What if We Were All Rich? My ten year old grandson Stephen, who has a Mensa quality mind is in process of putting my writings of a lifetime -- some two hundred papers -- on the Internet. He recently e-mailed me saying, "Grandpa, you're an Economist. What would happen if we were all rich?" I answered him in the form of a couple of lectures, the way my mind is programmed to work. In the first lecture, I told him how, by reason of the bell-shaped curve of distribution of skills -- brains, looks, athletic ability, musical talent, and above all entrepreneurial talent (see related paper Social Priorities, Economic Efficiency, and an Unexamined Premise of Alfred Marshall ), this would never happen. That fortunately, individual gifts didn't necessarily run together, so most of us can make our way through life as a skilled worker, professional man (or woman), actor or actress, model, or professional athlete, etc. And that if all the world's wealth were equally distributed tomorrow, within six or eight years we'd once more have rich people and poor people because of differences in talent and providence. I invited him to look at Russia, where only seven years after the breakdown of communism we again have millionaires and beggars. On the other hand, a regrettable eight or ten per cent of the population seems to have been left out when the good stuff was being distributed (see related paper The Concept of Sump Industries ), possessing neither looks, brains, or special talents or skills. These people constitute the underclass -- the perennially unemployed. As a great philosopher once said, "The poor ye have with ye always" -- and special provision must be made for them. But there's more to the story. I ended my first lecture by saying that "Rich" is a relative term. We're all rich compared to the people of just a generation ago. And rich people, or even people who feel rich, behave differently than poor people. In this regard, perception alters reality. Economics starts out by assuming a balance between supply and demand (there are things which can change this assumption and bring about a departure from such equilibrium as we'll discuss below). But under what we call "classical (that is to say 'typical') conditions", if demand is too high, ceteris paribus this results in inflation and the price of goods rises to ration them and restore equilibrium. But if labor unions are so strong that they can just demand higher wages when this price rationing occurs, then the rise of prices just accelerates and may result in runaway inflation, destroying the value of money and leading to a breakdown in the entire economy -- as happened in Germany following WW I (and as has happened more recently in Chile and Brazil). Then a society must start over with a new kind of money and all prior savings wiped out. While this is happening, the allocation of economic resources is disastrously distorted, leaving an economy in shambles. This can also happen under a "command economy" when government intervened in the Soviet Union, leaving the society deprived of its scarcest factor of production, entrepreneurship. Sometimes the breakdown can be stopped (if action is taken in time) by introducing a new kind of money and trading it for the old at a rate of, say, ten old for one new. This is good because it sometimes avoids people losing the value of all their savings. DeGaulle did this in France in 1962. Pinochet did this in Chile in the 1970s. Mr. Yeltsin is trying to return the Russian economy to an operational state by reintroducing market discipline after seventy years. If there is an excess of supply (too many factories producing too many unwanted goods or too many office blocks awaiting occupancy by too few tenants), as can happen when there's been speculatively excessive building of houses or factories, two things can happen. Under classical conditions, 1) competition will lead to a fall in the price of goods. This is known as deflation. Or when severe lags have been introduced into the adjustment process, there can 2) be a long interval without any new building (and massive unemployment until we get more children and a larger population, as happened in the nineteen thirties). This is called a "depression". The classicists didn't think this could happen, but it did in 1929 --because strong trade unions wouldn't accept lower wages for their workers, leading to the so-called Great Depression, which lasted almost ten years until the outbreak of WW II. John Maynard Keynes, an English economist, showed us that government can step in when a major recession, or depression, occurs, and by carefully calculated deficit spending (i.e. spending money the government doesn't have, through just printing more and more, or borrowing -- as from the Social Security fund or elsewhere) on government projects like new highways, bridges, dams, ports, or social welfare programs e.g. unemployment payments or Aid to Dependent Children grants, equilibrium can be restored, avoiding or reducing unemployment. Keynes took for granted that when prosperity returned governments would pay off the debt incurred. What he didn't see was that politicians greedy to remain in power would continue to spend even in times of prosperity to assure their reelection (assuring people jobs and building high cost projects in a constituency has the same effect as the now old-fashioned practice of buying votes). As a result we've accumulated a staggering national debt. Indeed, we've only had two balanced budgets in the last sixty years. It's estimated that if we continue spending at the present rate, within twenty-five years every cent of tax revenue will be required just to pay the interest on the national debt, leaving nothing at all for Defense or any of the other expenses of government. As we've said, rich people behave differently than the rest of us. They can only spend so much on food, cars, and houses, and while they can start buying bigger and more expensive houses and cars and eating in fancier restaurants, there is a limit to even this. So the rich save more of their income than common folk. If we all feel rich, and behave as if we were rich, too many people save too much of their income. Or if people lose confidence in the operation of an economy, anticipating a major downturn, they will spend less, cutting demand and leading to a disequilibrium between consumption and output, resulting in unemployment. This is part of the so-called wealth effect , when people feel richer (or more threatened) than in fact they are. There's more: much of the income of even common workers today is in the form of their employers' contribution to health and retirement plans. On top of this, union workers also contribute a lot to union "strike funds". This money is saved and must be invested. And the only place which can accommodate such vast quantities of money is Wall Street. This constant (and growing) inflow not only props up the stock market, such that we've had no major corrections since the great fall of 1929, it can lead to stratospheric increases in stock prices beyond any reasonable valuation of factories or hotels or other investment properties. This can undermine confidence in the market, resulting in the kind of roller coaster we've been experiencing in recent weeks. This is another of the highly dangerous thing that can (and does) happen when people perceive themselves to be rich (even though when put on a scale ranking low income people to the truly rich) they aren't. It's said that in Texas, there are three scales for rich . Those with only four or five million are called "poor millionaires". Those with up to fifty million are called the "middle class rich". Only those with a hundred million or more are considered truly "rich". This is due to the money illusion", by which older folks tend to think in terms of what money was worth when they were young, first learning the value of food, clothes, cars, and houses. I know this is a very true phenomenon because, while a professional economist trained in these matters, I'm still shocked to have to pay $20,000 for a car (what a house cost when I was first married), and $250,000 for a modest house (a sum which would have generated enough interest income when I was Stephen's age to live on, making a family independently wealthy). I've suggested in one of my papers (see letter February 1995 letter to Bill Archer of the Senate Banking Committee and paper called Some Ideas for Consideration by Congress with Respect of Tax and Monetary Reform, that the time has come to redenominate the US dollar by cutting a zero off the end of each note -- so one new dollar would be worth ten current dollars, and ten new dollars would be worth a hundred of today's devalued dollars. This would rip the veil off "money illusion" since the dollar is actually worth in purchasing power just about ten per cent of what it was before WW II. I was Deputy Economic Advisor to the US Mission to the OECD in Paris when DeGaulle did just this in France over thirty years ago -- and the franc still has almost the same value today. I think it's too bad the government didn't do this when it started introducing the newly designed US$100 and $50 bills a year ago.