The Smaug Fallacy

The wealthy aren’t hoarders — they’re stewards of capital

Among the most troubling rhetoric in the debate over income inequality in the United States is the notion that the rich “take in” or “control” wealth.

Recent arguments over the nature of capital suggest that all the wealthy want to do is to accumulate it — picture Scrooge McDuck hoarding huge chests full of gold, or Gollum fidgeting with his “Precious.” This view is based on the assumption that a wealthy man, having collected his gold, does nothing with it. So perhaps it is most fitting that I term this argument the Smaug Fallacy, after the dragon in The Hobbit who slept on stolen gold under the Lonely Mountain.

Here is an example plucked from a recent article in, bizarrely enough, Technology Review.

The gap between the wealthy and everyone else is largest in the United States. In 2010, the richest 1 percent of the population had 34 percent of the accumulated wealth; the top 0.1 percent had some 15 percent.

Then, following Thomas Piketty, the author concludes:

The implications of [wealth concentration] should be frightening for anyone who believes in a merit-based system. It means we are in danger of entering into an era that, like the 19th century in France and England, is socially and politically dominated by those with vast amounts of inherited wealth.

These types of arguments are fallacious for several reasons.

First, they rely on abstract aggregates and models that have no bearing in reality, which is precisely why it is easy enough to appeal to “19th century France and England” when access to capital today is more ready than at any time in history. More on this later.

Now, the wealthy actually spend a lot of their money. The top 10 percent of earners are responsible for 42 percent of consumption in the United States. And they do not spend on wildly expensive items (jewels for the pile), but on slightly more expensive versions of what the rest of us buy. For instance, the average wealthy woman pays $120 for a pair of shoes and $75 for a pair of jeans. While more expensive than the average offering from DSW or Wrangler, these figures aren’t massively out of the ballpark for what a more moderate earner might pay.

That the wealthy don’t pay that much more than the rest of us for consumer goods but are still responsible for much of the consumption suggests that they engage in a lot of consumer spending — that is, they buy what we buy, just more of it. That money then goes back into the economy, enriching the retailer, the retailer’s sales staff, the manufacturer, the manufacturer’s staff, the manufacturer’s suppliers, the supplier’s suppliers, and so on.

Such spending also buys down the stock of capital, transferring its benefits from the wealthy to everyone down the supply chain. Much like the hive of activity that goes into making a humble pencil, an invisible hand reallocates this capital to those who actually produce the goods and services on which the wealthy spend their money. Some of those who benefit will be wealthy themselves, of course, but then the process begins again, and again, and again.

Even those wealthy individuals who are frugal — even downright miserly in some cases — are benefiting the rest of us. There are no dungeons of gold. Instead, the frugal invest their capital in a number of ways. They can invest directly in a corporation via the stock market. Increasingly, they might invest in an individual project via peer-to-peer lending or crowdfunding. Or they can let others do the investment work for them and place their money in a bank. The bank then uses that money to make loans to businesses seeking to expand and individuals looking to establish their own capital in the form of a home.

Investment helps the less well-off. Without it, there would be little access to capital for anybody else, including the poor and middle class. Income inequality, such as it is, would indeed be permanent, just as it was in the Middle Ages (at least until one group of the powerful slaughtered another group of the powerful and reallocated their belongings; that’s how income “redistribution” has worked through most of history).

To paraphrase President Obama — in a way he wouldn’t expect — it is the genius of capitalism that it "spreads the wealth around.” As the sharing economy grows, the wealthy will have more opportunities to share their wealth to mutual benefit. Those of us with underused capital like a spare bedroom or a car that often sits idle can now share that capital with others through services like Airbnb or Lyft. Soon we’ll be able to massively increase the world’s computer storage capacity and make some money as well through distributed storage solutions like Storj, and so on.

Far from regressing to the Middle Ages, as leftist economists like Paul Krugman and Thomas Piketty claim, modern capitalism is not only making more people wealthier; it is on the verge of a vast explosion in its wealth-creating capacity — as long as regulators don’t get in the way.

As for Smaug, had he lent out some of his money, perhaps he wouldn’t have had that final encounter with Bard the Bowman.