- US net worth has been increasing due to asset price inflation.
- Asset price inflation has been influenced more by cheap money and less by GDP that has been growing on debt based consumer spending.
- As the FED is out of firepower to protect the markets and the economy from any shocks they have no downside cushion.
On June 9 the FED released its quarterly Financial Accounts of the United States. The report shows the total of accounts for various things, from net household worth, debt per segment, consumer spending to the general flow of funds. Unlike the usual newspaper that focuses on easy to reproduce single pieces of information, this 196-page report gives a clear picture of what is going on in the US economy, the developing trends and therefore has to be well understood by anyone who has an interest in the US economy.
Household net worth is at its highest level ever at $88,087 billion. The latest increase was mostly influenced by the $498 billion increase in real estate value while the value of held corporate equities fell by $160 billion.
Figure 1: US net household worth. Source: Federal Reserve.
Household net worth has increased from $56,214 billion in 2008 to the current $88,087 billion in 7 years that represents a growth of 6.6% per year. In the meantime, GDP has grown from $14,718 billion to the current $18,229 billion that represents a 23.8% growth for the period or just 3% per year.
The fact that asset prices have grown at twice the speed of the real economy indicates an asset inflation. This asset inflation is not publicized because it is not measured as asset prices commonly fluctuate and inflation is measured mostly through the consumer price index that reflects consumer spending. Thus it is not measured but is important for common wealth.
So if the wealth didn’t come from economic growth, it had to come from some other source. As you can imagine that source is not a very sustainable one in the long term. It is the same source that ignited the 2009 Great Recession, but now the culprits are not the banks. The culprit is the FED, which has been increasing its debt by rates never seen before.
Figure 2: US debt growth by sector per year in percentage. Source: Federal Reserve.
The FED’s debt grew by a yearly average of 10.69% in the last 10 years, foreign debt grew at an average rate of 7.77%, while consumer spending grew at an average rate of 3.83% and has increased to 6.5% for the last 4 years. FED borrowing has been slowing down in the last few years but it has been replaced by higher consumer spending based on debt and foreign debt. The conclusion is very simple, the increase in wealth is purely created by debt and cheap money which has never been a good sign for the long term.
The debt has fueled consumer spending that has further fueled increases in corporate earnings, which alongside low yields, increased the market value of domestic corporations by a staggering 132% since 2008. This increase contributes to 65% of the increase in net wealth since 2008. Any decrease in the US stock market would quickly erase the gains made in the last decade. The FED is well aware of that and therefore is more focused on the effect its monetary policies have on the market than on the economy.
Repercussions of Asset Inflated Wealth
When asset prices rise, most people don’t complain as it gives a good feeling of increased security. But that feeling is a very deceptive feeling as in order to use the benefits of the increased wealth, the only option is to sell those assets.
If a few people start selling there is no issue, but what happens when the majority starts selling? Well, a crash. And as most of US wealth is locked up in assets whose value easily fluctuates, the above 50% increase in wealth has to be taken with two grains of salt. A 25% S&P 500 decline would lower national household wealth by 10%. This is something to worry about as after a 7-year bull market, a 25% market decline is not improbable, especially since we have experienced two 12% declines in the last 12 months.
Will the FED Continue to Protect Your Wealth?
The FED is trying to keep things stable by not increasing interest rates as the economy is still not rolling as expected, even after 7 years of incredible quantitative easing. As soon as stocks have fallen a little bit, the FED has announced that any further increases in interest rates will be postponed and the market rallies. This does not mean that the FED will always be there to protect our wealth as at one point it will have to shift focus from asset prices to the long term economy. The fact is that the FED has no more fire power, it cannot lower interest rates by several percentage points like it did in 2008 to save the economy from a downward spiral or in 2002 to propel house buying. A return to quantitative easing is unlikely as it did not create sustainable economic growth in the last decade.
Unfortunately, the conclusion is not a rosy one, but a warning has to be sent out.
Everybody makes money in a bull market and with inflated asset prices, corporations find it easier to attract capital and investment banks make money on those deals. In such an environment, nobody wants a market decline except for some isolated shorts, but as no fundamental and structural reasons underpin the growth in wealth and the economy, a crash is bound to happen sooner or later. Nobody can know when but the fact that the S&P 500 did not grow in the last 18 months gives a clear indication that the party might be close to an end.
In this week’s meeting, the FED will probably sit tight by not increasing interest rates and try to issue consolation statements reassuring the public that the economy is doing well or that if the economy isn’t doing that well, the FED will intervene. This leverage that the FED has used to keep the economy stable and consumers to buy more things will eventually backfire. If it is already starting to backfire will be clear not after the economic data is released in June or FED actions, but after the earnings season in July when we will see how corporate earnings are affected by the above repercussions.