Bloomberg News

Wealth Effect Failing to Move Wealthy to Spend: Cutting Research

April 17, 2014

The wealth effect isn’t what it once was for the U.S. economy.

While the wealth of American households has jumped more than $25 trillion since early 2009 amid rising equity and home prices, the pass-through to consumer spending is lagging the $1 trillion fillip that would have been anticipated historically, according to Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York.

This means consumer spending has been exceptionally weak once wealth is accounted for, he said. With wealth gains now moderating, consumer spending could revert to what is already a weak trend, Feroli said in an April 11 report.

His calculations show that since the recession ended in 2009, households have spent 1.7 cents of every extra $1 earned in wealth. That’s less than half the 3.8-cent average implied by data between 1952 and 2009, suggesting the trend for consumer spending gains over the past three years has been less than 1 percent once the wealth effect is stripped out.

One reason for the adjustment may be that those enjoying gains in wealth are already rich, so have less propensity to increase spending incrementally. Withdrawing equity from homes has also been negative for five years.

The good news is that income expectations are starting to pick up, which should encourage the spending acceleration that greater wealth failed to spark, said Feroli, a former economist at the Federal Reserve Board.

* * *

Hedge funds may have been to blame for helping spread the financial crisis of 2008.

So argues a study published April 14 by Reint Gropp, a visiting scholar at the Federal Reserve Bank of San Francisco. It attempts to measure how deterioration in financial conditions spreads through various corners of the financial system.

Gropp’s findings show that while the risks to other financial institutions emanating from hedge funds are as small as those from commercial or investment banks in calm times, they are greater during periods of market turbulence.

A 1 percentage point increase in the risk of a hedge fund is estimated to weaken the position of investment banks by 0.09 point in normal market conditions. In times of financial distress, the same shock increases the impact by 0.71 percentage point, according to Gropp.

“There is a growing recognition that hedge funds are systemically important,” he said.

* * *

The accelerating U.K. economy may have a fault line in the form of a growing current account deficit.

That’s the warning of Deutsche Bank AG strategist Oliver Harvey. He argued in an April 15 report that returns on the U.K’s foreign direct investment and debt assets have collapsed, removing an inflow of money that traditionally offsets the current account deficit.

FDI income has dropped from a net surplus of around 5 percent of gross domestic product prior to the financial crisis to about 1.5 percent today, while the returns earned on overseas assets as measured by implied yields have dropped to less than 5 percent from 13 percent.

The most likely reason for the declines is the financial turmoil led first by the U.S.’s mortgage crisis and then the euro region’s debt woes. Those led to worldwide deleveraging and withdrawal from exposure to U.K. debt and investment, said Harvey.

The ebbing of such cash inflows is an issue because the U.K. ran its largest current account shortfall since 1989 in the final quarter of last year. That leaves Britain in need of attracting financing, which could be complicated if economic growth slows. One result, Harvey predicted: a decline in the pound.

* * *

Investors don’t always know best.

The best tool for predicting the future price of oil isn’t the oil futures price, according to the Bank of Canada. The central bank of Canada, home to some of the world’s biggest oil reserves, said this week it now uses the spot prices for Brent, West Texas Intermediate and Western Canadian select grades in drawing up its economic forecast.

“Recent empirical work has shown that this approach provides a more accurate forecast, on average, than the futures curve,” the bank said in its Monetary Policy Report. “Whereas in the past the bank had assumed that energy prices would follow the futures curve, it now assumes that energy prices will remain near their current levels.”

The move mirrors the central bank’s practice for its assumption about the Canada-U.S. dollar exchange rate in its economic models.

The Bank of Canada is right that futures markets “are not a terribly good predictor of the outlook for crude oil prices,” Patricia Mohr, a commodity market specialist at Bank of Nova Scotia in Toronto, said in a phone interview. The futures market is “really a product of technical trading or hedging in crude oil and it’s not necessarily indicative of what the outlook for oil prices really is.”

* * *

The U.S. economy may need people more to give up work if it is going to get stronger.

A rise in retirements would be a positive for the economy because it should help boost consumption and housing in the near term, according to Drew Matus, deputy U.S. chief economist at UBS AG in Stamford, Connecticut.

As net wealth is increased by rising equity prices, the pickup in retirements has led to a decline in unemployment rates for workers age 25 to 34 as they fill slots left by baby boomers leaving the labor market.

To Matus, this should mean an increase in household formation as young workers have the confidence to set up homes. It should also reduce the labor force participation rate -- which measures the share of working-age people holding a job or seeking one – and therefore unemployment.

Given that younger workers have low savings rates relative to workers nearing retirement, the shift should also reduce savings and boost consumption, Matus said.

To contact the reporter on this story: Simon Kennedy in London at skennedy4@bloomberg.net

To contact the editors responsible for this story: Craig Stirling at cstirling1@bloomberg.net Paul Badertscher


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