The Lorenz Curve and Social Unrest

June 2, 2020

When I went to business school about 30 years ago, one thing we learned as matriculating accounting students was something called the Lorenz Curve. In economics, the Lorenz curve is a graphical representation of the distribution of income or of wealth. It was developed by Max O. Lorenz in 1905 for representing inequality of the wealth distribution .

Having captured my interest all those years ago, the concept continues to stick in my mind many years later. It goes something like this. When a capitalistic society is formed there are equal amounts of poor people, middle class, and wealthy people, so that if plotted on a graph there is no curve but rather a straight line on an angle from the bottom to the top.

As time goes on, the wealthy people are smart enough to take the assets away from the poor people and the curve begins to bend. In other words, there are more poor people and more wealthy people as the middle class drops away.

What was interesting about this lesson that I never forgot was that the solution to income gap problem resolves itself by the lower class revolting against the upper class. Mind you this was 30 years ago, when I learned this, but it seems all too fresh right now, as I sit in my chair eating popcorn watching live riots on TV.

What are these people really rioting about? I believe they feel that they are being treated unfairly and they don't know what to do about it.

I am not a fan of Tucker Carlson, but he did reveal the problem accurately in this latest quote. “The ideologues will tell you,” he noted, “that the problem is race relations, or capitalism, or police brutality, or global warming. But only on the surface. The real cause is deeper than that and it’s far darker. What you’re watching is the ancient battle between those who have a stake in society, and would like to preserve it, and those who don’t, and seek to destroy it.” What Carlson chooses to ignore is how we got here.

Let's go back a little and see how this income gap occurs. The Federal Reserve is in charge of the lending rates and whoever controls the current administration is in charge of taxation. When interest rates are near zero and the income tax rate is low it benefits the asset holders. Asset prices rise because the dollar is weak. Weakening the dollar is a burden on those who only earn dollars and have no assets. It is actually Socialism for the Rich. Poor people have to spend every last dollar they earn to survive while wealthier people are compensated for the weak dollar through the value of their stock portfolio rising, the equity in their home and other assets rising as well.

This very scenario is what is happening right now. The Lorenz Curve is bending and the poor people cannot live this way any longer. Taxation of the rich is a form a socialism to redistribute the income and create social programs to lift up the lower class. However, when taxes are low none of the social rebalancing happens, the lower and middle classes sink lower down the economic scale, as the wealthy increase their net worth by leaps and bounds.

Low interest rates or essentially free money for corporations have strong implications. Corporations can borrow money by issuing bonds at low interest rates and then use that money to buy back their own stock. This raises their stock price without having to raise their income. Low interest rates also force savers to put their money in the stock market and punish those who need to keep it in the bank like older people who cannot afford risk.

Having learned this simple economics lesson 30 years ago, I would assume the nation's leading economists know exactly what they are doing today. This is by design. Make wealthy people wealthier AT THE EXPENSE of poor people. Donald Trump has exacerbated this problem more than any other president. He strong armed the Federal Reserve to lower interest rates to historic lows, while the economy was supposedly the best ever AND he lowered the tax rate. This was a double win for the wealthy and a double whammy for the poor. Trump bent the Lorenz curve all by himself.

This all works very well in the short term to stimulate the economy and dramatically shift the wealth from the lower and middle class to the top ten percentile. In the long run however, the whole system cracks. That is because corporate executives and entrepreneurs who run successful businesses need to sell their products to somebody, and if the consumer doesn't have any money to spend businesses fail.

The income gap is the widest it has ever been in 54 years! What happened to the greatest economy in history that Trump touts? It is all a lie. It is an artificial stock market rise by devaluing the dollar.

Ray Dalio from Bridgewater Associates has been touring the world doing interviews to discuss this very problem. The poor of this country are feeling more and more disenfranchised from the American dream. It is not that we have to give them money, but rather we must figure out a way to give them opportunity. With opportunity comes hope and with hope comes hard work toward a vision for a better future. Without it comes physical uprising and violence.

Violence is in every headline. There are helicopters flying overhead tracking violent unrest through the streets in my neighborhood, but the stock market continues to rise yet another day. Do you think these looters would be unhappy if their portfolios were rising? Not only do they not have a portfolio of stocks or own a house or a vacation home, they have no idea on how to get these things. They feel left behind and they are letting us know about it. The Lorenz curve needs to be straightened and it is up to the government to give guidelines and policy on how to achieve this goal to bring peace back to society.


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