 21, 2006 8:51:11 AM

No question that the inflation as measured by the CPI is understated. Beside the theory there is anecdotal evidence everywhere. But for some people believing mainstream media this new measurement might seem to be accurate or at least prevent them from connecting the dots that everything gets more expensive but there is no inflation. Tn my view that is between propaganda and disinformation.

Posted by: Gunther | Sep 21, 2006 9:10:40 AM

So if the market creates new needs, such as iPods, cellphones, more luxurious automobiles etc. and I dont have enough additional income to buy all these newly created "needs" its because of inflation? This actually sounds alot like the reason for inflation that JK Galbraith attrributes in his book "the affluent society".

Sounds more like we have an issue of creation not inflation. Hedonic measures make sense to me.

Posted by: cygnus | Sep 21, 2006 9:34:24 AM

Great post - reducing 'visible' inequality matters. How much stock, money, bonds, gold they have doesn't... it's how they flaunt it that does.

And surprisingly it should matter most to the wealthy who will lose their heads if the poor really get pissed. Its the way those things have always ended once irreversibly out of balance. Louis XIV, Romanov's, Hapsburgs, Gulags, Killing Fields, Bastille... it just happens over and over through out history.

I think we are a looooong way from anything close to that... and as long as everyone who wants a plasma can have a plasma we aren't likely to be marching folks from the country clubs to the guillotines anytime soon.

But I've said a thousand times on blogs like this... "good safety nets are the best insurance the wealthy keep their heads"... tell Kudlow that sometime when he's railing against social programs on his show, my guess he drops his gap.

Nice post, especially about the $100 & the brother in law - that just about sums it up.

Posted by: dryfly | Sep 21, 2006 9:37:35 AM

I hate to get technical on you but in 1999 in the report you cited Gorden said:By now the Commission's
conclusion that the U. S. Consumer Price Index (CPI) overstated inflation by 1.1 percent per year in
1995-96 has become familiar both within the United States and in the measurement community of
other countries. Since the report was issued, the Bureau of Labor Statistics (BLS) has moved rapidly
to implement some of the most important of the Commission's recommendations, so that the upward
bias in the CPI is substantially less today than in 1996.

Moreover, Census does not use the regular cpi to deflate the nominal income data. Rather it uses the cpi-rs that reconstructs the cpi history so it incorporates the Commission recommendations that in 1999 Gorden claimed made the bias substantially less.
As a matter of fact the cpi-rs show that infltion has been about 0.5 percentage points lower then the
regular cpi.

But in the article Gorden says the cpi still over states the cpi by the same ammount that it did before the Boskin recommendations were implemented.

So if you actually work out the numbers in the article it say just the opposite and shows that inflation overstated by rougly 1.5 percentage points annually.

Which is right, Gorden in 1999 or Gorden now?

Posted by: spencer | Sep 21, 2006 9:50:19 AM

"…the wealthy amongst us are inevitably poorer than people from the lower economic rungs 100 years from now." Inevitable? As Inego Montoya would say "I don't think that word means what you think it means." There is a reasonable chance that human ingenuity will not be enough to assure material advancement, that human fecklessness and greed will undo us, that our ingenuity to date will have unintended consequences of an unfortunate sort. You do not know, and cannot know, that our descendants will be better off than we are. You have made a statement based on faith. At the end, you insist that we should agree on this point. This is a politician's trick. There were long periods in human history in which material progress was the exception. There have been notable periods and locations when the human race has lost ground. You pull the same trick with inflation. It is your view, apparently strongly held, that official inflation stats understate inflation. There is another school of thought which holds that inflation stats overstate inflation. You just go ahead and say we ought to agree with you. Why ever should we?

There is also a serious definitional problem whenever we talk about wealth. We can define wealth in various ways, but defining it to be synonymous with well-being impoverishes the language. To assert that being generally better off means we are "wealthier" is sloppy speech. If my knees stop hurting because I figure out that I should clean the kitchen floor standing up rather than kneeling down, I have improved my well-being through the acquisition of knowledge, but I am not wealthier. It is purely a definitional question whether I am wealthier because I have access to books to which my grandparents did not have access, though I am surely better off for it.

The argument you are making asserts that wealth is a psychological construct. To be wealthy, we need to feel wealthy relative to somebody else. It is a useful point of view, but when we delve into relativism, we should also keep our ears cocked for irony. You offer your view as an absolute, but it is not absolute. The "given" is that facet of human thought which leads us to compare our situation to that of others. It is not a given that we must treat wealth in a way that relies on that facet of thought. We can define wealth as net assets. We can inflation adjust it. We can insist that wealth be defined as readily exchanged in the market place – clean arteries and a back that doesn't ache cannot be readily exchanged.

Argument by stealthy definition of terms is widely practiced, but doesn't get us very far.

Posted by: kharris | Sep 21, 2006 9:53:54 AM

just curious: what is the rough representation in percentage points of taxes that we pay in the cpi?

for example, in texas we pay school taxes and property taxes based on the value of our homes. in my case the tax i pay on my home has appreciated by 50 percent in the past 9 year.

does somebody have any information on this?

Posted by: Bill | Sep 21, 2006 10:15:34 AM

Nice post kharris. I particularly agree with your cautionary words about our success as a species undoing the earth on which we live. Past performance is no guarantee of "progress" and even then it depends upon what past performances you care to examine.

Posted by: lurker | Sep 21, 2006 10:23:35 AM

Amaranth revised its loss to 65%. The bizarre thing is they want to stay in business. Bizarre because the high water mark virtually assures they'll never qualify for a performance fee. Assuming some investors are willing to remain invested (which is probably a stretch), why wouldn't Amaranth close the current fund and relaunch to eliminate the high water mark?

Is it a case of attempting to regain trust/honor/reputation at the expense of greed? If so, they should be thrown off Wall Street forever. Their Master of the Universe union card must be revoked immediately. They have clearly lost their way. Greed must be the first priority.

On a related note, anyone know how T. Boone Pickens is doing?

Posted by: S | Sep 21, 2006 10:41:33 AM

I feel wealthy specifically because I have more then Henry the V. I force myself to view life this way. And with good results too.

Posted by: hassie | Sep 21, 2006 10:43:42 AM

To add a little to knzn's and spencer's points: not only should we be suspicious of someone who sings the same song no matter what the orchestra is playing, but we also should be extra suspicious if that person does not draw the obvious conclusions. If CPI is overstated, then yes, median earnings are not doing as poorly as we think.

Substantially more importantly, however, neither is productivity.

Whenever I read a column about an overstated CPI that does not use the word "productivity" I simply ignore it. Its author does not deserve my attention, and to engage it on its terms would be to subtract knowledge from my mind.

Feh.

Posted by: wcw | Sep 21, 2006 10:47:36 AM

So, if wealth is all relative, then it seems to me we should be deriving the inflation rate plain and simple from the change in median income, (i.e. median real income stays constant).

Wouldn't this be more accurate and tamper-proof than applying subjective hedonics as well as the ever changing "basket of goods" approach to estimating CPI?

Posted by: ticktock | Sep 21, 2006 11:08:15 AM

ticktock,

If you think that wealth is an appropriate benchmark for inflation, then go right ahead. However, since standard thinking about inflation has to do with prices of goods and services in this period relative to some prior period, you are going to have to do a lot of convincing to switch to a wealth-based definition.

Posted by: kharris | Sep 21, 2006 11:12:57 AM

That doesn't answer my question.

Posted by: ticktock | Sep 21, 2006 11:23:45 AM

The biggest problem with these sorts of smug claims that today's two-job holding single-mother is better off than King Henry is that they're ridiculous on their face.

Many of the inventions which didn't exist back then substitute capital for labor or other forms of capital. If you were rich enough to be able to afford the labor, you still had it pretty good.

For instance, ask me if I'd rather pay my air conditioning bill, or be able to afford a summer home somewhere where I don't need air conditioning. Ask me if I'd rather have a washing machine, or be able to afford to pay a couple of servants to wash my clothes by hand. Etc.

Posted by: M1EK | Sep 21, 2006 12:04:41 PM

Nearly 10% of all African American men ages 25 to 29 are in prison. The U.S has one of the highest incarceration rates in the world. Over 2 million people are currently behind bars in the U.S..

Have you seen the state of public schools in Baltimore, D.C., Cleveland, Philadelphia, New York or even inner-city Lincoln, Nebraska?

The U.S. infant mortality rate ranks down there with Croatia and Cuba.

Each month Americans roll an average of $10,000 in credit card debt at 17% interest.

The U.S. National Debt is over $8 trillion dollars.

40 million Americans have no health insurance whatsoever.

2,691 U.S. Dead in Iraq
20,000 U.S. Wounded in Iraq

George Bush is advocating changes to the Geneva Convention Article on torture.

Posted by: Insights | Sep 21, 2006 12:27:57 PM

Lack of Insight:

3000 US dead at WTC
19 US dead and 200 injured at Khobar towers in SA
17 US dead on USS Cole

We're fighting back.

If there's a better place to live than the US, name it.

btw: if socialism has all the answers then why doesn't Cuber have a low infant mortality rate?

Posted by: Bill | Sep 21, 2006 12:39:14 PM

The fact that Invidious Comparison is ignored in modern economics, while 'Free Market Capitalism' is invoked as a banner of political movements, and apparently actually believed in by vast numbers of people who think of themselves as intelligent tells you all you really need to know about 1) the relationship between truth and popularity, 2) the real causes of the problems in america today.

The fact that what I just said will strike many (most?) as obscure, only proves the point. I wonder how many people even know why mentioning Thorstein Veblen in any way relates to the original post.

Posted by: VoiceFromTheWilderness | Sep 21, 2006 12:40:28 PM

3000 US dead at WTC

What's that go to do with Iraq?

Posted by: Brian | Sep 21, 2006 12:52:26 PM

The problem I have with all these improvement arguments is they are all myopic and one sided. Where is the loss of buffalo roaming the plains? What is the price of polar bears only existing in the zoo?

Posted by: Lord | Sep 21, 2006 12:55:09 PM

100 years ago food, the most basic of staples, cost 43% of the average income; today it is 10%. Think of the pressure on a family in 1906 just to eat. Today, our poorest people are fat. Slice and dice with snowblowers, food in a nutshell is the sign of wealth generation.

Posted by: Norman | Sep 21, 2006 1:17:10 PM

Lemme see if I understand your argument. The Fed's statistics are no good. We know that the CPI is not keeping up with the cost of living. But wealth is a relative concept anyway.

So which is it? Either we try to include externalities in our measures of inflation and wealth (these include factors like avoiding the risk of being shot in one's neighborhood as well as keeping up with the Joneses), we don't, or we develop a full-bore ontology of wealth which we try to quantify: happiness surveys, longevity and health, free time, etc.

At the risk of being presumptuous, I get the impression your inner philosopher is trying to break free of your economist shell. Until you do, you'll continue arguing apples against the oranges of the mundane technical chore of managing the financial markets' expectations.

Posted by: John F. | Sep 21, 2006 1:35:31 PM

The best measure of wealth is the basic liquidity ratio.

Posted by: douglas | Sep 21, 2006 1:43:53 PM

December 2008

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