Thursday, March 12, 2009

Wealth destruction on a global scale

Since the peak of global prosperity in 2007 until today, the value of global equities has dropped by $34 trillion, as shown in the first chart. The second chart shows the components of U.S. households' net worth as of the end of last year. Most of the $12 trillion decline in net worth has come from the collapse in equity markets, not real estate values. As of today's prices, I estimate that U.S. households' financial assets have declined another $6 trillion since the end of last year, putting the total wealth loss to U.S. households at approximately $18 trillion, and probably more if you figure that housing prices have continued to decline this year.

So in round numbers, and adding in the losses in real estate values outside the U.S., figure that the world has lost at least $40 trillion in wealth in the past 18 months, while U.S. households have lost about $20 trillion. This is pretty remarkable when you consider that the initial catalyst for this mega-decline was $1-2 trillion of subprime mortgage debt that went sour. And even after 3 years of housing price declines, real estate values in the U.S. have only declined by about $5-6 trillion from their peak.

How can the real estate tail wag the global equity dog? Real estate losses have been only a fraction of total wealth losses. Lots of paper wealth has vaporized, to be sure, but the physical assets (roads, machinery, computers, factories, office buildings) that make the global economy function are still very much intact. The physical size of the global economic appartus has surely grown over the past 7 years, hasn't it? (The market cap of global equities today is about the same as it was 7 years ago.)

It doesn't seem unreasonable to me to say that the equity market is exceedingly bearish on the prospects for the future, and/or there is something else, such as a major shift in the direction of U.S. fiscal policy, with its attendant surge in future tax burdens, that is to blame. I've been arguing for quite some time that equity valuations have been extremely pessimistic, and I continue to believe this. We don't need much in the way of good news for things to turn up.


Mark A. Sadowski said...

The problem was that there wasn't a real increase in wealth to begin with. Sure the the real assets are still there. But there hasn't been any change (increase) in real assets in the last decade. That's the whole point. It was all an illusion.

Scott Grannis said...

It was not an illusion. The Chinese economy has grown 10% a year, and that's just one example. There is no way you can say that U.S. growth in the past 7 years was all an illusion.

Jon S. said...

Scott, I take Mark the Crank's enduring presence on this site as a sign that your blog has arrived. To paraphrase an old saying, "No good blog goes unpunished."

Bob said...


Much of the wealth that you allude to was created by excessive leverage, was it not? I agree that it was not an illusion any more than the person who sold their house at the top of the levered markets profits are an illusion. But delevering is in itself a destroyer of that pumped up wealth isn't it?


Scott Grannis said...

It's probably true that some portion of the rise in wealth was due to asset prices that in retrospect were too high. Leverage undoubtedly played a role. The point I'm trying to make (should have been more explicit) is that we didn't create $40 trillion of illusory wealth gains. The output of the economy has grown, there are more people working, and therefore the decline in wealth has been exaggerated, perhaps by all the deleveraging/unwinding of carry trades.

Equity prices now seem to be too low. It's a financial roller coaster ride.

Mark A. Sadowski said...

Jon S. is right. Great Blog. Otherwise I wouldn't check it out. Or harass you. Just Kidding, keep up the good work.
P.S. Bruce Bartlett had a nice article on capital gains taxes today (needless to say we were close in opinion, but had more than a few disagreements):

Scott Grannis said...

Mark: Thanks for pointing out the Bartlett article. I have a lot of sympathy for what he says, but I don't see the logic behind taxing gains that are subsequently consumed. Capital gains should never be taxed. Period. They are the result of money that was first earned, then taxed, then invested and put at risk. Why should you pay tax again if your risk-taking proved successful? This is like taxing prosperity. If your investment produced a gain, it was probably because some business became more successful. (We all should agree that taxing gains that result from inflation is mindless. If capital gains must be taxed, then they should first be adjusted for inflation.)

__ said...

[I was looking for old posts on savings, hence my comments on old blog posts!]

Scott, re: your comments on capital gains, surely the logic extends to sales taxes? I know those are taxes on consumption rather than investment, but consumption is paid for out of income which has already been taxed (probably at the Federal, state and local level).

Scott Grannis said...

MW: Not sure I follow you, but yes, sales tax would be a second tax on money earned. Capital gains tax is a triple tax: the first being on income, the second on the profits of the company, and the third on the gain in valuation driven by after tax profits.