Friday, May 25, 2012

Intergenerational Wealth

Vanderbilt Summer Cottage Newport, RI
Intergenerational Wealth 

By James Rickards

"While America claims to be a class-free society, the opposite often seems to be the case. Americans are obsessed with social status in all its forms whether based on celebrity, artistic or athletic accomplishment, or just plain money. Although royalty is not legal in America, our economic royalty including Bill Gates and Warren Buffett are as highly regarded as any English duke or earl.

When it comes to status, we don't look just at the size of one's bank account, we make distinctions based on the nexus of money and social standing. This leads to contrasts such as "old money" and "new money" with the former connoting generations of life on country estates and Ivy League credentials while the latter is something flashier. The Astor family have been wealthy for over 200 years and practically define old money in America.

Yet as one goes abroad, there is an even older kind of money, true dynastic wealth that has existed in some families for 300 years or longer. This type of wealth has survived not only business cycles but also war, invasion, the collapse of empires, revolution, and natural disaster. In order for family wealth to persist through so many centuries and through such adversity, something more is needed than ordinary investment skill. This rare kind of success in wealth preservation requires a longer view, infused with a sense of history and a keen appreciation for worst-case scenarios that too frequently become real.

When one inquires of family members and representatives as to what it takes to preserve wealth over centuries and not just cycles, the frequent reply is "a third, a third, and a third." This is shorthand for dividing one's wealth into one-third land, one-third gold, and one-third fine art. Obviously some liquidity is needed for day-to-day expenses and some room can be made for a speculative portfolio, but the basic idea that land, gold, and art outlast and outperform riskier assets such as stocks, bonds, and cash seems sound when viewed from the perspective of centuries and not just years or decades.

This may be difficult to grasp for Americans who have been badgered with mantras like "stocks for the long run" by Wall Street salesmen more concerned with their commissions than their clients. Stocks can indeed perform well for long periods although major indices have barely budged over the last 12 years. Yet stocks, bonds, and even cash all involve some claim on a third party and therefore contain credit risk in addition to whatever market risk they embed. The investor is always at the mercy of the issuer. Companies eventually go bankrupt. Bonds eventually default. Every paper currency in the history of the world has eventually proved worthless and there is little reason to believe the reigning paper money champions such as the dollar, euro, or yen will prove different in the fullness of time.

In contrast, the value of land, gold, and art is intrinsic. If you own it, you own it. There is no issuer who can suddenly make your land disappear or turn your gold into confetti. A painting cannot go bankrupt. Of course, it is possible that a totalitarian regime or an invading army might confiscate tangible wealth. Yet, even then there are defensive strategies that have been pursued with success.

Gold can be gathered up and stuffed in a saddlebag or sewn into the lining of a coat and moved. Art can be removed from frames, rolled up, and carried in one's luggage. Admittedly land cannot be moved, but with good title and patience a family can reassert its claim even generations later once interlopers have been ousted. Many Cuban families in South Florida are waiting to recover their estates seized by Castro in the late 1950s once the Communist government collapses, and they may do so with some success.

No portfolio is perfect or without risk. Yet, too often we think of risk narrowly and ignore the greatest risks of all in the form of monetary collapse, social disorder, regime change, and emergency edicts. Warren Buffett disparages gold because it has no yield. The reason it has no yield is that is has no risk. Yield is what you earn when you take risk. Gold has no credit risk, no currency risk, no maturity risk, indeed no risk of any kind. It is just gold.

In contrast, Buffett's Berkshire Hathaway stock when priced not in dollars but in ounces of gold has declined in value by about 75 percent since 2000 from 280 ounces per share to 70 ounces per share. Put differently, someone who bought gold rather than Berkshire in 2000 could today buy four times as much Berkshire stock using the same gold. There has been similar appreciation in the value of fine art. Admittedly this is a selective example. Yet it is true that over centuries it is the hard assets not the paper assets that retain value through collapse and catastrophe. The old money knows this—they have seen it all before."

James Rickards is a hedge fund manager in New York City and the author of Currency Wars: The Making of the Next Global Crisis from Portfolio/Penguin. Follow him on Twitter: @JamesGRickards.

Intergenerational Income Mobility

"Intergenerational income mobility refers to the extent to which income levels are able to change across generations. If there was no intergenerational mobility at all (that is, the intergenerational income elasticity was equal to 1), all poor children would become poor adults and all rich children would become rich adults.

In the case of complete intergenerational mobility (that is, the intergenerational income elasticity was equal to zero), there would be no relationship between family background and the adult income outcomes of children. A child born into poverty would have exactly the same likelihood of earning a high income in adulthood as a child born into a rich family.

As described by Statistics Canada researcher Miles Corak, “If we live in a society characterized by a high degree of mobility then low income during childhood may not be an experience that necessarily leaves a scar, pre-ordaining individuals to low-income as adults or to less engagement in society. In a society with a low degree of intergenerational mobility this is not the case: where one is going is closely linked to where one has been.

How is intergenerational income mobility measured?

Intergenerational income mobility is measured by calculating the intergenerational earnings elasticity. A higher elasticity number implies that it is more difficult for a person to move outside the income class he or she was born into. There are large differences among peer countries.

Canada ranks among the top performers and receives an “A” grade, with an intergenerational earnings elasticity of 0.19. If an individual earns $10,000 less income than the average, 19 per cent of that difference (or, $1,900) will be passed on to the individual’s children. In other words, the children will earn $1,900 less than the average.
The most income mobility is found in Denmark, which has an intergenerational earnings elasticity of 0.15. This means that 15 per cent the relative difference in parental earnings is transmitted, on average, to their children.

The U.K. is the worst performer on this indicator, with an earnings elasticity of 0.5. Parents earning $10,000 less than the average will pass on 50 per cent of that difference to their children. The children, in other words, will earn $5,000 less than the average.
Father-Son Earnings Elasticities (Click to enlarge)
 Johnston-Sequoia Commentary:

When we cross reference Jim Rickard's thesis with a sample of 5 of the top 20 wealthiest men in history (All American & all lived in the mid 1800's) we discover some shocking commonalities:

#16 Stephen Van Rensselaer: (November 1, 1764 – January 26, 1839)
Peak fortune: $68.5 Billion
Source of wealth: Major of the US Militia and member of the New York State Assembly, Rensselaer was also heir to one of the most well-endowed estates in the US. He founded the Rensselaer Polytechnic Institute with a portion of his wealth.
--- Business Insider: Stephen Van Rensselaer

#15 Jay Gould: (May 27, 1836 – December 2, 1892)
Peak fortune: $71.2 Billion
Source of wealth: Railroad baron and gold speculator, Jay Gould masterminded the 19th century transportation boom in America. He and financier James Fisk also bought up a dominating share of the gold market at the time - enough to directly affect market movements during Gould's lifetime.
--- Business Insider: Jay Gould

#8 John Jacob Astor:   (July 17, 1763 – March 29, 1848)
Peak fortune: $121 billion
Source of wealth: A successful fur trader, he established a near monopoly within the U.S. by around 1800. He subsequently switched trades and went on to investing in real estate, focusing on New York City.
--- Business Insider: John Jacob Astor

#4 Cornelius Vanderbilt: (May 27, 1794 – January 4, 1877)
Fortune: $185 billion
Source of wealth: An American industrialist and philanthropist who built his wealth in shipping and railroads. He was also the patriarch of the Vanderbilt family and one of the richest Americans in history. He provided the initial gift to found Vanderbilt University, which is named in his honor.
--- Business Insider: Cornelius Vanderbilt

#1 John D. Rockefeller: (July 8, 1839 – May 23, 1937)
Fortune: $336 billion
Source of wealth:
Fortune: $336 billion
Source of wealth: An American oil industrialist, investor, and philanthropist. He was the founder of the Standard Oil Company, which dominated the oil industry and was the first great U.S. business trust. Rockefeller revolutionized the petroleum industry and defined the structure of modern philanthropy.
---  Business Insider: John D. Rockefeller


The point of all of this is obviously not marvel at the amount of capital these gentlemen were able to amass or to strive to be the next J.D Rockefeller of John Jacob Astor, the point is that all of these men understood the value of investing for the future (Intergenerational wealth). 

This concept is why I invest - today at 32 years of age and having two children (ages 2 and 3 months) Intergenational wealth creation is my ultimate goal.  My grandfather (who came from a very modest background in Newburg, New Brunswick Canada) was fortunate enough to become a doctor as a result of serving in the Second World War- went on to have 12 children (7 doctors, 2 lawyers, 2 teachers and a business man) and became one of the largest land owners in South Eastern New Brunswick, Canada. 

Finally, as suggested in our last piece "Smooth Seas do not Make Skillful Sailors " we may have reached a bottom and subsequent Key point reversal on the S&P/TSX Venture Composite Index ($CDNX), the AMEX Gold Bugs Index ($HUI) and the spot price for Gold ($GOLD).  This as many (if not all) of our readers know can provide an opportunity - which may in turn translate into a tremendous amount of wealth creation in a very short period of time.  If this is in fact the case for some of you (my hope is of course all of you) please consider the above as a proven way for a contrarian to diversify and more importantly preserve wealth.

As always please do your own due diligence.

"The Breakers" Vanderbilt Mansion - Newport, Rhode Island

2 comments:

  1. Matt:

    As always, a fine collection of thoughts and an insightful look at long term wealth creation... and, as you point out as even more important ... wealth retention. I can add very little to your piece.

    Jim Rickard's focus on the three 1/3 rd's focus on land, art and gold is a keen observation of the ultra rich. For us lesser beings and want-a-bees living in a truly different age and circumstance... I would shorten that list to land and gold .... and then add my own 'new 1/3' of a well founded, hopefully well paid profession that allows the stable income that gives one the time and the personal stability to gradually amass the first two 1/3 rd's.

    There is basically no support in modern society for the arts as per bygone eras. Most talented artists have to work 2 jobs and then find the time to perfect their talents. This is not the formula that will produce a perpetuation of valued art from this current society.

    I do want to make a personal observation about a modern tendency which I would define as a lack of desire of people to not want to physically relocate in order take advantage of opportunities for wealth generation and career advancement.

    In the last 2 generations professionals would move consistently to the next job, the next chance at advancement. The current up and comers have, in my observation, rejected that ethic of mobility. They have in major part rejected that old life style in favour of stability of the family, stability of job location (even though they may change jobs constantly in that stable location). The 2 parent working family has reinforced this new paradigm.

    Of course, cheap airfares, fantastic advances in the technology of communication (the internet, Skype etc.) have enabled this new lifestyle of locational stability.

    My point is not to wish for a return to the old ways... but... au contraire...to point out that society, through major technical advances, is in fact allowing new pathways for wealth generation and retention at the same time as allowing locational stability.

    I believe that the Income Mobility trends issue that you explore above is about to be turned on its ear in this new 'Information is King' age.

    Those stats in your Nation State chart above will be passe in 20 years time. There will be less and less national tendencies for defining Income Mobility in that way.

    It will all come down to the individuals’ ability to take advantage of the information available to all of us for personal wealth creation (where ever they live).

    Then ... as you say… go stuff that wealth into gold and land.

    Tom

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