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Real Net Household Wealth Hits a New High


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September 30, 2005

Real Net Household Wealth Hits a New High

Michael Mandel

The wealth of Americans just keeps rising.

I like to keep track of what I call "real net household wealth". That is, household net worth, subtracting out federal government debt, and adjusting for inflation. In effect, this measure assumes that households will have to eventually pay back all of the debt, and it accounts for debt owned to foreigners as well.

And guess what? This measure hit a new high of $45.3 trillion in second quarter, up 7% over a year earlier, and significantly higher than the boom peak of $44.4 trillion.

And it's not just housing either. Real household net worth would have risen by 3% over the past year, even taking out the value of real estate.

07:04 AM

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Michael,

That chart seems to map the DJIA rather closely.

It also does appear that REAL wealth creation grows at a solid 4% CAGR, which is higher than GDP growth.

Plus, the curve seems rather smooth over the long term, so if the Real-Estate bubble crashes, the rise in wealth growth to the trendline might necessitate a big rise in the stock market. Do you agree?

Lastly, if this 4% real growth rate persists, but, as we know, most of the wealth gains gravitate to the top 20% of households. THis will probably not change. Does that mean that the wealth of the top 20% would potentially be growing at 15-20% per year? In other words, if 20% of the households are getting 80% of the gains, their growth rate might be 15-20%, while that of the bottom half might continue to be near zero.

This is not necessarily a bad thing, despite what the left says. It shows that the road to riches is more attractive in America than ever before. The most capable people are getting more than ever before.

Posted by: Kartik at September 30, 2005 03:08 PM

out of curiousity, have you tried to adjust for the valuation losses on US external assets -- with the euro at $1.20, the US will be giving up all of the valuation gains from currency moves in 04, and about 1/4 of the gains from 03. Total losses here are not entirely trivial -- $400b plus i think -- though no where near the changes linked to changes in valuation of the US residential housing stock.

Posted by: brad at September 30, 2005 05:24 PM

Brad,

I think the wealth number already includes exchange rate effects. For example, the market value of corporate equities should reflect any changes in the value of overseas corporate investments.

Posted by: Mike Mandel at September 30, 2005 05:34 PM

Kartik,

I don't actually know for sure that the wealth gains are all going to the people at the top. The distribution of residential real estate is less concentrated than the distribution of stocks.

Posted by: Mike Mandel at September 30, 2005 05:37 PM

It?? not all housing, but housing is more than half of the increase over the past year. I look at the total with some skepticism, because an increase in the market value of housing is not truly an increase in real wealth. At best it is a transfer of wealth from renters to owners. It does not change anything real about the housing stock itself, so it cannot directly increase true net real wealth. It has some indirect effects on real wealth (e.g., relaxing liquidity constraints), but these effects are not likely to constitute a significant increase in real wealth. (Of course there has been some increase in the real housing stock, but that?? obviously a small part of the story in the increase in housing wealth.)

Housing prices have risen primarily because of low long-term real interest rates (a lagged adjustment to the increase in the capitalized value of rents). The fall in long-term real interest rates over the past several years has also meant that financial wealth, measured as annuity value, declined relative to what is in your measure. That is, one may have more wealth in dollars today, but over time, one will not be able to buy as much, because one will not receive as much interest.

Posted by: knzn at September 30, 2005 06:30 PM

Michael,

What do you think the distribution is? Even if it is less skewed, it still may mean that the top quintile grows at 10%/year, while the bottom at 1%/year. Plus, your post itself mentioned how Real Estate is less than half of the gain, even in a record year of RE appreciation.

Also, if the RE bubble in California and other inflated markets corrects, for wealth gain to be on the same curve, that may imply a sharp increase in stock market values, just to get back to the 4% CAGR trendline. What do you think?

Posted by: Kartik at September 30, 2005 07:01 PM

knzn,

What you say *used* to be true in a closed economy, before we started selling mortgage-backed securities to the rest of the world. Now we can turn our housing wealth into real consuming power--basically we borrow from foreigners, using the value of our homes as collateral. The higher the real estate value, the more we can borrow. The mortgages get paid back from future income--so as long as the economy is growing fast enough, the housing wealth is no different than "real" wealth.

Posted by: Mike Mandel at September 30, 2005 10:53 PM

Michael,

Can you extend the chart back much further, say, to 1960? If not, how far back can you go?

Can you also overlay the S&P500 over it?

It would be interesting the long-term trend and corelation.

Posted by: Kartik at September 30, 2005 11:09 PM

Michael, I?? not sure I follow your logic. I would agree that the expectation of growth in itself constitutes real wealth, because the value of our human and physical capital depends on how much it can produce in the future. However, I don?? think the ability to borrow against that growth is a major component of wealth. It doesn?? mean that we have more wealth, just that we can consume our wealth sooner. The ability to borrow is worth as much as the difference between the maximum interest rate we would be willing to pay and the actual interest rate we do pay. Certainly the rising market value of housing has increased that difference, so it has added something to our wealth, but surely not nearly as much as the total increase in market value.

I would also agree that the ability to borrow due to rising housing prices has had a large effect on consumption, but I don?? regard that as a wealth effect. It?? similar to the effect of a temporary tax cut. A temporary tax cut produces little increase in wealth (arguably no increase in net wealth), but it does increase consumption because it enables people to consume now instead of later.

Posted by: knzn at October 1, 2005 11:10 AM

Mike,

Just wondering how much of this growth came from "Pure Tax Cuts" and how much wealth came from "Pure Investment/Profit Growth?" Because if the growth of wealth came from the shifting of cost to future generations does it count as growth or the borrowing of money?

Posted by: Henry Schlatman at October 1, 2005 05:00 PM

Hi knzn,

Wealth can be thought of as a claim on future flows of income. So, for example, Bill Gates is wealthy because he has a big claim on future flows of income of Microsoft, in the form of stock. And the faster that Microsoft's profits are expected to grow in the future, the more money that people are willing to pay him for that stock.

Such an increase in wealth appears to have some sort of foundation in real economic variables, such as future profits and productivity growth.

Housing wealth, though, seemed to be another type of beast altogether. Suppose that a home doubles in monetary value, but it's still the same home (3 bedroom, 2 bath, cracks in the living room ceiling). It's hard to say that the increase in monetary value reflects a real change in actual services delivered by the home. What's more, the only way to take advantage of housing wealth used to be to sell off the home--perhaps to someone who owned before, but eventually there has to be a current renter at the end of the chain.

That was yesterday. Today, in effect, a foreign investor can be at the end of the chain, buying up mortgage-backed securities. That housing wealth has passed the market test..somebody is willing to put up money for it who doesn't have to live in the home.

Housing wealth can now be monetized in the same way that stock market wealth is. It's now real wealth.

Posted by: Mike Mandel at October 3, 2005 12:19 PM

Michael (or Mike if you prefer) --

two points:

a) US equity prices should reflect the value of US FDI abroad, tis true. but what about changes in the value of US holdings of portfolio equity linked to currency? that is probably a negative 200b this year.

b) I accept part of your argument about monetization of housing wealth. And to extent that foreign investors buy up dollar denominated mortgages, they are taking the really big risks associated with the mortgage and the exchange rate. they have the interest rate risk and the exchange rate risk, not the US borrower. in my view, asian buyers (and probably oil exporters as well) have more or less locked in future losses -- a dumb investment, but maybe there are sufficient offsetting benefits. But i still worry that changes in their willingness to continue to buy financial claims on the US (at current rates) will quickly translate into falls in US financial wealth, as the existing stock is revalued at a higher interest rate. That of course assumes that interest rates go up, which is by no means certain, but it still strikes me as a risk. Of course, a fall in the price of US housing helps all those who don't already own homes -- but I gather than effect is kind of small v. the wealth effect.

Posted by: brad at October 4, 2005 12:26 PM

At least you divided by the price-level - something the National Review types (Malpass, Tamny, and Kudlow) never do. In terms of real wealth per capita, however, we are still $2000 per person lower than where we were in late 1999. See Angrybear (including my comment to my own post updating the calculation to 2005Q2) for details. Alas, this is almost as bad as Robert Samuelson's recent article claiming wealth has never been higher. I guess I owe David Wessells a thank you for not being as confused as Samuelson and the National Review!

Posted by: pgl at October 13, 2005 03:41 PM

Hi pgl

In the past I've sometimes reported real wealth per capita. I decided not to use it, though, because I don't have a good sense about what's happening to real wealth per capita in other countries, China and India in particular.

Posted by: Mike Mandel at October 13, 2005 08:02 PM

Michael - the International Financial Statistics reports population for each reporting nation and I'm sure this type of information is also available elsewhere. So if one can construct a measure of real wealth over time for a nation (this is often the hard part), then doing this per capita is simple division. BTW - I favorably noted your piece over at Angrybear as a nice way of wrapping up my week long tirade on this particular discussion. Cheers!

Posted by: pgl at October 13, 2005 08:25 PM

What does China and India have to do with this post?

And are the population numbers in India and China unavailable? Division is not that difficult.

Posted by: c&d at October 13, 2005 09:22 PM

It's comparable wealth figures which are missing for China and India, not the population data. And my problem is that in high pop growth countries, I'm not sure how much real wealth per capita has actually risen, so I'm not sure whether the U.S. is doing better or worse on a ten year basis.

Posted by: Mike Mandel at October 13, 2005 09:34 PM

By developed nation standards, the US is also a high population growth nation, not too dissimilar to India or Brazil. China is aging faster than Japan, more like a European country.

Furthermore, we have only the vaguest idea of what US population growth really is, or how many "households" comprise it right now. Illegal immigrantion is huge, and a huge question mark.

Finally, expectations of productivity growth in the US may be wildly optimistic. The rapid access to virtually unlimited cheap labor at all levels of economic activity appear to be causing a shortage of development in capital equipment and expansion. We're substituting cheap labor for technology R&D or investment - going flat or in reverse.

Finally, to the extent that mortgages are monetized and sold to foreigners, we may be a temporary beneficiary of risk takers. They may well change their mind, and decide to invest in their own plant and equipment rather than ours. I would, if I were them, with the longer view in mind.

Posted by: OldVet at October 14, 2005 10:28 AM

Michael, I?? still having trouble with your point about mortgage-backed securities. It seems you are trying to argue that anything used as collateral for an international loan should be valued for wealth purposes at its collateral value. In that case you could also consider asset-backed securities backed by credit card loans. The ultimate collateral for these is nothing at all, and yet they are increasingly sold internationally. If you want to say that the real value of our houses has gone up because they are valued more highly by creditors, then you would also have to say that the real value of our ??othing at all?has gone up.

The real question is, are we better off (i.e., wealthier) because the market value of our houses has gone up? The answer is, we are a little bit better off, because we can borrow more, and more cheaply, from abroad. However, it is quite a different matter to say that we are better off in proportion to the increase in market value. I don’t believe that we could actually sell a large fraction of our housing stock to foreigners at their current prices. Even if we could, we wouldn’t really be better off, because we would be stuck with financial wealth that now has a lower annuity value because of low real interest rates.

Posted by: knzn at October 14, 2005 01:12 PM

If I wanted to propose a "WEALTH" tax, does this indicate that It would be about 5% to collect about $2.0 Trillion, e.g. the current US Federal expenses? Second: Do you have a link to any indication of the distribution of wealth. We can get the distribution of Net Income from the IRS figures, but I wonder how the WEALTH of the country is distributed. Thanks... Note: If such comments are not "appropriate" here, I have put a link to this topic/question in: http://wematter.blogspot.com/2005/10/wealth.html

Posted by: Mike Liveright at October 14, 2005 04:30 PM

"The wealth of Americans just keeps rising."

The wealth of which Americans? I think you should divide Americans into 12 groups. Take the bottom 90% and divide them up into 9 equal groups. Take the top 10 and divide them up into 3 unequal groups, 9%, 0.9% and 0.1%. Then comput the mean income and net worth withing each group. So Bill Gates net worth goes up and 100,000 Americans have a negative net worth, but Bill's is so great it more than compensates for the negatives. What is so great about that?

Why don't our ingenious economists tell everyone how uch they loose on depreciation of automobiles each year? If it weren't for planned obsolescence of cars couldn't we all have greater net worth?

http://discussions.pbs.org/viewtopic.pbs?t=28529

DT

Posted by: dal_timgar at December 23, 2005 10:20 PM

This would be great knews if the accrual basis national debt weren't $45.5 trillion dollars. Each of us net in the hole.

Rationed healthcare here we come.

Posted by: Brad D at March 22, 2006 01:58 PM

This would be great news if the accrual basis national debt weren't $45.5 trillion dollars. Each of us net in the hole.

Rationed healthcare here we come.

Posted by: Brad D at March 22, 2006 01:58 PM


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