Isn't the theory of compound interest sufficient to explain why the rich get richer faster than that poor get richer?
If they both got the same interest rate, then their wealth would grow at the same rate. Add in progressive taxation and the gap might narrow.
If they’re getting different rates and taxation is regressive, then those seem like better explanations.
Edit: also spending patterns.
Edit again: note that this wasn’t meant to be a complete explanation. I just wanted to point out a few reasons why compound interest is not sufficient to explain a widening wealth gap (the claim in the comment I responded to).
High income save & invest a higher % of their income - therefore inflation is good (their stocks go up).
This isn't some sort of moral or judgmental statement. It's simple math. The more your income goes up over time, the less of a % is needed to cover the basics of food/shelter/energy.
Point being, through the same exact investment vehicle and with the same exact rate, a rich person of course will built more wealth than a poor person. It's just the nature of a percentage-based growth.
Owning something that earns while you sleep does tend to increase you ability to focus on what is important.
Sadly, I'm not sure anyone who is wealthy has what I would call a focus on what is important. Terrible situations, failed marriages, relationships with kids, etc..
(Eg where I live, there's no capital gains tax, so someone like Elon Musk could just sell their shares without any extra taxes, instead of having to borrow against them.)
Notably, the rich do not have problems with "credit score", which never seems to apply to them.
First, the banks charge you interest depending on amongst other things the risk incurred. More risk, more interest. (Look at eg junk bonds for an example.)
Second, when you borrow against your stock, you typically only get, say, 50 dollars loaned for every 100 dollars of stock. (Details vary.) If the value of your stock drops anywhere close to eg 75 dollars, typically the bank has the right to sell some or all of your stock to pay off the loan.
If your stock dropped so quickly that it's gone before the loan has been paid off, the bank might or might not come after your other assets. Whether they can do so, depends on the contract you have with them. Again, if it's a non-recourse loan, you are going to pay higher interest, and they'll demand more conservative loan to value ratios.
> If the stock goes up, you can pay off the loan and keep the difference.
Third, why would you pay off the loan, and with what money? The whole point of the scheme is to never sell stocks, so you never have to pay capital gains taxes.
You just let your loan's balance accumulate over time with the compound interest.
(One popular scheme is called 'buy-borrow-die': because of a quirk in the US tax system, you don't pay capital gains taxes when you die. So you acquire stock somehow, then borrow against it, and you pay off the loan only when you die: your estate or the bank sells enough stocks to cover the loan, and doesn't have to pay capital gains taxes.)
The banks are happy to let you run up a balance, as long as your loan-to-value ratio stays low enough. Ie as long as your stocks grow sufficiently faster than your outstanding loans.
> Notably, the rich do not have problems with "credit score", which never seems to apply to them.
Credit scores are a standardised system to deal with average people. If you are rich enough, the bank can afford to have a real human look into your specific situation, instead of relying on a number.
As as a slightly made up example: Elon Musk is known for getting into legal fights and being annoying to deal with, and trying to wiggle out of obligations. So creditors might charge him more interest purely for that risk. Whereas Michael Bloomberg always stick so this agreements, and a handshake from him is a firmer commitment than an thousand page contract with Elon Musk that covers all eventualities.
Paradoxically, someone who is known to to be able to afford expensive and competent lawyers might have to pay higher interest rates than some middle class Joe Average. It's not that the bank thinks Elon Musk has a higher risk of running out of money than Joe Average; but it's that the bank fears that Elon Musk is harder to sue than Joe Average is to foreclose on.
Yet in that same year, the net worth of the top 5 wealthiest individuals in the USA (carefully watched on Bloomberg terminal and elsewhere) increased a LOT. Famously Elon Musk in particular.
How does "compound interest" explain that?
Edit: for those that doubt [0]
[0] https://www.sciencedirect.com/science/article/abs/pii/S01602...
> Regression results suggest no statistically distinguishable relationship between IQ scores and wealth
Stop spreading dangerous myths.
First, the rich don't reliably get richer faster than the poor get richer. (Despite what the linked article or other texts might claim.)
Second, interest rates are mostly an abstraction. Yes, if two people are both putting money in a bank account in the same currency, the one with the higher interest rate will get richer faster.
In the real world, many investments yield a variable nominal rate of return (eg real estate, stocks, art, etc). And you also have to worry about factors like inflation or counter party risk.
yes they do, as money printing benefits those who are leveraged into assets more than other types of debt holders.
The rich (by proxy, through investing in the stock market) actually hold more debt in aggregate. And per capita, they hold WAY more debt, hence benefit from money printing even more.
Money printing is indirect wealth transfer from everyone else to the rich.
Any inflation that's anticipated at the time a debt contract is made will be priced in to the debt contract. That's (part of) why high inflation economies have high interest rates.
You can load up with debt as well: it's fairly easy to open up a margin account at eg Interactive Brokers, or (almost equivalently) to trade in options (which have margin financing sort-of built-in).
After 2008 and 'too big to fail', you don't?
That's very different from normal creditors being morons.
(And yes, the people with resources often, but not always, have an easier time getting the government to give them even more resources.)
Chart M2 growth to CPI and you can clearly see what I mean.
So we agree and you say that this thing is already priced in? Good.
Yes, market participants anticipate many things, and make their contracts based on what they expect. Not on any mechanical considerations of what happened before.
Given same rate of return, the one who puts in the most money gets richer faster, in absolute dollars.
The article says that on top of this, those with more capital get better relative returns too. You don't refute this by just saying it's not so. The increasing wealth disparity we observe would seem to support this idea.
(Mostly thanks to India and even more so China going from dirt poor to poor or middle income. But many other countries like South Korea or Singapore and previously Japan have also caught up. Poland and many, but not all, former Eastern block states have also done quite well.)
Doubling 100M in 10 years to 200M is, IMO, getting richer faster than double 25K to 50K in 10 years.