Friday, March 13, 2009

Congratulations, You’re Broke: Down 20% and $11 Trillion Vastly Underestimate Wealth Destruction

The Federal Reserve released data yesterday showing a 20% drop in household wealth from a peak in the second quarter of 2007. The wealth loss for the year of 2008 was $11.2 trillion, $5.1 trillion of which came in the fourth quarter. As astounding as the numbers are, they almost certainly vastly underestimate the magnitude of wealth destruction the country is experiencing.

Part of the differential is obvious – the markets have continued to plummet in the first quarter of 2009. One estimate, given the decline in stocks and housing prices, lops another $2.5 trillion, or 5%, off of household wealth. Leaving all prediction of future stock and housing market movements aside, the Fed number still likely comes under the reality. Given the leveraged nature of home ownership, the actual wealth decline from an absolute drop in price is magnified.

Much more importantly, though, the Fed calculation misses a vital side of the wealth ledger – liabilities. The “New Era of Responsibility” budget entails a deficit for next year that is greater than the previous eight years combined. It also projects similar deficits as far as the eye can see. The estimates of GDP growth are suspect, but the spending bonanza is certain, and gargantuan. Trillions upon trillions of new debt to finance the spending is slated for the next several years. A household’s credit card debt represents a net reduction in overall wealth. The government’s debt represents a net reduction in the country’s collective wealth. The massive projected increase in government spending is essentially a repugnantly awe-inspiring obliteration of household wealth.

Yet it gets worse. There are several aspects of household wealth that are difficult to put a number on, but are nonetheless a vital aspect in the calculation, even if the amount itself is theoretical. A household’s wealth includes the present value of its projected future income stream. To the extent that potential future income has been squashed, there is a corresponding reduction in household wealth. Unemployment is on the rise, millions of jobs are being lost, and wages and bonuses are being suppressed. Exacerbating the loss of potential future income is the decreasing value of what little money households have left. As the government prints more and more dollars to satisfy its corpulent spending habits, the value of that money decreases.

From the theoretical to the abstract, the picture gets even uglier. There is a wealth value associated with simply being an American. Sadly, this value is diminishing. Again, while the computation of the number is vague, the logic is clear. The American way of life has intrinsic economic value. It comes from the rule of law, the natural resources, the technology and infrastructure, and our core fundamental values. It is a major part of what causes millions to flock to our borders and seek entry. The level of economic freedom we enjoy is a vital component of household wealth. But it is on the wane, and headed down a terrifying path.

Thankfully, all of the above aspects of wealth destruction can be reversed. To do so, we must get government to about-face from socialistic tendencies to pro-growth fiscal sanity. And we must right the ship towards economic freedom. We must drastically change the course we are on, lest the phrase cometh, “Congratulations, you’re broke!”

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