If Piketty is right about rich people getting high returns, why do banks lend at low rates?

A critical assumption in Thomas Piketty’s Capital in the Twenty-First Century is that rich people get a better return on investment than average S&P 500 buy-and-hold idiots. This assumption leads to runaway wealth inequality and the necessity for a new worldwide tax on wealth.

Why do rich people get such a great return, according to Piketty? They have access to brilliant financial managers and investments that the rest of us can’t find.

What about big banks then? With billions in assets they are unarguably rich. Their office towers are stuffed full of the best financial managers that $500k-$20 million/year salaries can buy. They sit in the biggest cities and have access to every conceivable business idea. Big Banks should have ever better investment opportunities than Mr. Generic Rich Bastard. Yet they are happy to lend out money right now for a return of about 2 percent (e.g., margin interest on stock holdings, best adjustable mortgage rates for the first five years). If there are such great investment opportunities out there for the sufficiently rich and sufficiently connected, why would a big international bank want to lend out money at 2%?

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The Gulfstream crash at Hanscom Field

Friends have been asking me about the crash of N121JM, a 2000 Gulfstream G-IV, after running off the end of Runway 11 at Hanscom Field on Saturday evening (Boston Globe). I didn’t know any of the people involved, I don’t have a Gulfstream type rating, and at this point the most that anyone can do is speculate. However I will share with readers what I have shared with friends, mostly based on my experience flying the Canadair Regional Jet, a similar size aircraft.

Background: In theory, you take off in a twin-engine turbojet by holding the brakes, pushing the thrust levers forward, verifying that you’ve reached full power, and letting go of the brakes. The pilot flying looks down the runway. The pilot monitoring checks the airspeed indicators on both sides and says “100 knots cross check”. Then the pilot monitoring calls out “V1“. This is the “decision speed”. If an engine quits before V1, you pull the thrust levers back, hit the brakes and stop before running off the end of the runway. The FAA allows about one second as a reaction time and assumes near-perfect technique after that. This is the reason that commercial airport runways are so long. The plane needs enough runway to come within 1 millisecond of taking off and then enough runway to brake to a stop from 150 miles per hour or so. If an engine quits and you’ve reached V1 you continue the takeoff on one engine. You wouldn’t be at that airport with that load of passengers and fuel if the dispatchers hadn’t calculated your ability to take off and climb out to clear obstacles on one engine (i.e., you won’t be able to carry as much weight if taking off from a high altitude airport surrounded by mountains, since turbojet engine power output falls as altitude increases).

Takeoff configuration: The CRJ simply would not take off, even from a 15,000′ runway and with full power, unless flaps were extended. The clean wing was designed to minimize drag during high-speed cruising. Thus it is critical to have the flaps properly configured for takeoff or the airplane will simply keep accelerating down the runway without lifting. All of the standard performance charts for the Gulfstream G-IV assume “flaps 20” but the NTSB reports so far have described the flaps being set to just 10 degrees in the cockpit (given that the plane supposedly reached 165 knots, it should still have been able to lift off at flaps 10).

Refinement 1: In the real world, pilots aren’t that great at aborting takeoffs and it is hard on the airplane’s systems to slam to a stop once the plane reaches about 115 miles per hour. So at our airline we had a rule that unless it was something pretty dire we would continue the takeoff once we reached 100 knots and then work out the problem in the air.

Refinement 2: Passengers prefer a “rolling takeoff” in which the brakes are not held as the thrust levers are advanced. Unless one is operating from a short runway in the mountains, this is how take-offs are typically done. Unfortunately this chews up additional runway due to the plane rolling as the engines “spool up” to full power. For the CRJ, no data are available regarding exactly how much runway is wasted in this fashion and whether or not the plane can still be stopped after recognizing a problem at V1. A friend sent me a portion of the Gulfstream G-IV Airplane Flight Manual (AFM) and it seems to indicate that the performance charts can be relied upon even given a rolling takeoff.

Refinement 3: In the real world, a twin-engine turbojet has way more power than it needs for most flights. If you’re lightly loaded (few passengers, short trip so not too much fuel) and departing from sea level, why would you want to make those engines work so hard? The FAA Advisory Circular AC 25-13 from 1988 explains that “Takeoff operations conducted at thrust (power) settings less than the maximum takeoff thrust (power) available may provide substantial benefits in terms of engine reliability, maintenance, and operating costs.” An additional advantage of reduced thrust is that passengers on a lightly loaded plane won’t be slammed back in their seats like astronauts.

If you’re an engineer you would naturally assume that this would all be idiot-proof on a $50 million plane stuffed full of computers. The airplane infers its departure runway and airport altitude from the GPS location and heading. You push a button for “reduced thrust”, the airplane reads its weight from the strain gauges on the landing gear, and then you advance the thrust levers fully when you’re ready to go. The airplane will make sure that the flaps are set properly and if one engine stops developing thrust the other one will automatically advance to full power. If you lived to be 1000 years old you would probably not be able to get this design certified by the FAA (for the same reasons that the FAA-run air traffic control system will not send your airplane a text message with the instrument flight plan waypoints; instead a controller will read it to the pilot over the radio and the pilot will enter a bunch of 5-letter waypoints and 3-letter VORs into a GPS (possibly getting them wrong)).

In real life what happens is that the pilots calculate the aircraft weight (we did it on paper back in 2008!) and then use a paper chart or maybe an iPad app to calculate the proper reduced thrust setting. If there is a error in this calculation or the transcription from the calculation or the entry of the airport/runway, the resulting thrust might not be enough to become airborne. This is a serious problem because pilots are making the go-no-go decision primarily on aircraft speed (V1 yet?) not based on how much runway is left. The assumption is that the calculations have ensured that the runway length will be sufficient for all possible events. And of course the actual setting of the thrust requires the pilots to watch gauges, another opportunity for misinterpretation. The airplane, though equipped with a GPS, does not have a warning such as “You’ve got 2000′ of runway left. Maybe it is time to go to full power?”

Can a pilot get this wrong? Sure. In fact, four pilots can get this wrong, as demonstrated on March 20, 2009 by Emirates A345, an Airbus A340-500 departing from Melbourne (official report). A simple data entry error caused a lower-than-sufficient thrust to be calculated and the $200 million airliner ran off the end of the 12,000′ runway, taking out lights and antennae. The Emirates crew made the “go” decision rather than the “stop” decision of the Hanscom Gulfstream. When the end of the runway was near the pilot pushed the thrust levers forward for full power and the airplane then flew quite easily.

Please don’t read this posting and infer that I know anything about why this Gulfstream crashed. The intent is just to answer the question that friends asked repeatedly, i.e., “Is there any way to crash a modern business jet on takeoff without the cause being a catastrophic mechanical failure?” And I am as saddened as everyone else about the loss of life.

[Separately, local pilots have been discussing the safety record of our airport, which has more than 150,000 operations per year. The NTSB database shows that the most recent fatal accidents were the following:

  • 11 years ago: four-seat single-engine Cessna crashed on an instrument approach due to pilot disorientation in the 400′ overcast (report from 2003).
  • 16 years ago in a four-seat single-engine Piper that got slow in a turn and suffered an aerodynamic stall after a 4.5-hour flight (see this NTSB report from 1998)
  • 30 years ago: four-seat single-engine Piper crashed due to spatial disorientation on an ILS, almost identical to the 2003 accident (report from 1984)

]

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Are any smart home systems, such as Zigbee or Z-wave, ready for prime time?

Folks:

I am setting up a new office inside a house built in the 1960s. It is going to need a lot of electrical work including upgrading the service from 60-amp to 200-amp. I am thinking “Maybe this would be a good time to rip out all of the switches and outlets and replace them with the smart home standard.” But as I poke around I find that the smart home still exemplifies the old adage that “The wonderful thing about standards is that there are so many to choose from.” smarthome.com offers INSTEON, UPB, X10, Z-Wave, Zigbee, and WiFi, for example.

“The dumb state of the smart home”, a January 2014 article, is not encouraging:

not all ZigBee products can communicate with each other, and that’s a major problem for what’s intended to be a standard.

Can it really be that a country that figured out to cover itself in McMansions while making German investors pay for it all cannot figure out how a PC can turn on a light?

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Stupid Piketty Question: Why does it matter if the rich get (nominally) richer?

Thomas Piketty’s Capital in the Twenty-First Century urges readers to take drastic action to prevent what he says is an inevitable explosion in the wealth of rich people worldwide. Piketty assumes the following: (1) rich people get a better return on their investments than regular investors, (2) governments will stop taxing dividend and capital gain income, (3) the world economy will grow at best slowly for the next 50-100 years, (4) the return on capital will be high, and (5) rich people won’t consume too much (which means most of their income gets plowed into additional investment). If one accepts these assumptions today’s disgustingly rich will become tomorrow’s ridiculously rich in a runaway process. This is why we need to take immediate action to tax wealth so that it doesn’t spiral upward out of control (and actually Piketty says that we need also to take immediate action on climate change for the same reason).

I have a feeling that this is a stupid question but I haven’t figured out a clear answer…. Why does it matter if today’s billionaires become tomorrow’s trillionaires?

As the Detroit realtor no doubt would have said 20 years ago, “they’re not making any more land.” I.e., once rich people own most of the world’s land all that can happen is that the nominal price of the land goes up, but the total amount of land owned doesn’t change. Similarly, there are only a certain number of factories in the world. If every rich person suddenly has 100X the wealth it will take a long time before more factories are built so the dominant effect will be bidding up the price of existing factories. General Electric is still the same company even if its shares in the aggregate become worth 10X as much as they are today.

How about personal lifestyle? Will the huge wealth increases allow rich people to live more lavishly? Not if they want to live around other rich people and show off. See the June 1, 2014 “Sky-High Demand for Luxury” in the New York Times: “multimillion-dollar apartments have been snatched up hours after they hit the market and buyers have shelled out $1 million over the asking price to secure a winning bid.” Sure the S&P 500 is up, but the price of a Manhattan duplex, a Range Rover, and a parking spot for that Range Rover, have gone up even more. A rich person could now buy all of Detroit, but why would he or she want to?

Will the super rich becoming super duper rich affect the lifestyles of the non-rich? Consider that millions of Americans have a lifestyle that is set by the government in absolute terms, i.e., they are provided with whatever housing, medical care, and food that a government official decides that they should have. Additional millions of Americans are employees of the government or government contractors. Once again, the government decides what to pay these employees, generally without reference to the market (example). How about the shrinking group of private industry workers who don’t work for government contractors? Can the uber rich force them into accepting minimum wage? It seems unlikely. The rich have to give the capable and hard-working some incentive to show up, so the wage of a good worker should be bid up until it is sufficient to support a comfortable lifestyle.

Natural resource consumption seems like the place where the rich could do some serious damage to the middle class. When people who don’t care about money travel, for example, they burn a lot of oil. The President of the United States, for example, will send out a couple of Air Force cargo planes a couple of days ahead. These are stuffed full of SUVs, helicopters, and other vehicles. Then the President shows up in his private Boeing 747. If there were another 10,000 people worldwide who traveled in the same style this would put a real dent in oil supplies and middle class people might be reduced to walk/biking/Guatemalan chicken bus. The middle class private car era will draw to a close.

But except for oil, what good will it do the rich to become uber rich? Won’t they just bid against each other and generate inflation in the prices of 20-carat diamonds, townhouses in Paris, used Gulfstream jets, etc.? Once the rich own all of the world’s land, all of the world’s factories, and all of the world’s gems and gold, how can they actually get richer from a functional point of view?

And finally why does it matter to the rest of us if a family holds onto a lot of wealth for a while? If they’re holding it aren’t they investing some of it in productive enterprises? And don’t they have to eventually spend a lot of it to get any value out?

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Thomas Piketty: Al Gore with a French accent

In addition to being an expert on economic history, Thomas Piketty turns out to be an expert on atmospheric physics. One would think that an advocate of greater wealth equality would welcome a sea level rise sufficient to wash away all of the Wall Streeters’ houses in the Hamptons. Apparently not.

climate change and, more generally, the possibility of deterioration of humanity’s natural capital in the century ahead. If we take a global view, then this is clearly the world’s principal long-term worry. The Stern Report, published in 2006, calculated that the potential damage to the environment by the end of the century could amount, in some scenarios, to dozens of points of global GDP per year.

Piketty never explains why growing wealth inequality was the world’s #1 problem in the preceding 600 pages but climate change takes over the #1 spot for a short portion of the book.

Should we attack the problem now, when America’s best engineers can’t figure out how to deliver working WiFi service at brand new billion dollar airport terminals (see SFO, for example!)?

Nicholas Stern, who is British, argued for a relatively low discount rate, approximately the same as the growth rate (1–1.5 percent a year). With that assumption, present generations weigh future damage very heavily in their own calculations. William Nordhaus, an American, argued that one ought to choose a discount rate closer to the average return on capital (4–4.5 percent a year), a choice that makes future disasters seem much less worrisome.

For Stern, the loss of global well-being is so great that it justifies spending at least 5 points of global GDP a year right now to attempt to mitigate climate change in the future. For Nordhaus, such a large expenditure would be entirely unreasonable, because future generations will be richer and more productive than we are. They will find a way to cope, even if it means consuming less, which will in any case be less costly from the standpoint of universal well-being than making the kind of effort Stern envisions.

Stern’s opinion seems more reasonable to me than Nordhaus’s, whose optimism is attractive, to be sure, as well as opportunely consistent with the US strategy of unrestricted carbon emissions, but ultimately not very convincing.

Piketty proposes spending vast sums, though he admits that nobody has any idea what would be worth funding:

The public debt (which is much smaller than total private wealth and perhaps not really that difficult to eliminate) is not our major worry. The more urgent need is to increase our educational capital and prevent the degradation of our natural capital. This is a far more serious and difficult challenge, because climate change cannot be eliminated at the stroke of a pen (or with a tax on capital, which comes to the same thing). The key practical issue is the following. Suppose that Stern is approximately correct that there is good reason to spend the equivalent of 5 percent of global GDP annually to ward off an environmental catastrophe. Do we really know what we ought to invest in and how we should organize our effort? If we are talking about public investments of this magnitude, it is important to realize that this would represent public spending on a vast scale, far vaster than any previous public spending by the rich countries.

Should we count on advanced research to make rapid progress in developing renewable energy sources, or should we immediately subject ourselves to strict limits on hydrocarbon consumption? It would probably be wise to choose a balanced strategy that would make use of all available tools.55 So much for common sense. But the fact remains that no one knows for now how these challenges will be met or what role governments will play in preventing the degradation of our natural capital in the years ahead.

More: read Capital in the Twenty-First Century.

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