“Debt in the 21st Century”

13 November 2014

The book “Capital in the 21st Century” by the French economist Thomas Piketty has attracted worldwide attention during the last months. In his book, Piketty analyses historical data on income and wealth distribution in over 20 countries and concludes that inequality between rich and poor has increased since the 1980s and will continue to grow in the future. Daniel Stelter, strategy consultant and author, summarized and analyzed Piketty’s theses in his book “Debt in the 21st Century.” In his opinion, it is the high private and public debt rather than the unequal distribution of wealth that causes problems. On 11 November, Stelter presented his book at the CFS Lecture Series on the Order of Money.

Stelter started out by explaining the data collected by Piketty and the author’s conclusions. Piketty’s data gives information about how much wealth an economy had at a specific point in time and how this wealth was distributed, Stelter said. The data showed that wealth had grown faster compared to income since the 1980s in all countries under examination. Stelter agrees with this conclusion, even if several people criticized that some of the analyzed data points were incorrect. However, according to Stelter, this would not change the overall picture.

Piketty derives a formula from these results which is supposed to explain why inequality is increasing: r>g. “r” is the rate of return on capital and “g” is the rate of economic growth or the increase in incomes. If the rate of return grows faster than earnings, inequality will rise and the concentration of wealth will increase.

But is this assumption realistic? Piketty assumes that the annual rate of return on capital is between 4-5% and that the world economy is annually growing by 1.2%. On the one hand, Stelter considered such a low economic growth rate to be realistic because innovation that has a positive impact on productivity would be decreasing in the future. Besides, the pressure on wages would increase through more international competition and prices of resources would grow when they become scarce. On the other hand, the assumption that the rate of return on capital is between 4-5% was unrealistic, Stelter said. A lower rate of return was more likely.

Furthermore, Stelter criticized that Piketty regarded debt as neutral in his analysis. Public and private debts had been increasing parallel to wealth, Stelter explained, and contributed to economic growth. The increase in wealth above economic growth was only possible because of high debts. In contrast to Piketty, Stelter does not believe that this process will continue over the next years. In his opinion, the extremely high debt rates would sooner or later result in a haircut or inflation.

Also, Piketty did not take into account that, in fact, public debt was even higher for many countries if one also considered the pension promises that have been made but for which no reserves have been created. Given the actual public debt, income and wealth ratios would be much lower, Stelter said. These liabilities could cause serious problems for many countries with an aging population and could even result in state insolvencies in the long run, he warned.

While Piketty wants to reduce growing inequality through greater distribution of wealth, Stelter regards a reduction of private and public debt as important as well as lowering the uncovered liabilities as key. Besides, in his view, more should be invested in education and innovation, and immigration policy should counteract the upcoming labor shortages. The monetary system also contributed to the growing debt by allowing banks to create money. A new monetary system, where private money creation was not possible to this extend, would be desirable, Stelter said.