Wednesday, October 12, 2016

Money: The zero sum game and the cycles of money distribution

Let us say, cash supply in a system in constant. Then if one person has to become richer, it will be at other people’s expense as it becomes a zero sum game. More money one person accumulates is the outflow from the rest.

But in the practical world, money supply increases every year. But inflation too catches up. Let us say money supply got increased from 100 units to 105. And also assume that inflation too went up by 5%. In such a scenario, 5 units of newly printed money helped to increase the monetary transactions but due to inflation, it’s buying power went down so there was no increase in value of money. In another words, 105 units of money has the same value of 100 units of money in the previous year. With this background, if one has to increase his or her wealth, still it would be at other’s expense. We can also say that whoever makes most of the newly created money will become richer. If one still has the same amount of money he had last year, he lost it to winner through inflation.

Now we need to explore how the money is earned. Broadly two classes are present. Majority of world’s population earns through labor, in the form of wages or salary. Other smaller segment put their capital to work. Profits or interest earned on that is their income or way to make money.

Now, it is time to introduce interest rates and wage growth rates. Every year new money is created. And if wage growth rate is more than interest rate, then the labor class gets more portion of that new money. If rates are higher than wage growth, then it is capitalists who will make more money than labor class. But that is not all, we cannot forget the impact of inflation, so we need to look at the real rates of growth.

Real Interest rate = Nominal Interest Rate – Inflation

Real Wage growth rate = Nominal wage growth rate - Inflation

These equations will decide if rich are becoming richer or the rich-poor gap is getting closed. Let us say interest rates are at 6% and inflation too is at 6% but wage growth rate is 7%, you know that capitalists could not increase their wealth in that year and the labor class made most of the newly created money. But it is not like that same all the time. Most of the times real interest rates are positive and will be higher than the real wage growth rates, that gives an advantage to capitalists. Their money works for them, throughout their lives. So you know how the system helps  rich to remain in top positions for decades unless they make some blunder mistakes losing out their wealth.

But the interesting point is, interest rates are common across market but the wage rates are not. There are many professionals (like in IT industry) whose pay checks showed higher growth than that of interest rates. They are able to reduce the gap with capitalists. Or they might become new capitalists if they learn the tricks of savings and investing. So we find many Merc’s and Audi’s on our roads and they do not belong to Tata or Birla families.

Coming to the common man, if his earning growth is better than inflation rate, he is getting ahead. If it is same, he is just catching up with the transformation. But those earning less are losing out to the winners of the race. If one wishes to get out of labor class, savings and re-investments are the keys. If one person earns a handsome salary but spends it all, he is no better than daily wage labor in the long run despite the high lifestyle he could afford in the earning years.

When you read an article of rich becoming richer, take a look at difference between interest rates and wage growth rates, you will know how the money got distributed for such an outcome. Though it is happening everyday in front of our eyes, we do not realize it and wonder what’s happening in this world. Well, nothing dramatic but very systematic.