“When will these guys ever learn that maybe, just maybe, these Fed policies aimed at targeting asset prices at levels above their intrinsic values is probably not in the best interests of the nation?”

-Dave Rosenberg, chief economist and strategist at Gluskin, Sheff

>

It is taken for granted that a rising stock market stimulates the animal spirits, sending consumers off shopping.

The basic premise of the wealth effect is well known: As the value of stock portfolios rise during bull markets, investors enjoy a feeling of euphoria. This psychological state makes them feel more comfortable  — about their wealth, about debt, and most of all, about spending and indulgences. The net result, goes the argument, is that consumers spend more, stimulate the economy, thus leading to more jobs and tax revenues. A virtuous cycle is created.

The rule of thumb has been that for every one dollar increase in a household’s net equity wealth, spending increased 2-4 cents. For residential RE, the increase is even greater: Consumer spending increases 9-15 cents (depending upon the study you use) for every dollar of capital gain.

The problem is, the theory is mostly nonsense.

I make this statement for two reasons: 1) the distribution of equities in the United States; and b) the classic causation/correlation issue.

Let’s start with equity ownership. The vast majority of Americans have a rather modest sum of cash tied up in equities. 401ks, IRAs, investment accounts — these are primarily the province of the well off. Ownership of equities is heavily concentrated in the hands of the wealthiest Americans. Start with the top 1%: They own about 38% of the stocks (by value) in the US. The next 19% owns almost 53%. That leaves the remaining 80% of American families with less than 10% stake in the stock market (See Federal Reserve’s Z.1 Flow of Funds report for the most recent info).

How is THAT going to cause a wealth effect? Especially when you consider the median family’s stock portfolio is worth well under $50k. These are the millions of families who are the principle consumers of cars, food, clothing, electronics, energy, health care, etc. To them, a rising stock market is nearly meaningless.

The biggest investment for the typical American household remains their home, with a median value of ~$200k. Put 20% down, and you see a 10 to 1 leverage. The impact of Real Estate on any wealth effect is much greater than the stock market. Unfortunately, homes remain somewhat overvalued — 10-15% by our measures — and are in a downtrend. They are not contributing to improvements in consumer spending in any meaningful way.

Our second factor is quite simple: The causation/correlation problem. In the 1990s, the Fed under Alan Greenspan look backwards, focusing on the stock market gains. But I suggest they would have been better off looking at the myriad factors impacting consumer’s psyches: Plentiful jobs, wage increases, economic expansion, labor mobility, modest inflation, and bountiful credit availability. These are sufficient to explain the behavior of consumers. Its not a secular bull market in stocks that causes the consumer spending — its all the other contemporaneous elements that are the prime drivers. [Update 06.26.12: In other words, the same factors that drive a healthy economy and make consumers feel positive also drives equities higher]

~~~

Regardless of your views of QE2 — if the Fed is doing it create a wealth effect, they are wasting their time and money.


>

See also:
Housing Wealth and
Consumer Spending
January 2007
http://www.cbo.gov/ftpdocs/77xx/doc7719/01-05-Housing.pdf

Wealth, Income, and Power
G. William Domhoff
September 2005 (updated September 2010)
http://sociology.ucsc.edu/whorulesamerica/power/wealth.html

Housing Wealth Effects: Housing’s Impact on Wealth Accumulation,
Wealth Distribution and Consumer Spending
Eric Belsky and Joel Prakken
December 2004
www.jchs.harvard.edu/publications/finance/w04-13.pdf

Consumption and the Wealth Effect: The United States and the United Kingdom
Remarks by Governor Edward M. Gramlich
Before the International Bond Congress, London, U.K.
February 20, 2002
http://www.federalreserve.gov/boarddocs/speeches/2002/20020220/default.htm

Category: Federal Reserve, Markets, Psychology, Really, really bad calls

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

66 Responses to “Wealth Effect Rumors Have Been Greatly Exaggerated”

  1. Winston says:

    I am glad to see that we agree on this, Mr. Ritholtz. The ridiculous “wealth effect” scheme was, in my mind, doomed before it was conceived. Bernanke and his like-minded ilk at The Fed show very little understanding of human psychology outside their tight little circle.

    Who in their tiny little mind is going to hire, purchase and, otherwise, bestow money based on their investment portfolio’s value? From concept to action – the plan is just daft.

  2. machinehead says:

    Even if there were a wealth effect, the fundamental problem with trying to stimulate it is that central planning of asset prices leads to disastrous results.

    Both the tech bubble (Bubble I) and the housing bubble (Bubble II) produced horrendous asset price slides in their aftermaths.

    Now Bernanke is seeking higher stock prices, even though stocks are already richly valued on traditional valuation measures. In other words, he’s trying to blow up Bubble III.

    This will go down in history as Bernanke’s Folly. The fallout will be so awful, that there’s a good chance the Federal Reserve will be abolished. Good freaking riddance to the value-subtracting central planners.

    How many PhD Econs does it take to dig a ditch in the hot sun? I don’t know, but I think we should run the experiment.

  3. toddie.g says:

    Has Rosenberg considered the possibility that the Fed is just continuing overall government policy of deliberately keeping the wealth effect targeted to the top 10% of the population, and not trying to broaden it? It’s just trickle down economic theory, in essence. The problem being that the trickle down is the experience of being that puppy in the bottom cage in a puppy mill.

    The move towards a plutocracy in the United States continues unabated, particularly in this decade. The top 10% gets wealthier and corporations generate record amounts of cash on their balance sheets while financially engineering tax rates as low as 2.4% like Google, at the same time as the average American gets poorer, balance sheets of the Federal government, state and local governments are eviscerated as tax revenues collapse, with tax cuts leading to 45 year lows of tax revenue as a percentage of GDP.

    It can be argued the policies of the last 30 years, and particularly this decade, has effectively created a massive transfer of wealth from the average American to the top 10% and corporations, creating a plutocracy where all the wealth and all the power is concentrated in a few hands, disempowering anybody else. Now with the Supreme Court’s Citizen United decision where unlimited corporate money unchecked by any required disclosure can virtually assure election results, it reinforces the distinct possibility the US becomes increasingly more a plutocracy, not less.

  4. [...] Don't get to excited about the stock market's "wealth effect".  (TBP) [...]

  5. BennyProfane says:

    “Plentiful jobs, wage increases, economic expansion, labor mobility, modest inflation, and bountiful credit availability.”

    Exactly. Especially the “bountiful credit availability” part. It’s absurd that the argument is even being used right now at a time that most of the “little people” have fled the market for safety in bonds and other investments. When I hear this wealth effect being rolled out again, I have to wonder if just BS, or another symptom that the actors in the financial industry are that isolated and clueless from the rest of us.

  6. I suspected that the Fed’s QE2 was intended to lower interest rates farther out on the curve, but by limiting the purchases to shorter durations, the long end of the curve has spiked back!

    It seems that they should have been taken at their word that they were counting on the wealth effect as Reuters opined some time ago in “The Fed is Counting on Phony Wealth Effect”

  7. ubnutsagain says:

    “Regardless of your views of QE2 — if the Fed is doing it create a wealth effect, they are wasting their time and money.”

    —–

    Absolutely right, BR!!

    Go to the head of the class.

  8. Here’s the ironic part: The wealthy won’t be spending any additional monies.

    Studies show that additional income — dividends, windfalls, even tax rebates — are saved, not spent by the wealthy.

    If QE2 is based on the wealth effect, its unlikely to succeed.

  9. curbyourrisk says:

    “How is THAT going to cause a wealth effect? Especially when you consider the median family’s stock portfolio is worth well under $50k. These are the millions of families who are the principle consumers of cars, food, clothing, electronics, energy, health care, etc. To them, a rising stock market is nearly meaningless.”

    Sorry Barry, have to disagree with you here. It never was or is about actual wealth effect, but the APPEARANCE of good times. They want people to believe that things are better. Since the MEDIA harps on the stock market as a measure of good times….incorrectly I might add…. that is what they chose to push. Simply the appearance of a strong stock market is expected to spur spending.

    Obviously…we all agree that what ever they are doing IS NOT GOING TO WORK. Nothing will work until the debt is discharged from the system, one way or the other.

  10. cognos says:

    Rosenberg is an idiot. He’s was a mad raving short at 900 on SPX in summer of 2009.

    I assume he’s been bearish since 1985. Why is anything he says interesting? (Ans – Its not!)

    The Fed is not targeting “asset prices” despite all the raving of mediocre thinkers like DR. The Fed is target ACTUAL PRICE INFLATION. Again, we remain in deflation on the main CPI measure (down since summer 2008, and therefore lagging by 5% versus “expectations”).

    Is not “stock prices” that have house prices and commodity prices OFF BY 30% in 2-yrs. Its just PRICES.

    Why does this seem so complicated here? Go look at some historical commodity price graphs… they ARE NOT high. They are off 30-50% since summer of 08. Many are down on long-term trajectory. For example CORN is DOWN 10% FROM 1993 PRICES!

    Seriously, this stuff is really simple. Inflation… worldwide… has been on a continuous long-term decline in almost every country. What were US inflation readings in the 1990s? They were 3%. In the 1980s? They were 4%. Why dont you people get that 1.5% inflation (following depression-style negative price shock) is the problem?

  11. MayorQuimby says:

    Fed has no business targeting anything.

    The ONLY thing the Fed should do is provide liquidity WHEN IT IS REQUESTED. It should not be attempting TO FORCE CREDIT CREATION down our throats.

    Which is why they ARE targeting higher inflation. That forces credit initiation and credit growth is ESSENTIAL to keeping the whole system afloat.

    Remember – we’re talking about individuals that spend their entire lives at higher-end restaurants and locales. They have no idea what life is like on ‘the bottom’. They only have sheets of paper telling them what we’re GOING to do.

    They’re failing miserably and will continue to fail.

    The only hope we have is to have Congress cut spending and raise taxes in the midst of the worst recession in 75 years. If they don’t, our debtload will run away from us towards the event horizon after which we will default. You REALLY don’t want THAT.

  12. Key takeaway from BR’s post: “The impact of Real Estate on any wealth effect is much greater than the stock market.”

    The effect of rising stock prices on consumer sentiment is a drop in an empty bucket of wealth. It’s hard to create a wealth effect when so many people have a negative net worth.

  13. cognos-

    You really think the mandarins at the Fed can target “actual” inflation, or inflation in any one thing at all. Yes, they will drive prices up, but they really have no idea where or what effect it will have. It will certainly hurt older Americans on fixed incomes first, but then, the whole policy seems bent on helping those in debt, but only indirectly and with the unhelpful effect of having everyone’s cost of living increase.

    Remember, this same august body was actively encouraging ordinary people who could not afford fixed rate mortgages to speculate on interest rates via variable rate loans – how could anyone expect them to target anything?

  14. call me ahab says:

    this post fits in nicely w/ my snarky post to Invictus yesterday:

    “. . .and you have to admire the central bank of a country- whose stated goal (via QE2) is to force stock prices up so people will spend more- and (via QE2) to lower rates (that are already rock bottom)- so people will borrow and spend more (maybe those few basis points will make all the difference?)

    All I can say- it makes me feel confident we got the right man in the right job- dude really knows what he’s doing”

    Ben “there is no housing bubble” Bernanke- he’s the man

    Also, Cognos = tool

  15. phb says:

    Not crazy about agreeing with Cognos, but in this case he is mostly correct. The issue is clearly deflation, however, Rosie is far from an idiot. I believe if you actually read beyond his headlines you would see that Rosenberg believes that deflation is the issue as well and there are other methods to combat than massive buybacks.

  16. phb says:

    Also, doesn’t QE2, et al, seem to be akin to our broken Social Security system? Where does this end?

  17. wngoju says:

    BR: Not sure I agree. This post (http://goo.gl/k9JUr) makes a case that the middle class does not matter. A cynical, but possibly true observation. How depressing…

  18. KentWillard says:

    Asset inflation is the illusion of wealth – no good or service is produced, no one is employed. It is an incentive for speculation, not investment. Asset inflation leads to bubbles, which when they burst destroy savings. And asset inflation creates a lower standard of living for people that have to consume the asset rather than speculate in those assets (rent a house, buy a commodity based good).

    I think too many people are confusing this kind of inflation with price wage spiral inflation, or the hyper inflation caused by the government creating money to pay their expenses. Both of those lead to general, and in particular wage inflation. There is no sign of that here because the new money doesn’t circulate through the economy.

    But Austrians are so brain damaged by their theory that they define inflation as an increase in money supply (not an increase in prices).

    http://www.kentwillard.com

  19. Petey Wheatstraw says:

    Exactly, BR.

    As if we (the middle class) haven’t already been played for fools and taken the beating of our collective lives. The moment of truth will come when the reality of the wealth transfer that has taken place becomes undeniable to the citizenry, generally. On the ‘have’ side (top 2%, or so), vast sums of cash and assets are being siphoned from the system while the getting is good (the sheriff is in on the crime). On the “have not” side (the lower 98% — even those who think they are above this), it’s unemployment and/or debt slavery and/or financial devastation all around.

    Eventually, even the most dimwitted and deluded among us will recognize that they have been screwed. That’s when the really interesting times will start.

  20. cortezj29 says:

    Our situation is so simple but the solutions are being obfuscated by the corporate elite dominated government. In a world of massive supply, the serial bubble blowing has led to artificial debt-based demand which effectuates a wealth transfer to the business world. Blowing further artificial debt-based demand is failing because main street and small business isn’t willing to take on debt and burned banks aren’t willing to extend credit to marginal borrowers, including small businesses. However, the disinflationary trends will prevail until oversupply is reduced to match income based debt adverse demand.

  21. PrahaPartizan says:

    What accounts for the business press’s almost total focus on what is happening on Wall Street – right now? Is this single-minded attention to almost nothing but the current market index fluctuations simply the final result of the dumbing down of American media? After all, it doesn’t take much money or talent to simply present the pecuniary porn that are the jiggles in the DOW and NASDAQ with breathy undertones. With only the sizzle being presented in the media, who has time or attention for what is really undermining the economy?

  22. wngoju,

    this http://www.businessinsider.com/what-americas-latest-recovery-has-exposed-is-the-fact-that-a-large-chunk-of-american-consumers-dont-matter-to-the-economy-2010-11

    is, actually, a good article..

    one that should be read, and understood.

    we should recall that it wasn’t that long ago, 2004, that John Edwards was reminding the Polity that: “There are “Two Americas”"

    http://search.yippy.com/search?input-form=clusty-simple&v%3Asources=webplus&v%3Aproject=clusty&query=John+Edwards+Two+Americas

    ~~

    as an aside, for those still playing the “What letter-shape will the ‘Economic Recovery’ take?”-Game

    get out your Mirror, and go with: “y”

  23. AHodge says:

    Agree its for the affluent
    Agree its lower than for house prices
    However, to put my geek hat on.
    2% is pretty dam low, hand the nation $1000 and they spend $20? also by my earlier calculations it only gets spent with long lags sometimes year or more. you may argue stock prices or gains not “real” but they realizable, or at least cash convertible even for pensions IRAs. That 2% is noticeable as % of the entire stock market valuation. its also arguable that money growth will raise other asset prices?

    While i think Capital M Monetarists are academic buffoons, generally worth less than zero…
    money expansion has some effects
    1 it weakens the currency –strong relation
    2 it raises asset prices generally, less strong relation
    3 it can raise inflation–weaker and longer lagged
    4 it could raise growth-weakest relation, relying in part on the first two, but could be more than offset by inflation and bond yields

    QE 2 is a desperate act, and only makes last ditch sense..
    1) if they wont do the right things, namely fix finance
    2) it works in the near term

    bigger deficits, spending or tax cutting, also stinks to high heaven,
    but might be slightly preferred to QE if they cannot do the right and obvious thing

  24. cortezj29 says:

    @ Kent
    The effect of rising stock prices on consumer sentiment is a drop in an empty bucket of wealth. It’s hard to create a wealth effect when so many people have a negative net worth.

    ____
    Additionally, so many people lost half their stock wealth in the tech bubble and built it back up to watch it evaporate again in 08. Essentially, most Americans have been fooled twice. There isn’t going to be a third time as these people will take low yield over risk perceived to be massive.

  25. stevea says:

    Barry

    Could not agree more, perhaps the chairman is following Greenspans lead in so much that perhaps the target of the wealth affect is not individuals but businesses, particularly as it relates to hiring. Thinking goes that wealth affect is translated into higher capital spend, hiring, and so on. It is highly likely that corporations have gotten all of the feel good affects from intervention already and are focused on bad public policy instead

  26. MayorQuimby says:

    “Our situation is so simple”

    Actually, it’s close to impossible.

    We need to cut spending and increase revenue but any cuts in spending will decrease revenue.

    We’ve backed ourselves into a corner and getting out will be incredibly difficult.

    Nothing in life is simple. Life is difficult.

  27. Guambat says:

    Guambat cannot for the life of him understand how Mr and Mrs Main Street are going to be gladdened and have their confidence restored if Wall Street keeps getting wealthier.
    Saving whose asset ?

  28. b_thunder says:

    **** “if the Fed is doing it create a wealth effect, they are wasting their time and money. ” ****

    EXCUSE ME, it’s their time all right, but since when it’s ***THEIR*** money ???? Simply because they can print it? If it’s their (Fed’s) money, if they can make the unlimited quantities of their money as they’ve been doing lately, that makes Us the People of this United States, the Fed’s slaves in the worst, and the indentured servants int he best case.

    If it’s “their” money, then I call for an immediate regime change!

    Also, a minor correction: “home, with a median value of ~$200k. Put 20% down, and you see a 10 to 1 leverage.” – 20% down implies 5:1 leverage, not 10:1

  29. ToNYC says:

    “…if the Fed is doing it create a wealth effect, they are wasting their time and money. ”

    The wealth effect is not at all wasting the FED Corporation’s time and money. The FRS protection program to preserve the bank monopoly on money and interest creation is indeed transferring wealth while this long, turgid debate proceeds. Our future indebtedness and diluted saved currency now rendered valueless in earning interest being their exclusive using their better, newly-made for bank earnings only Notes is assured in trade for their Wealth Effect. This Effect of course is not what the republic is expecting, but all the dithering debaters really deserve in their desire to swap Security for Liberty. The FRA of 1913 has permitted the kidnapping of the Free people’s agenda and have no humanity to lose in the bargain.

  30. ZackAttack says:

    I’ve been saying this for a while: Cite me a credible body of empirical evidence that would plausibly lead me to believe in the existence of a “wealth effect” and in central banks’ ability to influence inflation expectations through asset price targeting.

    In the absence of such evidence, a half-assed academic belief system is an awfully thin premise for an unelected 4th branch of government to use as an excuse to undertake the largest social engineering experiment in world history.

  31. dougc says:

    If you want to lead the victim (middle class) to voluntary walk into the slaughter house you tell him it’s going to be OK. They deserve what is coming.

  32. Mannwich says:

    @DR: But luxury spending is back and that’s all that matters to those running the show.

  33. carleric says:

    This entire scheme is simply the Fed – led and controlled by Bennie -pandering to the Wall Street investment banks and the market in general. The only people feeling richer are those getting richer….the banks, brokers and their ilk. Will increasing debt and feelings of good times are here again work? Not in this lifetime. Everybody needs to tightent heir belts, accept the realities of a lowered standard of living, a scale down of spending and a total change in the nation’s current mindset.

  34. fugazzi says:

    BR, you don’t get it…”wealth effect” works when combined with “trickle down” effect…all that fantastic wealth that the top 1%/10% enjoys allows the rest to live, as spa operator/manicure/massage, baristas, nannys, waiter, cab/limo driver etcetc…what’s not to like? -)

    What, you want real jobs, with a decent living wage and healthcare and retirement benefits? you a communist or somethin’ ?

    Seriously, big drawback you forgot is that even if there were a wealth effect, all that “extra consumption” is unsustainable since asset prices can’t go up forever…but the economy gears up to supply those goods and services, and when the game stops, you have massive oversupply of, well, everything…

    This is really just basic economic principle..fix the price of something (money/credit) and if it’s too low or too high (which it will always become at some point) you create surplus or deficits…do it long enough, and you’re in big trouble…

  35. Mannwich says:

    So the Fed’s policies basically boil down to one giant confidence game. The Sheeple are supposed to see OTHERS (namely on Wall Street and in the executive suite) getting even wealthier and that will make US confident enough to spend money on things we don’t need and still can’t afford, yet again, to blow yet another bubble. Is that that plan?

  36. Thor says:

    Great post BR!

  37. MayorQuimby says:

    There sure as hell IS a wealth effect -

    When Blankfein eats out at Jean Georges with this newly printed money, he tips the waiter. After taxes, the waiter is left with a few sheckles of brand new wealth.

    HOORAY!!!!

  38. ToNYC says:

    “In Tale of Two Cities”, didn’t the noble carriage owner allegedly toss a Livre to the youngster crushed by his ride? That too is the Original Wealth effect-the ability to provide for the necessary serfs so important to the good life. Gaspar de Portola had a similar narrative in 1769 to the indigenous people on the coast they chose to harvest for the Queen of Spain. They pointed to the abalone, but de Portola had other ideas to earn his reward and kidnapped the slow learners, and converted them to indentured servants.

  39. MBD1120 says:

    20% down on a purchase implies 5 to 1 leverage, not 10 to 1, as you implied. Not that 5 to 1 isn’t significant, just want to make sure you have your math right.

    Nice piece overall, very insightful.

  40. cpd says:

    If they want a wealth effect, they should raise rates back to 5%. The savers (i.e. those with the capacity to spend) will be more likely to spend. As one of those savers who has refused to go into the stock market (which is a ponzi scheme), no way do I loosen up on spending while this ridiculous wealth transfer to the borrowers (mostly banks) continues.

  41. ~This is good:

    “Our situation is so simple but the solutions are being obfuscated by the corporate elite dominated government. In a world of massive supply, the serial bubble blowing has led to artificial debt-based demand which effectuates a wealth transfer to the business world. Blowing further artificial debt-based demand is failing because main street and small business isn’t willing to take on debt and burned banks aren’t willing to extend credit to marginal borrowers, including small businesses. However, the disinflationary trends will prevail until oversupply is reduced to match income based debt adverse demand.”

    ~This too:

    “Seriously, big drawback you forgot is that even if there were a wealth effect, all that “extra consumption” is unsustainable since asset prices can’t go up forever…but the economy gears up to supply those goods and services, and when the game stops, you have massive oversupply of, well, everything…

    This is really just basic economic principle..fix the price of something (money/credit) and if it’s too low or too high (which it will always become at some point) you create surplus or deficits…do it long enough, and you’re in big trouble…”

    ~This is not:

    “Seriously, this stuff is really simple. Inflation… worldwide… has been on a continuous long-term decline in almost every country. What were US inflation readings in the 1990s? They were 3%. In the 1980s? They were 4%. Why dont you people get that 1.5% inflation (following depression-style negative price shock) is the problem?”

    But Keynes, as usual, said it best:

    “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”

    ~Bernanke’s printing scheme is already failing. Check out T-bond prices since the announcement of his program. This is good. There is no monetary solution to our problems. Maybe, just maybe, after the latest round of printing fails to move the needle of monetary velocity; fails to reanimate those animal spirits; we can discard finally the completely cock-eyed idea that economic fundamentals can be substantively altered by tinkering with the method by which we account for them.

  42. Sechel says:

    The point on wealth effect is well taken.

    B.R. since rates can’t really come down, I’m left with the conclusion that the goal is two fold:
    1) Lower the dollar in the hopes of increasing exports(which will fail)
    2) Transfer funds from the Fed to the banks via front running POMO

  43. Mark Down says:

    Don’t even try to fight the 24/7 go out and shop till you drop media…….

  44. DrungoHazewood says:

    Mannwich,

    Let’s add the wealth effect bullshit to the ‘let bubbles run wild, and mop up after’ bilge. No need to point out where all these money vectors point.

  45. Arequipa01 says:

    A few random questions:

    what if QEII already happened? What if the intended was to pump commodities to jam a deadly bubble into China’s manufacturing complex which was tottering? What if all hell is going to break loose on Nov. 26? What if gold doesn’t bounce at 1290? What does the decline in production in India mean?

    Also, how can the BOVESPA go up from here? All the deals are being renegotiated with Dilma and her cadre, so is BZQ worth a look?

  46. Mannwich says:

    @Drungo: It’s not even about “letting bubbles run wild”, it’s about being one of the main drivers of said bubbles. Seeing who ends up winning and who ends up losing in the aftermath of these bubbles over and over and over again, will make us better understand who the Fed really works for. Hint: It ain’t most of us.

  47. partimer1 says:

    If you knock down the gas price by a whole dollar, that dollar will go to the economy right way. if the gas price goes up by 30c, like the result of this QE2 BS, then that 30c get sucked out from the economy, pretty much instantly. funny enough, the gas price and food price are not in the CPI index. How can you grow anything when the oil is at $87 except to grow OPEC’s coffer?

  48. Arequipa01 says:

    Also, speaking of bubbles, indulge me a brief bulletin from Urubamba, Peru- 2010 CADE, so this prof from Haaaahhhvvaaahdddd, ahem , Harvard, Michael Porter gives a talk, blah, blah, competitiveness, effficiency, blah, blah,…distribution of growth, blah, oh and by the way a financial bubble is being blown in Perucito….aqui cae el silencio y croa una rana…qué?…

    Felipe Jaramillo, IMF minder for Peru and environs, leaps into the breach and pulls out his best tut-tut, and a foyne and effective tut-tut, it is, it is…and does it over and over again de nuevo y otra vez with any reporter who will take dictation from him.

    So, what’s the over/under on a financial bubble in an emerging market economy which has been accumulating real capital as the commodity run fills their coffers?

  49. partimer1 says:

    another thing I realized that the people making these monetary decisions don’t drive. therefore, they don’t have a clue what the real effects of oil price is except for the ticker price on the board.

  50. deanscamaro says:

    Great blog, Barry! Every time I read about believers tying stock market rises to increases in household spending, all I can do is shake my head. Any push like that is nothing but an effort by those on the upper end (as defined by your percentages) to increase their worth by heating up the market. The split between those with and those without just continues to get larger. I can’t help but imagine this picture of Wiley Coyote and The Roadrunner, with the boulder having just fallen and crushed The Coyote as The Roadrunner rips off down the road. Wiley Coyote is always on the losing end.

  51. Mannwich says:

    11K DOW we hardly knew ye. Again.

  52. rktbrkr says:

    Q: Whats the difference between Iceland and Ireland?
    A: One letter and one year

    I think the Irish are going to be Irish (stubborn and contrary) and not got for the bailout (a financial “GI shower”).(Given to someone who usually is in need of a shower but who refuses. The offender is forced into the shower (sometimes blindfolded) where others scrub him or her with scrub brushes or steel wool)

    The Irish comments about having enough cash til mid 2011 reminds me of the comments Lehman and Bear were making until they suddenly didn’t have any money.

    http://www.tucsonsentinel.com/nationworld/report/111610_ireland_existence

  53. gordo365 says:

    What creates a wealth effect in my family’s home is paying bills, setting aside savings for long term, and then having some cash left at end of month.

    Even better – having enough of those savings to buy an asset (rental property, oil-change shop, car wash etc) that has positive cash flow each month.

    I guess for me – I’d rather build wealth than build a wealth “effect”.

    Is that normal/typical/representative?? Don’t know.

  54. swervin says:

    just my opinion but i think it is quite notable recently that when the data was bad (both hard and soft data) and everyone talking double-dip the market was down, whereas as recently as the market has risen all the data has looked much better…as you seem to be saying the higher market might be an effect rather than a cause, but maybe it is just a virtuous circle…there are some soft indicators like consumer confidence, leading indicators etc (maybe even the ISM?) that clearly turn on the level of the sharemarket, but things like retail sales, consumer spending have been ok of late as much as you can pick holes in the data..

    of course, there is no right answer here because the wealth effect cannot really be quantified but…i am pretty sure.

    also it is not just the consumer… corporate America will probably be more likely to expand, invest, hire, takeover when “its” share price is high – is there really any doubt a strong sharemarket is good for the economy overall? I guess this is a circular argument…

  55. Marc P says:

    This is sick on sick.

    The financial press focuses on two things: GDP and Dow. GDP went down, so the gov’t borrowed and spent, and said voila! Our economy is back to $14T and thus things are fine. The Dow went down, and so the gov’t forced interest rates to zero to encourage money to go into equities, and the HFTs fired up to pump up volume to make the market look appealing. The Dow went up, and voila! Everything is fine.

    Even the brightest have jumped in, evidenced by BR’s many recent posts about not standing on the sidelines when the market is going up, about how the naysayers have talked about fundamentals while the market went up 83%, and you can be right or make money, etc. He hopes there are enough chairs for him when the music stops. Everyone currently in the market hopes there will be enough chairs when the music stops.

    This is beginning to look like a classic late-90s pump and dump isn’t it?

    Folks, we have two options. One is that the Treasury and Fed are stupid. The other is that they know what they are doing and have an agenda. Consider who benefits from the market rise, and then make your decision.

    There are three notable things about stock trading over the past 20 years. The large trading houses are now playing with other people’s money, leverage has gone to the moon, and they have devised derivatives and methods to bet on almost anything, and in particular to be able to bet on things going bad.

    All that’s left is for them to predict the timing so they can place their appropriate bets. Who controls the direction of the market now? The Fed, a private company owned by those very same trading houses. Who makes decisions at the Fed? Those very same trading houses.

    For them, “investing” isn’t like shooting fish in a barrel. This is shooting ducks in a barrel.

    Just remember the saying about playing poker: “If you’re in a game with strangers and you don’t know which one of you is the sucker, it’s you.”

  56. Blissex says:

    «The basic premise of the wealth effect is well known: As the value of stock portfolios rise during bull markets, investors enjoy a feeling of euphoria. This psychological state makes them feel more comfortable — about their wealth, about debt, and most of all, about spending and indulgences. The net result, goes the argument, is that consumers spend more, stimulate the economy, thus leading to more jobs and tax revenues. A virtuous cycle is created.»

    The major effect by widespread capital gains sought is a massive redistribution of income from “unproductive” low earners to “productive” high earners (e.g. Jimmy Cayne or Angelo Mozilo): capital gains are income (taxed at a low rate) and the bigger capital gains go to those who already earn a lot, as a rule low earners own little capital, and high earners own lots of capital.

    If all house prices double, those owning a $100k home get a (largely untaxed) windfall of $100k, and those who own a $1m home get a (largely untaxed) windfall of $1m, and this redistributes a lot of purchasing power from the owners of the $100k houses to the owners of the $1m houses. Same for stock prices: the vast mass of “unproductive” low earners with the median 401k of around $40k will benefit from a doubling of stock prices a whole lot less than “productive” high earners with a $1m stock account.

    Of course the “unproductive” low earners with little capital are absolutely gagging for windfall capital gains that increase their nominal wealth, as they think they are getting it by screwing those with even less or no capital, while they don’t realize that in practice it is those with a lot more capital than they do who are the real winners.

    «The rule of thumb has been that for every one dollar increase in a household’s net equity wealth, spending increased 2-4 cents. For residential RE, the increase is even greater: Consumer spending increases 9-15 cents (depending upon the study you use) for every dollar of capital gain.»

    This is an average across a very large spectrum of wealth. The median 401K has $45k in it, and many house owners have negative or negligible equity.

  57. mharring says:

    I agree the positive wealth effect of the financial markets is dubious. Certainly the gyrations of the past decade would dampen any popular enthusiasm for the illusion of temporary riches. (One thinks fondly of the innocent days of that E-trade TV commercial of boom and bust on a computer screen.) After tech/telecom crash it was fairly obvious that retail investors abandoned equity markets for the nirvana of a man and his castle. Home prices became the new financial gamble – one that was supposed to never go down.

    I suspect QE2 is meant to continue to support risky asset prices and punish cash savings, but I’m sure the Fed hopes that leaks into the housing market and the consumer economy. However, I doubt that is likely anytime soon. Home owners not only consumed off re-fis and HELOCs, they adjusted their psychological retirement endowments to the rising value of their houses. Now that that fantasy bubble has burst, wealth expectations have been greatly diminished, even for those who have substantial equity in their homes.

    So I suspect the Fed is battling the persistent negative wealth effect of housing. Lower interest rates won’t make a significant dent in this and one wonders how much capital is just waiting on the sidelines for rational pricing to return to real estate? In the meantime, as deleveraging coexists with QE2, we should see relative price bubbles in a variety of financial and near-financial assets. The casino is still open for business.

  58. Blissex says:

    «The financial press focuses on two things: GDP and Dow. GDP went down, so the gov’t borrowed and spent, and said voila! Our economy is back to $14T and thus things are fine. The Dow went down, and so the gov’t forced interest rates to zero to encourage money to go into equities, and the HFTs fired up to pump up volume to make the market look appealing. The Dow went up, and voila! Everything is fine.»

    As you and other have likely already figured out, total GDP (as opposed to median GDP-per-person) and capital gain are of interest to the narrow group of large property owners; the wider group of medium and small property owners are getting shafted, but they are deceived by appearances, and the financial press targets them with their stories. The rest? Well, what do they matter? There is a long queue of people willing to work for a lower price in China, India, etc.

  59. Marc P says:

    Blissex, agreed with one refinement: that total GDP is of most interest to a narrow group of business owners. More GDP = more sales = higher stock prices and thus executive compensation.

    What is silly is the financial press and the Fed drooling over higher GDP when personal incomes are going down. That’s like bringing champagne to your annual board meeting when your revenues have gone up but your company is now losing money. “We lose money on every sale but we make it up on volume!”

  60. [...] The wealth effect is greatly exaggerated.  (Big Picture) [...]

  61. Estragon says:

    As an owner/manager of SME’s for some years, I have to say there was definitely a wealth effect of sorts on and through me. Stocks etc. outside my operating businesses were my only cushion if something nasty happened. If that cushion was reduced in value, it absolutely made me operate more conservatively than if it was performing well. The reverse was also true; if the operating businesses were doing well, my investing style was less conservative than if I thought the cushion might be needed to get a business through a stuff-happens period. I never trusted that bank lines would actually be there if I ever actually needed them.

    Being more conservative meant holding off on hiring, expansion, new projects, etc., which obviously has knock-on effects on others as well. Maybe I’m just the exception that proves the rule though.

  62. rfullem says:

    the Fed, amazingly, has, once again, flipped the concept of productivity on its head. The marginal cost of “working hard and saving” balloons if you are not also an asset (risk) owner. Insanity. Financial/economic risk goes up, productivity down. 1. asset owners usually invest outside of own expertise and depend on Fed to “save the day” 2. those without assets lose incentive to work (got to be in it to win it). Wall Street (asset owners) defines productivity as throwing Fed or taxpayer cash at falling incomes. Amazing.

  63. philipat says:

    A perhaps more interesting issue raised by this data is whether the US economic model is sustainable in the face of such massive concentration of wealth, particularly with the unavailability of healthcare for an increasing number of Americans, a breakdown in the rule of law and a structural unemployment problem? Is it not increasingly taking on the characteristics of a Banana Republic?

  64. sellstop says:

    If we would make social security sustainable, that would take alot of uncertainty out of retirement for many people. The social security program was the biggest wealth effect of the last seventy years. It took the urgency out of saving for retirement. People did not have to have their parents move in with them in their old age, and they didn’t need to see people starve when they couldn’t afford food. Kind of a moral hazard thing, but moral hazard is not necessarily bad if it is done responsibly and regulated to keep the capitilists from gaming the system. Single payer medical could do the same.

  65. One of the key assumptions of the wealth effect theory is that households need to perceive the changes in wealth as being permanent. Otherwise it doesn’t hold. Well, this is readily verified. Who thinks the stock market, commodities, gold and what not have absolutely NO chance of crashing whatsoever? Certainly not people who have seen their pension funds melt during the recession. So yes, Barry you are very right. Banking on the so-called wealth effect at this time is a pure act of desperation.

  66. [...] Ritholtz from the Big Picture makes interesting remarks on the wealth effect theory, rightfully noting how useless the theory is [...]