Observations on Wealth Inequality

[Steve81]

I wrote this little tidbit up for a side project... Enjoy. Any feedback / comments welcome. My related background: 15 years of accounting drudgery preparing monthly financial statements for the CEO, and studying Business Administration (and thus economics) at CSU East Bay.

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As most people are probably aware, wealth inequality is a big problem around the globe. On the one hand, we have centi-billionaires who can fly off to space at a whim; on the other, we have masses of financially disadvantaged people with few opportunities to improve their living conditions, who can barely afford to put food on the table. The reason for this disparity is simple: a company like Amazon has a market capitalization (i.e. market value) of nearly 1.4 trillion dollars, and Jeff Bezos owns 12.3% of the company. This makes Jeff Bezos, at least on paper, worth well over 100 billion dollars. In this article, I aim to explore the how this came to be.

First, we need a primer on how a stock market functions. When a company makes the decision to transition from a privately owned entity to a publicly owned one, they have an IPO, or Initial Public Offering. This process allows the company’s owners to issue shares of the company in order to raise capital for paying off loans associated with company startup, expand the business, and other assorted uses. An IPO requires a great deal of due diligence in order to accurately price the offered shares, and a company must follow SEC rules regarding registration and future public financial reporting requirements.

Once these shares are sold, they are in public hands, and can be traded accordingly on the stock market. Obviously, potential stock buyers would be wise to do due diligence of their own; this is how Warren Buffet became the Oracle of Omaha; he doesn’t have a crystal ball, he just does extensive research before purchasing stock in a company. Continuing to use Amazon as an example, let's look at few of its key metrics.

1. Market Capitalization : $1.367 Trillion. As noted above, this is the market valuation of Amazon, as determined by the number of shares multiplied by the (variable) market rate per share.

2. Shareholders Equity: $146.04 Billion for Year End 2022. This is the company’s assets less its liabilities. In other words, if Jeff Bezos decided to liquidate Amazon at the end of 2022, this is the amount that would be split among shareholders.

3. Net Income Over Time: Maximum of $33.364 Billion in 2021. Minimum a loss of 2.722 Billion in 2022. Net income is revenue less direct (cost of goods/services sold) and indirect expenses / overhead (everything else it takes to actually run the company). In other words, net income = profit that can be reinvested into the company, or distributed to shareholders as dividends.

A quick observation: market capitalization is nearly ten times the shareholder's equity. While it's not abnormal for a company to have a market value higher than its shareholder's equity, the profitability (actual or expected) has to match. Suppose you are looking at a house to purchase, and it is appraised for $146,040. The seller's asking price is $1,367,000, and tells you it comes with a tenant. After maintenance and other expenses, the current owner notes he made as much as $33,364 in one year, though he admits he lost money the very next year. Would you buy this house?

Now, as it relates to 401k's: these instruments are tax-sheltered investment accounts that people can use to save for retirement. Taxes are only applicable after withdrawal, allowing compound interest to work its magic. In and of itself, that’s not a horrible thing. Today, the system is almost entirely automated, making it easy for anyone to save for their retirement. Sure, most people may not know an actively managed fund from an index fund, but we seem to get decent returns over time.

So what's the issue here? The problem appears to be this: conventional wisdom states that to achieve an adequate rate of return to beat inflation, you need a high percentage of stocks in your portfolio. This drives tens of millions of people to invest the bulk of their retirement savings into the stock market. There are only so many outstanding shares to go around, so stock prices will naturally go up over time, creating a bubble and likely increasing the magnitude and effects of market volatility. We're also making people like Jeff Bezos, Elon Musk, Bill Gates, et al. ludicrously wealthy at the same time, as an added bonus.

To fix this mess, we need new retirement strategies that don’t attempt to use the stock market as an oversized piggy bank. We also don’t want to rock the boat so much that the system crashes like a buggy app on your phone. One potential solution would involve the Federal Reserve gradually tightening monetary policy to encourage investments in bonds; if relatively less volatile bonds provide adequate returns, there is less need to invest in stocks in the first place. Combined with shoring up Social Security via elimination of the taxable maximum amount (currently $160,200), we can better ensure a comfortable retirement.

If we want to fight wealth inequality, and at the same time reduce our risk of having to subsist on cat food when we’re elderly, the system needs to change. While I bear no ill will towards the wealthiest members of our society, they shouldn’t be enriched as an unintended consequence of people merely trying to save for their golden years.