The Wealth Effect Jude Wanniski March 3, 1997

Memo To: Jonathan Fuerbringer
From: Jude Wanniski
Re: "Wealth Effect"

Congratulations once again. Your Sunday NYTimes report on the puzzling failure of the climb in the value of financial assets to be translated into increased consumer spending is another excellent effort. Allowing a great many people to express themselves on the subject provides several of the answers to the puzzle. Larry Lindsay has only a tiny piece of the answer when he says a rise in the wealth of a wealthy man does not increase his spending. A sudden, unexpected rise in the income of a young man on the other hand will shift him out of Chevrolets into BMWs. But of course most of the rise of equity values in the last several years — you cite $3 trillion as the number since '93 — has accrued to the broad population, not to a handful of multimillionaires. Just one of my clients, CREF, which manages the retirement funds for college teachers, has climbed in value by $60 billion in that span. The 125 million people in the work force are those who get the lion's share of the increase, as the retirement funds they held at the beginning of the bull market, in 1982, were underwater with the value of their retirement funds. Look back and you will find that corporate and state and local government pension funds were in a deep collective hole, not to mention the $4 trillion actuarial debt in the Social Security system. The country has not yet rebuilt the level of wealth we enjoyed 30 years ago, which means the baby boomers must continue to invest more in capital assets if they are to recover what they lost and to build a sufficient nest egg for retirement after 2012.

Some of the quotes in your piece made it clear a lot of this is going on at the anecdotal level — with people telling you that now is the time to make hay, while the sun is shining, so they are putting their surplus income in mutual funds instead of buying a new sofa. Haven't the "demand siders" been worrying for years, and to this day, that we are consuming when we should be saving? Your piece would have been more illuminating if you had taken the trouble to convert these nominal dollar amounts into ounces of gold — which for millennia has been the way the private markets assess real values of paper assets. The DJIA in early '66 traded at 1000, which today in ounces of gold is worth only 700 — dividing the Dow of 7000 by 10. I can't be critical of you for missing this point, because there are no financial writers who take this into account. If you think about it a bit, you would see that there is less "wealth" with which to have a "wealth effect" than meets the eye. Households are simply rebuilding their ravaged balance sheets, with no real enthusiasm that they have the luxury of increasing their general spending patterns.

Remember, too, that the prices of financial assets — wealth — are the result of expectations about the future. They are not about the present. Income is real, in that it is about the present. The values on Wall Street cannot be converted into income without a sale of the assets, and when that happens a high tax must be paid. The population is deferring that income as much as it can in the expectation that there will be a lower capital gains tax on the realized wealth increase. There is an expectation, too, that the Fed has found a way to eliminate inflation of the dollar, which was the source of the collapse of household balance sheets in the 1970s. If the specter of inflation returns, people will rush to sell paper assets and buy real things, and the first to do so will get the best deal. This is why the whole country is watching the Fed for signs of wisdom — and why they punished Greenspan, and stocks and bonds, when he made such terrible statements in his testimony last week worrying that the rise in wealth in the stock market will be converted into a rise in economic activity and real wages. Once the capital gains tax is really signed into law, and is not mere expectation, we should expect a relaxation of spending patterns and an increase in economic activity. Unless, of course, Greenspan can take steps to bring that to a standstill by unnecessarily raising interest rates.