Wednesday, November 9, 2011

The 99%ers: Part 4


Pick your poison. What wealth is seems obvious. However, when one tries to rigorously define it so that it can be measured, things get complicated. Different definitions yield different wealth distributions.

For those who believe the market is always right, mark-to-market seems like a reasonable approach. That presents some problems for those who don’t believe in the efficient market theory. Since markets are very volatile, it also leads to a volatile definition of wealth and who the wealthy are.

For those who only focus on what one could consume over a short time horizon, mark-to-cash seems like a reasonable approach. That presents problems for those who recognize a difference between liquidity and wealth (i.e., net worth). It also presents an element of uncertainty. There are multiple ways to measure liquidity, and they’re all designed to address the fact that at any given moment, liquidity isn’t knowable. It’s only knowable after the fact (i.e., after the transaction is complete).

One might argue that having the right to an income stream is wealth. On the other hand, one might argue an income stream isn’t wealth; it’s an income stream. Then, however, one is left with the awkward question of what is wealth if it is not the ability to consume over time. Being able to consume over time is exactly what an income stream is. It’s also what wealth is. So, from an individual’s perspective, having an income stream seems like a worthy candidate for wealth.

To some people, the only thing that counts is being able to convert it to consumption immediately. To others, it’s the ability to convert it to consumption within in a year or a given tax year. To those who are very security oriented, it’s the ability to ensure that they have the ability to consume over the rest of their life, or theirs and their spouses’ lives. To others, it’s a multi-generational time frame that matters. The most interesting form is the endowment of a charitable fund where the endowment is intended to finance the charity’s consumption of resources indefinitely. Personally, I put a high premium on optionality (i.e., the flexibility to manage the consumption stream), but I fully recognize that the selection of an accounting period is arbitrary.

So, it seems more legitimate to define wealth as control of an income stream than to base the definition on a specific form of the income stream. In the next posting, the issue of comparing income streams with different time patterns is addressed by reducing them to annuity values.

People who want the option to consume it all immediately may object that it overvalues the income stream. Given their time preference for immediate gratification, that’s true for them (although, conceptually, they could swap their benefits for an immediate settlement). Similarly, people who know how difficult it is to build a reliable income stream may also object for the opposite reason (although they could purchase an annuity). Again, however, that just reflects their preference for a particular form of income stream.

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