While recent crashes in UK bond prices, China real estate and US stocks have been driven by different catalysts, they all reflect a common cause that has been largely ignored: the bursting of a global wealth bubble.
The implications are huge for economies, fiscal and monetary policy, investors and savers everywhere. Even if the Federal Reserve succeeds in deflating the growth rate of US consumer prices, it needs to be careful about how much it reinflates this huge bubble when it starts cutting interest rates.
Prior to 1990, asset price inflation and income in the US followed similar trajectories. The total value of all households’ net wealth, including housing and retirement accounts, grew in line with economic output. That connection was broken long ago by a combination of loose fiscal and monetary policies and a global glut of savings.
During the period 1947 to 1990, the net wealth of all households and nonprofits averaged about four times annual economic output; by the end of 2021, the ratio was equivalent to about six and a half times a production of $23 trillion. By the end of 2021, excessive asset price growth alone had added more than $50 trillion to measured household net worth.
Put another way, every $100,000 you would have had in home equity and retirement savings as of December 31, 2021, without this excess asset price inflation, would have been worth only about $60,000. The drop in stock values in 2022 took away only a small portion of that $40,000 gain.
The recovery of this world from 1990 to 2021 could stimulate the economy in the short term, but the long-term consequences can no longer be ignored, as recent British and Chinese examples warn us.
One is the growing inequality of wealth. We have already seen how the Fed’s re-inflation of asset prices during the Great Recession, however necessary, led to greater wealth inequality than before.
But it’s not just rich versus poor; it’s old versus young. Today, many like me who bought a house decades ago have seen profits that made our housing costs almost free. Not so for our children and grandchildren who buy at today’s high prices. In many ways, young people should want the bubble to burst so they can buy houses and pension funds at lower prices.
The wealth bubble also adds significant structural risks to the economy as a whole.
Years of low nominal interest rates gave investors extraordinary incentives to get some of the “free money” created by negative costs of borrowing, once adjusted for taxes, inflation and bankruptcy protection. Despite rising nominal interest rates, today’s real borrowing costs remain negative just by subtracting inflation. Buying unproductive assets becomes profitable when negative asset returns are less than negative borrowing costs. The large tax shelter market of the 1970s and early 1980s is an example of what happens when borrowing costs go negative. It wasn’t until Paul Volcker got a nominal interest rate above 20 percent that the real cost of borrowing turned positive and stagflation ended.
Now add to those incentives for unproductive investment the added protection afforded even to bad investments by the $50 trillion excess bubble-up of asset valuations in the modern era. Very low or negative borrowing costs to buy assets that increase in value independently of their productivity are worth a lot to even the dumbest leveraged buyer, but not to the economy.
Who are the possible losers? Today’s taxpayers, for example, who have to pay the increased costs of paying down our very large government debt once real interest rates rise.
Savers, for another, who already have limited ways to diversify to protect their portfolios from decline.
Higher valuations also gave states excuses to cut contributions to retirement plans when pension actuaries, who look to the past as a harbinger of the future, predict that future returns will far exceed what pensioners earn at today’s negative real interest rates and low equity earnings. – price ratios.
Many retirees make the same mistake by predicting how much the return on their savings will support them.
Commercial bank lending, in turn, relies too much on bubble valuations to assess the risks of highly leveraged real estate investments and leveraged buyouts. And, of course, the more the bubble is inflated, the greater the potential asset price correction that can boost bankruptcies and depress demand overall.
The fear of this fall in asset prices was one of the reasons why the Fed has been so slow to switch from making net asset purchases to making net asset sales and voting to raise interest rates. But that slowdown only added to current consumer price inflation.
On the other hand, if the Fed does not allow real (post-tax, post-inflation) interest rates to move out of negative and near-negative territory, then it retains all incentives to inflate the bubble further.
It will not be easy to get out of this bondage. Allowing these disruptions to continue threatens economic stagnation, greater wealth inequality and congressional inattention to the cost of growing government debt. One way or another, the Fed and investors will have to reduce their reliance on excessive asset price inflation for years and probably decades.
Eugene Steuerle is a fellow at the Urban-Brookings Tax Policy Center.