Wealth, Income, and Keynesian Boobs

As I write the politicians of both parties are again throwing spears at one another with respect to a cliff.  Rather than complicate that mess further, I thought it might be a nice change of pace to focus on the difference between two economic concepts – income and wealth. Most of us would be happier if the economy grew faster. Faster growth would make solving the financial crisis a little easier. Our Keynesian predilection is to seek policies that aim at income and economic growth. Most of the stimulus policies focus on income. That’s the way we think because many of us were nursed on Keynesian boobs. Apparently we still aren’t weaned. A look at wealth might be more nourishing. 

Income is an intuitive concept. My Dad said that if I would do my chores I would get an allowance. The allowance was my income and while paltry it was worth a lot more than what he got out of me in the way of washing his car and drying the nightly dinner dishes. As an assistant professor at the Kelley School of Business in 1976 I earned a handsome sum of $15,000 in return for a year of confusing students and doing research that led to me to this glorious blog. We all know that we have to pay income taxes on what we earn and what is left to either spend or save is what we call disposable income. Let’s write that in big letters – DISPOSABLE INCOME. I write it in all caps to see if you are still awake. Also because it is the key to Keynesian economics. 

If the economy is weak, then Keynesian fiscal policy aims its bazookas at something that would increase disposable income. The government could give you a tax cut. Or perhaps the government could build a nice new and shiny bridge and pay construction company workers for the work – thereby increasing their take-home pay. A Keynesian monetary policy pours hot money into the financial system with the intent of lowering interest rates – causing homes, autos, and other interest-sensitive goods to be purchased and  produced – enriching with income those who produce all that stuff. So whether it is fiscal or monetary in nature, Keynesians are all about raising spending and disposable income.

That leads us to the four-letter word of the day – Wealth. Okay it is actually 4 letters with a “th” added to the end. Who am I Euclid? 4 letters 6 letters who cares? What matters is that wealth has become an ugly word. It has become an ugly word because most of the wealth – like much of the income -- is owned by a very small group of really rich people who live in castles and eat snails and sit in vaults and count their money over and over. Some even have their own television shows.

But what is wealth and why does it matter? It matters because there is more to economic growth than Keynesian preoccupations with income. Wealth is basically what must of us try to accumulate by earning income. My Dad gave me my allowance each week and said – Son, do not spend all your money and someday you will be a wealthy man. I laughed as I bought enough gum (and the enclosed free baseball cards) to make my dentist a wealthy man. Yes, as a young man I didn’t save a penny and my baseball collection didn’t amount to a hill of beans.

Saving is defined as the part or residual from your disposable income that you don’t spend. That’s easy. While it is true that much of the nation’s savings belongs to the wealthier people – most of us save or at least say we are going to save.  For example, much of our saving is done to provide for times when we no longer work – for bouts of unemployment and for our retirements. The saving that we and/or our employers do for our retirement is called a pension. 

As of 2011 the Federal Reserve estimated that Americans had about $13 trillion in pension reserve funds. We also save through our houses. We often think of the mortgage payments we make each month but the other side of the equation is that our homes are worth something.  The FRB estimates in 2011 U.S. households having homes worth a little more than $18 trillion. Of course we also hold our wealth in many other forms including bank deposits of about $8.6 trillion, equities or stocks worth about $9 trillion and various credit market instruments of almost $4 trillion. In total, the FRB estimates our total assets or wealth to equal about $73.6 trillion. Wealth data comes from the Federal Reserve Board Flow of Funds Accounts published in September 2012:  http://www.federalreserve.gov/releases/z1/Current/annuals/a2005-2011.pdf

Are you feeling rich? Want to buy a used hot tub? Don’t get too crazy. While we own all these assets we also incur a lot of loans or liabilities. If you borrow $1,000 to buy a cool new Fender electric guitar, your wealth has not really increased. You own a guitar but you also owe $1,000. When you pay off your loan in 47 years and your guitar is worth $35 dollars then you have some real wealth. When you subtract the liabilities from the assets, we get something called NET WEALTH. It is in caps because that is the important concept comparable to disposable income and because my Caps Lock key sticks sometimes.

Like disposable income, NET WEALTH gives you spending power. When all of our homes seemed to be worth a ton of money in 2006 because housing prices were making homes more valuable, we felt very wealthy and so we went out and bought groovy  pipes, sweaters with patches on the elbows, and we hired drivers for our all electric cars. NET WEALTH can have powerful impacts on the economy – just like disposable income.

That brings us back to now. US Net Wealth peaked at $66 trillion in 2007 and then subsequently fell to $53.5 trillion in 2008. That’s a decrease of almost $13 trillion or 19%. We felt a lot poorer! Even if a decrease in Net Wealth of $100 decreased spending by only $1, then this impact alone would have decreased GDP by more than $100 billion dollars in 2008. For that you can buy a lot of stinky fish and bindaetteok in Seoul. Much of that decline came from real estate and equities but pension funds and other asset values tumbled. When you see all your wealth vanishing you don’t run out and buy the most expensive Galaxy Note II.

So Net Wealth contributed to the recession we had in the USA in 2009 and 2010. As Einstein said, what goes down must come up. Or something like that. But the point is that Net Worth recovered and by 2011 it was estimated to have increased to about $60 trillion. Net Wealth recovered about half the value it lost after 2007 and was a positive force in the economic recovery. But we all know the recovery has been weaker than usual and we remain concerned that we are stuck at lackluster economic growth rates and high unemployment to boot.

Keynesians want to kick start disposable income. Since 2008 they have been stoking the fires of demand and disposable income and today Keynesians are pushing programs to keep government spending growing strongly and to pay for these increases by impaling rich people, or in modern terminology raising taxes on the rich. Vlad the Impaler would have been proud.  These programs have not been working and yet they keep asking for more taxes to support them.

An alternative approach is to think about New Wealth. If Net Wealth had already increased to its earlier value of $66 trillion it would have had a much bigger impact on the economy. Why didn’t Net Wealth return to its former value? To answer that we need to know a little more about the current market or the replacement value of wealth. Let’s suppose Aunt Lucy gave you some things when she passed in 1990. You received a house worth about $40,000, some stocks valued at about $2,000, and some long-term bonds worth $8,000. Is all that stuff worth a total of $50,000 today? Probably not – inflation has pushed the value of that house to about $120,000. Lower interest rates boosted bond prices so your bonds are now worth about $6000, and the growth in the overall stock market means that your stocks might be worth $24,000. 

Your wealth in this illustration increased to about $150,000 – an increase of $100,000. The point is that many factors can and do affect the prices of the assets we own.

So let’s use this understanding of net wealth in the context of recent policy to see why Net Wealth has not risen more in today’s policy environment.

·        

Explosions of monetary policy contributed to an environment of lower interest rates and that has helped to stimulate housing and autos. But what if the increase in money also contributed to an increase in expectations about future inflation? Bonds and stocks do not do well in an inflationary environment so this contributed to lower expected future Net Worth. 

·         Furthermore, with interest rates so low and the economy recovering that means interest rates will likely rise – and will likely increase a lot. That will not be good for valuations of bond wealth. 

·         Policies that intend to hurt the rich by raising taxes on dividends and capital gains clearly are not good for stock market wealth.

·         A thicket of new regulations on companies specializing in housing, finance, nonrenewable energy, and health are not the best ways to increase the values of the stocks of those companies.

·         Finally, lackadaisical approaches to government deficit and debt moderation a la Europe clearly portend bad things for both bond and stock markets.

Keynesians and other macroeconomic policy liberals ignore the value of national Net Wealth to their peril. It seems fair to them to pay for more government spending for the middle class by taxing the rich. It seems like business as usual to keep middle class taxes low to stimulate disposable income to create growth.  An unrelenting force to redistribute income from the rich to the poor may well accomplish what they want in the short-term but the reality is that this will be bad for National Wealth and for the economy. As in other attempts to do such things, if these folks with their apparent mandates accomplish their policy goals – we as a nation might find fleeting equality but at a much lower level of wealth and income! It is like the guy with one bad foot who prayed that one day both his feet would again be equal. He got his wish and now both of his feet are bad!