The ‘Wealth Effect’ is Bunk, It Never Existed

The ‘Wealth Effect’ is Bunk, It Never Existed

The Wealth Effect is Bunk, It Never Existed


The so called “Wealth Effect” has been taken as a core component of monetary policy over the past several years. The world’s Key central bankers (Fed, BOE, ECB, and BOJ) will not admit it, but stock prices are a Key element of their strategy.

Former Fed Chairman Ben S. Bernanke explained in November 2010 why a 2nd round of QE was necessary: “This approach eased financial conditions in the past, and so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”

You should notice the modifying and controlling word in his phrasing: “can” also spur spending. The reality is that economists do not now or then understand how this works.

“As with all statistically based models, there wasn’t a whole lot of data to fill out all possible ranges of scenarios in order to produce truly robust models of correlations between asset prices and consumer spending under all conditions. Most of the econometric work was taken from the 1980’s and 1990’s, when asset prices were rising and so was spending. Rather than view that as perhaps an accident of mere circumstances unique to those times, this Wealth Effect was instead, as usual, given status as a core economic “truth,” analyst Jeff Snider said recently.

The central myth of all central banking is that if it happened during the great moderation, central banks could make it happen again by mere policy.

Understanding, the actual money evolution and potential would have disproved the idea at its origin.

When Janet Yellen, the current Fed Chairwoman spoke in Portland, OR, in July 2005 at a time when the housing version of the “Wealth Effect” was increasingly questioned not by policymakers but from analyst like me , she, as Messrs Bernanke and Greenspan, foresaw little or not difficulty in what were the very worst circumstances.

Fed officials believed they had a handle on the Wealth Effect should such a low probability event happen, whereby the potential damage would be limited.

Even where housing prices “might” decline by 25% or more, their math claimed: “First, there would be an effect on consumers’ wealth. With housing wealth nearing $18 trillion today, such a drop in house prices would extinguish about $4.5-T of household wealth, equal to about 38% of GDP. Standard estimates suggest that for each dollar of wealth lost, households tend to cut back on spending by around $0.035. This amounts to a decrease in consumer spending of about 1.25% of GDP.”

This was entirely manageable and thus no cause for any concern at all.

Ms. Schoolmarm Yellen even uses that word: “How manageable would this scenario be? Like the wealth effect, these added interest-rate effects operate with a lag, so, again, there probably would be time for monetary policy to respond by lowering short-term interest rates. This obviously would not be a for sure, but in many circumstances it would seem manageable.”

Even though she recognizes after this statement the complications and dangers of financial fallout from housing, she again dismisses it because “the financial system and consumers appear to be in reasonably good shape to handle the situation.”

As most other economists, she was proved totally inept just 2 years after making the claim when the monetary system dictated to the financial system how this was really going to go, and it was not anything like any econometric model ever anticipated.

The regressions all believed such a scenario was impossible, and at best no more than a very minor concern.

Though that was her way of relating the Southside, incorrect in every way possible, the Wealth Effect stayed, as Dr. Bernanke wrote, an article of faith if maybe not so precisely calibrated in the aftermath. But no matter how high especially stock prices go, there is no wealth effect: None.

The Fed’s Financial Accounts of the United States (Z1) shows that there is and has been restoration in at least the 1st part, the Wealth.

Household net worth jumped to a record high $89-T in Q-2 of Y 2016, up from $88 trillion in Q-1 and $54.4-T at the depths of the monetary crisis in Y 2009.

But, that has not led to any of the effects Dr. Bernanke described in his justification of QE2, QE3, or QE4. Instead, when comparing Wealth Vs Spending there is considerably less relationship just as “paper wealth” builds to ever higher record levels.

No direct effect and no spillovers especially from the labor market and its more determined relationship with spending.

Stock prices and paper wealth are ephemeral, since they largely only apply toward the top of the wealth spectrum and there is no “trickle down” without monetary growth. So,record stock prices do not matter compared to what economists call “gloom” since all that is actually just plain reality.

In the real role businesses do not invest because their revenues don’t expand, FINI.

Revenues are not expanding because businesses will not hire no matter what the unemployment rate says, FINI2.

This was all one of the factors that quantitative easing was meant specifically to address, derived from the statistically modeled understanding of expectations rather than the actual conditions of them.

The Wealth Effect was supposed to break the economy out of any “gloom”, as rising asset prices, especially the repeated and emphasized record highs of stocks, bonds, or anything in between, would surely negate any immediate “gloom” as it rolled over into expectations of an impeccable future.

Now, given the disconnect between the future stock prices have been priced for and the reality of that future particularly over the past few years, record high asset prices would not accomplish all that much anymore even if a Wealth Effect were to become real.

The track record of record high stock prices is fast approaching the sub-standard performance of Schoolmarm Yellen, BDr. Bernanke, and all economists who speak well of them.

Over the last 9 yrs many myths have been debunked, yet they persist in the media and in econo-metrics because statistical mathematics is given the same deference as if it is real science. It is Not, it is speculative conjecture.

The failure of the Wealth Effect is another in a lexicon of irrefutable evidence that the official policy makers  do not know what they are doing.

The Big Q: When will the markets bring them to task?

The Big A: We wait to see.

Thursday, the US major stock market indexes finished at: DJIA +98.76 at 18392.46, NAS Comp +44.34 at 5339.52, S&P 500 +14.06 at 2177.18

Volume: Trade was moderate with 833-M/shares exchanged on the NYSE

  • Russell 2000: +11.2% YTD
  • NAS Comp: +6.6% YTD
  • S&P 500: +6.5% YTD
  • DJIA: +5.6% YTD
HeffX-LTN Analysis for DIA: Overall Short Intermediate Long
Neutral (-0.03) Bearish (-0.43) Neutral (0.10) Bullish (0.25)
HeffX-LTN Analysis for SPY: Overall Short Intermediate Long
Neutral (0.12) Neutral (-0.11) Bullish (0.33) Neutral (0.12)
HeffX-LTN Analysis for QQQ: Overall Short Intermediate Long
Bullish (0.29) Bullish (0.27) Bullish (0.35) Bullish (0.25
HeffX-LTN Analysis for VXX: Overall Short Intermediate Long
Bearish (-0.38) Neutral (-0.06) Very Bearish (-0.50) Very Bearish (-0.58)

Stay tuned…

The following two tabs change content below.
HEFFX has become one of Asia’s leading financial services companies with interests in Publishing, Private Equity, Capital Markets, Mining, Retail, Transport and Agriculture that span every continent of the world. Our clearing partners have unprecedented experience in Equities, Options, Forex and Commodities brokering, banking, physical metals dealing, floor brokering and trading.

Latest posts by HEFFX (see all)