Saturday, March 6, 2010

Savings and Household Wealth

Looking at graphs of the S&P 500 and other stock indices, one is quickly struck by the fact that the index level is not much changed from its level about one decade ago, around the time the tech bubble was getting rolling. Okay, in the mean time we had some serious ups and downs, so the volatility was there, but capital gains over the period were zero. If you did buy and hold 'till now returns are coming only from dividends. Certainly some portfolios have gained wealth on net over this period, but others have lost, and in the aggregate wealth gains were zero.

What does that mean for the wealth generated during that period? Was any of it real? Since a great deal of the GDP growth in the period was due to consumption growth, fueled by negative savings (borrowing), I would suggest that aggregate wealth generated was attributable to lenders. When borrowed funds are primarily used for consumption, though, the money used to pay back the funds must come from future income, and money used for consumption doesn't contribute to growth, real future income probably wasn't growing.

So any gains to wealth over the past decade have come at the expense of future income. Given that future income wasn't growing in real terms, future household wealth should be expected to decrease. I think people are beginning to realize this, and it is causing people to be quite scared for the future at this time.