Thursday, December 9, 2021

Record-setting gains in wealth threatened by rising inflation


Today the Federal Reserve released its estimate of the balance sheet of US households (which includes non-profit organizations) as of Q3/21. It's basically a summary of the assets and liabilities of the US private sector. Once again, things look better than ever. Private sector net worth now stands at a record level of $144.7 trillion. That's up 24% (+$28 trillion!) since just before the Covid crisis hit, and it's up 105% since just before the 2008-9 Great Recession. Financial assets top the scorecard, with a gain of 111% since their 2007 peak. Tangible assets are up 55% since their 2006 peak.

Chart #1

Chart #1 shows the evolution of households' balance sheets over the past 20 years. What stands out the most is the relatively small increase in household liabilities. They are up only 21.% since their 2008 peak. Meanwhile, net worth has more than tripled in the past 20 years, up from $45 trillion to now $145 trillion. 

Chart #2

After adjusting for inflation, we see that over the past 70 years, households' net worth has increased eleven-fold! A caveat, however: note how net worth has moved above its long-term trend line. This could be a replay of what we saw in 2000 and 2007, when some markets got very overextended. By that I mean that for the next several years a mere reversion to trend would mean very modest returns for investors.

Chart #3

After adjusting for inflation and population growth, net worth has sextupled (see Chart #3), soaring from about $72,000 to now $432,000. That works out to annualized gains of more than 2.3% in real, per capita net worth. Same caveat as with the prior chart: the blue line has moved substantially above its long-term trend. 

Chart #4

Not only are households wealthier than ever by any measure, their finances have improved dramatically relative to the peak of Q1/2008. Leverage (total liabilities as a percent of total assets) has plunged by 43%, and now stands at levels not seen since 1973. This wealth boom was not debt-fueled, as was the boom that occurred from 2002 through 2008. Private sector finances are on solid ground. This mitigates some of the fears that I refer to in the previous charts. Also bear in mind that short-term interest rates are extremely low, as are real yields. Those rates are not the sign of irrational exuberance; investors are paying huge multiples for safe assets (e.g., the PE ratio of a 10-yr Treasury is about 70).

Chart #5

Ahhh, but you say, isn't the federal government in debt up to its eyeballs? In a sense yes: federal debt outstanding was an astounding $23.2 trillion at the end of Q3/21, up 30% since the end of 2019 (+$5 trillion), making it equal to 96% of GDP. But the burden of that debt (interest payments as a percent of GDP) was as low as it's been for many decades, as Chart #5 shows. Federal debt is astoundingly large, but it's quite manageable.

But, you say, isn't the burden of federal debt going to skyrocket when interest rates go up, as they surely must, given the elevated level of inflation? Not necessarily. In fact, we will likely see a huge reversal of fortunes in the years ahead. The government has leveraged up as the private sector has leveraged down, but leverage—especially when interest rates are extremely low relative to inflation—is not always a bad thing. Also bear in mind that even if market interest rates soar, the average maturity of federal debt is 7-9 years, so total interest costs on the debt will only rise slowly as low-interest debt matures and is replaced by higher-interest debt. In contrast, federal revenues will soar as inflation rises (inflation boosts incomes, and that in turn boosts tax revenues), and we're already seeing that: in the 12 months ended this past October, federal revenues were up 18% relative to the same period two years ago (i.e., before the Covid crisis). That's an extremely fast pace of revenue growth. Of course, what's good for the federal fisc is bad for the taxpayer, since he/she will be paying a hefty inflation tax as their incomes push them into higher tax brackets. 

Furthermore, the federal government stands to benefit enormously in coming years as high inflation and very low interest rates effectively transfer wealth from the private sector to the public sector. This could be the driver of below trend growth in household net worth in coming years. As Chart #2 and #3 suggest, real net worth is significantly above its long-term trend, so a reversion to trend would mean much smaller gains in the years ahead. In fact, it would not be surprising to see net worth fall below its long-term trend, as it did during the high-inflation 1970s.

With inflation running at 7% and the average interest rate on existing federal debt outstanding running just over 2%, the real value of federal debt is currently declining by about 5% per year. In other words, inflation is subtracting over $1 trillion of the real value of federal debt outstanding every year at the same time inflation is boosting government revenues and nominal GDP. This means that the private sector is effectively paying an additional $1 trillion per year in taxes to the federal government (aka the inflation tax). 

If I were a cynic, I would argue that the Fed's easy money posture is perfectly designed to bail out the federal government. I've seen this happen time and again in Argentina.

In any event, don't cry for the federal government; it will do just fine. It's taxpayers who will suffer from rising inflation.

UPDATE (12/10/21):

Chart #6 shows federal revenues by source, updated with the November figures released this morning. Note the huge jumps in individual income tax and corporate income tax. Payroll taxes are flat to slightly down, because total payrolls are still 4 million below what they were pre-Covid (Feb. '20). Chart #7 shows total spending and revenues. Both charts use a rolling 12-month sum. Although spending is through the roof, at least it is declining and should decline further in the months to come, thus further narrowing the deficit. The 12-month deficit peaked at $4.1 trillion as of Mar. '21, and over the 12 months ending Nov. '21, it fell to $2.7 trillion. Things are headed in the right direction, thank goodness, even though the situation is still far from normal. 

Chart #6

Chart #7




45 comments:

Michael Meyers said...

Exactly, as they say “inflation is a feature, not a big.” 🤪

And if the natives get restless, greedy corporations will be blamed.

Always enjoy your posts!

Michael

Michael Meyers said...

BUG!

Benjamin Cole said...

Great post.

Verily, federal debt. Of course, the Fed has been buying back debt. About $8 trillion. Total outstanding: $29 trillion.

Yeah, the Fed pays interest on reserves, but that is volitional. Probably a sop to the banking industry. Kind of nutty in a way. "We want to stimulate the economy by lowering rates, but we will pay interest on federal reserves so banks don't lend the money out."

So, as in Japan, the interest payments from sovereign bonds flow back into the Treasury.

Call it Mobius-strip economics.

When we were feeding our fortran cards into computers in college, this was not a version of macroeconomics that was taught. Sure is interesting.

Carl said...

^Reserves can be lent against, but reserves, in themselves, cannot. When the Fed 'prints' money as a deposit in commercial bank accounts, the offset is a reserve liability on the Fed balance sheet. Reserves have to stay within the Fed-banks money circulation pipes, they cannot circulate in the real economy. Excess reserves exist because the Fed printed them and will only disappear when retired. Banks cannot do a thing about this.
As recently reported, banks' cash (reserve) assets have increased as a % of total assets (up to 18.2%, a percentage that would be much higher absent a massive swelling of banks' holdings of 'government' securities). At a rate of 0.15% paid on reserves, this aspect is responsible for about 2% (now about 0.027% on about 1.30-1.35%) of the return on assets on aggregated commercial banks.
The Fed-treasury complex in a way benefits now from the Fed balance sheet expansion but the Fed has expanded into the business of borrowing short in order to lend long. The essential reason to pay interest on reserves is to maintain a floor on the Fed Fund Rate and may be useful, eventually, in trying to resist rate movements into negative territory.
Today the inflation rate is 6.8% and the 30-yr rate is at 1.86% and this gap is considered a conundrum looking for an explanation. In the recent past, the fixed income market eventually provided the explanation but maybe this time is different?
-----
"Private sector net worth now stands at a record level of $144.7 trillion. That's up 24% (+$28 trillion!) since just before the Covid crisis hit..."
What does this rear-view mirror data indicate?
Dissecting a bit and forgetting about the unequal distribution, the biggest contributor, by far, came from valuation changes and the second contributor came from the government going into debt, both contributors contingent on low(er) interest rates.
An alternative way to 'compute' household wealth is guess the net present value of future productive income and to substract the net present value of future government expenditures.
-----
Disclosure: the opening gap between inflation and interest rates was expected but the size of the gap is surprising, another manifestation not predicted by classical macro models (or mine).
-----
Question: Is the relationship between net worth and income mean reverting?
https://fred.stlouisfed.org/series/HNONWPDPI
A cynic may suggest not, if interest rates break the zero bound but at some point someone will notice that the emperor has no clothes, no?

wkevinw said...

The inflation numbers are starting to cause negative real income results. If there are about another 6 months of this, the chances of recession are very high. It would start about a year from now.

Timing of this, if it happens, is critical for the 2024 elections.

Jeremy R. Whittaker said...
This comment has been removed by the author.
Jeremy R. Whittaker said...

You can't use average net worth because it is so skewed to the top decile. You need to use median net worth.

Benjamin Cole said...

Carl-

The topic of QE is fascinating.

My take is QE is not terribly stimulative, especially within a defined geographic area such as the US.

The world has global capital markets, maybe $350 trillion (stocks, bonds, property, bitcoin, etc.).

OK, so the Fed prints $8 trillion and buys Treasuries and some MBS. Yes, the global capital markets have a little more liquidity or demand. But not much more Main Street spending in the real economy in the US.

The strange little secret about this is a country like the US can monetize its debt without consequence.

The US has moderate inflation now, but it is caused by real-world demand (deficit spending) and COVID-19 snags, and OPEC+, and some one-offs.

Inflation is not caused by QE, IMHO.

Seems a prudent policy would be to buy back federal debt, and put it in onto the Fed balance sheet and flow bond interest revenue back into the Treasury.

IMHO.

Benjamin Cole said...

BTW--

CPI comes in hot on Friday...and S&P goes up 1% to new all-time record.

I guess profits are going a lot higher....

Carl said...

^Yes real incomes have started to go down in correlation to tapering government support.
What happened to real and nominal personal disposable income during the recent (demand-supply adjustments both during the down and the up phases) is unprecedented:
https://www.tradingview.com/symbols/FRED-A229RX0/
Click "All"
And this is not accounting for the unprecedented direct government transfers to corporations allowing the levels of price increases we've seen.
Yes the averages don't paint a proportional picture but, essentially, 'we' all got richer during the pandemic which, at the very least, should give time for pause.
https://www.weforum.org/agenda/2021/11/unequal-covid-saving-wealth-surge/
Going forward, assuming government taper and Fed relative easing continue, it will be supremely interesting to follow trends. The Fed, it seems, has painted itself in a corner with longer term yields remaining amazingly low and with the zero-interest-rate Maginot Line seemingly impassable.
That's what happens when splendid cooperation becomes straight jacket.
It is ironic that the outcome may mean simultaneously both more 'independence' and a more rule-based framework.
-----
On the debt monetization theme.
This belongs somewhat to the unknowable world and maybe individuals should just follow Warren Buffett's advice to keep at it while building an ark but it's fun to try to use a contrarian approach and i'm haunted by the Turkey Illusion and what happens to the turkey when it still expects to be fed on that fatal day as i'm haunted by the total indifference by collective markets about deficits and debt. It's got to be a red flag of some sort.

marcusbalbus said...

why do you mindlessly call current price asset increases "wealth" wealth is the gain in productive assets. moronic and cheerleading w abandon. go home.

Carl said...

"why do you mindlessly call current price asset increases "wealth" wealth is the gain in productive assets. moronic and cheerleading w abandon. go home."
The increase in "wealth" as a strong signal for further consumption makes sense contingent on the following assumptions:
-increasing inequality has not reached negative incremental return
-the wealthy's higher propensity to consume will be released once the economy opens up more
-the substantial increase in wealth in cash, checking and savings deposits (up $3.4T since Q42019) is believed to be 'caused' by people putting more money into these accounts instead of artificially created by easing and government deficits
-the recent unemployed experience (69% of unemployment benefit recipients actually earned more money being unemployed than when they were working and the median recipient received 134% of their previous after-tax compensation, as per NBER) doesn't explain the transitory and sticky nature of wage inflation in a lower participation rate climate
-the outcome of unprecedented monetary and fiscal easing during one of the greatest economic experiment (massively shutting down and opening up the economy) is benign and not linked to unintended consequences

K T Cat said...

You da man, Scott, but I'm skeptical about the debt and interest payments. The Federal debt isn't going to sit at $29T, but go up. A $1T deficit is now normal and the necessary cuts to bring that under control will trigger mass hysteria. I can see that inflation will prune the debt through higher tax revenues and shrinking the real value of the debt, I think you need to add $1T+ per year to it to get the real equation.

The Grumpy Economist agrees. https://johnhcochrane.blogspot.com/2021/12/the-ecbs-dilemma.html

I'm also in agreement with wkevinw. Inflation isn't going away and it will be a drag on the economy. The sugar rush of higher tax incomes probably won't last and we'll still be stuck with a monster debt that continues to grow.

Carl said...

^The Japan's fiscal situation is often depicted as an open-crocodile-jaw pattern (diverging expenditures and revenues) and Japan has shown how far (so far) this divergence can be sustained. They should be OK because the government just announced a monster expenditures package to 'fix' the economy.
So the US still has potential room down this rabbit hole although the US is stuck with its own open-crocodile-jaw pattern (divergence between mandatory and discretionary spending).
Who supports expansive austerity these days? The Fed is about to find out how little room it has to 'tighten' and on, top of that, the yield curve has pre-emptively started to flatten..
i bet the Fed wish they didn't have to deal with inflation (at this very specific point) and perhaps they should heed what they wish for but, then again, they will tend to do "whatever it takes".

Benjamin Cole said...
This comment has been removed by the author.
Scott Grannis said...

I don't see how I'm cheerleading when I point out that inflation threatens wealth, since by inference it also threatens the health of the economy. It's possibly too early to say with confidence that the Fed has screwed up so badly that the economy is headed for an imminent recession, but I do think it will take the Fed awhile to get inflation back under control. Meanwhile the economic headwinds (inflation, rising tax and regulatory burdens, and the Biden administration's utter incompetence) certainly exist and they will prevent the economy from growing more than 2% per year on average.

Fred said...

I guess the real test will be whether you applaud the FED's hawkishness if signaling rate hikes results in a 20% decline in stock values like it did in December 2018. I remember you were pretty mad at the FED back then and urged more QE.

Ataraxia said...

The worst part of this cycle is rents, for me. And then how they broke the durable goods deflation. That inflation chart Scott does is great.

Scott Grannis said...

Fred: The Fed was demonstrably too tight in late 2018. Inflation was very much under control: breakeven spreads were a tame 1.5%, the yield curve was almost flat, real interest rates had jumped stock markets worldwide were very weak, the dollar had surged, commodities were falling, and credit spreads and real yields were rising. All warning signs were flashing red. The Fed finally figured it out and eased, and things calmed down quickly. In retrospect, they were tightening because they thought the economy was too strong (Trump stimulus) and not because there were inflation warning signs.

This time it's very different. Real yields have plunged, breakeven spreads are rising and inflation is surging, commodities are rising, the stock market is rising, credit spreads are low. But most important of all, the M2 money supply has exploded (it was very much neutral in 2018). This time they really need to tighten. If they tighten by enough, the market will be relieved. How can it be a bad thing for the Fed to do the correct thing?

K T Cat said...

It sure feels to me like the market has topped. I'm considering taking a good chunk of my portfolio and moving it into a corporate bond fund or something like that. Inflation is 10+ and retail sales gagged today. The sugar rush of insane money printing that drove the 25% SP500 growth looks to be coming to an end.

Opinions?

Benjamin Cole said...

Markets seem to like the Fed decision.

S&P 500 up 27% ytd.

Frozen in the north: the hawks have been predicting hyperinflation since the 1970s, maybe longer.

But even in the 1970s and 80s annual core PCE never got into double digits.

My guess is we see 4% to 5% inflation for a while, maybe a couple-three years. Not a good idea, but not the end of the world as we know it.

I guess the market is saying that corporate profits will shoot through the roof.

Benjamin Cole said...

Strong retail sales release on Wednesday. Maybe the wage hikes are passing through to retail sales?

Carl said...

-The Chimera
So the crowd is stuck between
Almighty fear of missing out
And there is no alternative
Corporate profits so keen
No worries and no rout
Real yields, negative

K T Cat said...

I went to Costco yesterday to do some grocery shopping. The price increases for the things we buy most often were way beyond 10%. We like to throw parties and our normal fare for such shindigs is more like 20-30% more expensive. It had an emotional impact on me and made me want to buy less and spend less. I can't be the only one.

Paradoxically, it also made me want to buy things like paper products even though I didn't need them, just to lock in the price. See also: Scott's excellent post on Argentinian inflation.

Like wkevinw said above, this inflation could easily lead to a recession.

McKibbinUSA said...

Savage cuts in government spending are now an emergency. Only uniformed personnel should receive government paychecks. All other jobs should be filled by volunteers or eliminated. Both guns and butter must be cut by at least 90%. Social Security and Medicare should only go to the fully disabled (loss of two limbs). Everyone else gets the guaranteed right to work for the rest of their lives. If none of this can happen, then let's break up the country into a west coast country, a gulf coast county, and a northeast country. All the upper mid-western states can do what they want or join Canada. Income taxes should be eliminated. Politicians should learn to raise money or contribute their own fund to pay for vanity programs. Never forget that government is lard and should be despised and hated by the people.

McKibbinUSA said...

PS: The dollar is now worthless. A default on the national debt has already occurred. Buy cryptocurrencies, precious metals, and other hard assets to survive the next 50 years. We are entering dark times. Make sure people owe you money and not the other way around. The only question that needs to be pondered is whether the coming wars, pandemics, and famines will result to millions, tens of millions, or hundreds of millions of deaths. I personally plan to survive by whatever means necessary. I wish I had better news. Take cover and keep you heads down...

honestcreditguy said...

the fed has lost control....expect the long forgotten bond bears vigilantes to show up near April-May....

Inflation is roaring and most young folks have never seen what is coming.....

the pale white horse is leading the US into its sunset...

K T Cat said...

So what you guys are saying is that I should go long on timber stocks because the demand for pine boxes is about to skyrocket ...

;-)

Fred said...

Scott: I guess the market is not buying your argument that it's good to tighten. Are you aware of any time in history that the market has not corrected followed by a recession after the FED raises interest rates?

wkevinw said...

"Are you aware of any time in history that the market has not corrected followed by a recession after the FED raises interest rates?"

There are a few, see 1994-1995 for one example. There are also the converse, where the stock market tanked, but there wasn't a recession- e.g. ~1962, 1987.

Other topic: Federal Taxpayer Bailout of Too Big to Fail States, e.g. CA.

There are so many ways to skin this cat- they will bailout however they can, e.g. subsidize bubble-level mortgages in California:
https://www.sacbee.com/news/politics-government/capitol-alert/article256742217.html

Benjamin Cole said...

Another all-time record high close on the S&P 500.

They say the stock market is forward-looking.

My guess is the profit-explosion seen in recent decades in the US will continue.

Large private-sector enterprises are well-managed.

Apple is worth $3 trillion, and seems to make more money than it can use.





wkevinw said...

Apple, and many other multi-nationals, especially that do manufacturing:

Slave labor and other labor unethical labor practices, making for "cheap labor", are a big reason for their huge profits, and low wages in the US.

https://www.businessinsider.com/apple-china-tim-cook-responsibility-world-peace-world-trade-2021-11

I agree that it is best to stay engaged, even with bad actors in multi-national trade. However, one can still make an effort to avoid the worst practices. Apple, Nike, and others don't care, but their PR will be full of statements that say they do.

Ataraxia said...

They don't call economics The Dismal Science for nothing. Also, the corporate scale now achieved, and rent seeking lobbyists are definitely squeezing the vulnerable and less connected. Are we crony Capitalism?

How's that for a Christmas Eve post? :-) Good Day.

K T Cat said...

Merry Christmas, all!

Daniel said...

Isn't the wealth correlated with asset holdings that have benefitted from the easy money driving value up? Isn't the average taxpayer left holding the bag for the debt?

Ataraxia said...

Excellent discussion about inflation, below trend GDP, and exiting the gold standard by former Dallas Fed Sr. Economist Lacy Hunt:

https://www.youtube.com/watch?v=Qb2z6FqF_4c&ab_channel=DanielleDiMartinoBooth


randy said...

Merry Xmas Mr. Cat and all. Many thanks to Mr. Grannis for sharing and hosting.

Carl said...

@Ataraxia
Thank you for the Lacy Hunt link.

Mr. Hunt has been quite consistent over time and there's nothing really new. The underlying logic remains solid but there are limitations:
1-Timing
Timing remains elusive although the size of the bust will be proportional to the size of the boom.
2-Unknown unknown
It's possible that a new variable (black swan event) happens and causes some of the secular trends (aging, debt, productivity) to become less relevant. Apart from general resilience, not much can be done about that.
3-The whatever-it-takes mentality
It's quite possible that the Fed-Treasury complex tries even more unconventional tools when a real and significant downturn occurs which could potentially mean more command-and-control, more inequality and more division, in other words further attempts at easing before entertaining constructive and productive reforms. Then who knows what happens to interest rates?

Ataraxia said...

@Carl My pleasure, happy to share with this group.

#3 It seems some very educated and level headed people agree with this possibility

Happy Holidays

Carl said...

^So, since the (macro) future is (mostly) unknow, the exercise, with 2022 coming shortly, is to 'see' how the course of human events may impact portfolios.
At the very least, i wonder if the value of resilience is mis-priced.
All the best for 2022!

Benjamin Cole said...

Well...

Back in school, they taught us the stock market was forward-looking. Nixon was president.

The S&P 500 just set another all-time record high.

If there is doom and gloom in 2022, they don't know it on Wall Street.

Carl said...

"The S&P 500 just set another all-time record high."
What does it mean, at this point, and going forward?

Last December 30th, i went to get a champagne bottle at the store (alcohol market mostly nationalized in my province). There were barely any bottles left (especially the more 'premium' stuff).
What does it mean?
The last time this happened (i call it the roaring champagne index), the year was 1999 and that's when investing started to become fascinating. Who knows and there was also the year 2000 bug (supply chain) issue. All i remember is that i had sold Nortel during the year and felt (for this aspect) completely stupid compared to the champagne crowd.
The 10 year yield was also at 6.45%(!).
At least then the value stuff made sense and maybe we've attained a permanently elevated plateau or is this time different?
From the investing point of view, IMHO, the present period is the greatest time to be alive.
Something tells me that inflation (or the desperate lack thereof) will be the story of the 2022 vintage year.
Enjoy the ride!

randy said...

Carl,

"The danger of civilization, of course, is that you will piss away your life on nonsense." The lesson may be that we should spend our time chasing Veuve Clicquot. Or a fly rod and rye whiskey at least.

(ht - Jim Harrison)

Carl said...

Hi Randy.
i did not know Jim Harrison (interesting chap) and thought you meant Jim Morrison (The Doors) and, of course, we know how that Chivas-Regal-Jack-Daniels whiskey adventure ended.
The Veuve Clicquot brand is interesting and the idea behind the origin of the brand may be fitting to today's environment.
As you may know Veuve Clicquot is now part of LVMH (how do you pronounce Louis Vuitton?):
https://www.lvmh.com/houses/wines-spirits/veuve-clicquot/
and LVMH is one of those Great Gatsby stocks that have done very well in this high and growing net worth era but the period when the brand was developed appears relevant to today's America?
The House of Clicquot was a wine house formed in France in the latter part of the 18th century during the period leading to the 1789 Revolution (a period during which there was deteriorating national finances, growing political discontent and permeating social malaise tied to a deadlock-type of Ancien Régime tsk...tsk...), a period during which an amazing entrepreneur opportunistically took advantage of a changing and challenging set of business conditions. The head of the Clicquot house died and the widow ("veuve", young with one child) took over the business. She was an amazing woman and a business genius geared to take bold risks. She focused on the champagne business, developed a "shaking" technique and an upside down bottle position through oblique holes (became the standard, still to this day), used the Russian occupation in Reims in order to let the Russian officers to become agents of the brand once back in aristocratic Russia. She also played around rules and regulations in order to circumvent supply issues, for example by sending the champagne products as exports in advance of expected return to normal trade routes (including right after the 1814-5 Russian invasion). She navigated (commercially) the difficult trading conditions related to the Napoleonic wars, was an expert at expanding markets, established the yellow label and, as a result of her outsized personality and multiple talents, became very wealthy over time. It's interesting that her female descendants eventually married into restored French nobility..
----
The future looks bright but 'winning' in this environment may require an unusual set of (investing) skills?
Let it sparkle and let's drink to that!

randy said...

Yes, the Clicquot story is a story worth telling - and I had forgotten it. As an aside, over the holidays someone gave us a $300+ bottle of Dom Perignon, and we also had a $50 Vueve Clicquot. We all agreed the Vueuve Clicquot was much better. More character and sparkle. I'm not much on bubbly anyway, but my wife loves it on occasion. Best wishes in 2022.