Wealth may matter more than income
The resilience of the US economy in the face of higher interest rates has surprised many. Members of the US Federal Reserve’s federal open market committee, having pencilled in several cuts to interest rates to come in 2024, have seemingly reversed course.
Their pivot was precipitate. The still highly satisfactory state of the US economy must take the credit or the blame, depending on whether you a borrower or lender be, including in SA.
US GDP, or total output, grew by 3% year on year in the first quarter and by a 1.6% annualised rate in the quarter. Retail sales, an all-important measure of the state of demand in the US, had a lively February and March. Yet sales fell steadily for many months before, and retail sales deflated by the consumer price index are still 2% below that of January 2023.
This revived willingness of US households to spend more came despite minimal growth in real personal disposable incomes. In February, incomes were only 2% higher than they were in early 2023, despite very full employment. Tell that to the White House.
The good news about spending propensities, with their implications for high interest rates for longer, had a mixed reception in the financial markets. Given the new uncertainty about Fed action to come, stocks and bonds have fallen back in April.
This minor pullback has come after investors had enjoyed a full recovery from the significant declines in the valuations of stocks and bonds in 2022, when rates rose dramatically to deal with the inflation that took central banks and the markets by surprise.
Yet it has all worked out rather well in the financial and housing markets. History tells us that it takes a financial crisis to cause a recession, and the global financial system avoided one this time round.
The place to look for an explanation of US economic resilience is the behaviour of the US financial markets. US wealth, consisting mostly of financial assets, stocks, bonds and equity in homes, net of household debt, has been increasing dramatically since the global financial crisis of 2010. And it received a huge injection from the Covid-19 relief payments and the strength of the financial markets in 2023.
US household wealth, net of debts, is now of the order of $156-trillion. That is about seven times personal disposable incomes. It was but $110-trillion in early 2020. Now it is up by about $40-trillion since the Covid-19 lockdowns. Personal incomes after taxation grew a mere $45bn since then.
Changes in wealth are as much a source of additional spending and borrowing power as any other source of income. In aggregate, unrealised wealth gains dominate changes in other sources of income. Changes in wealth, even if capital gains can reverse, can significantly influence spending now.
Predicting the wealth effect on aggregate spending requires predicting wealth itself, which is even more difficult than predicting the disposable income effect on spending. Success in predicting financial markets would be modern alchemy. Yet it is essential if economic forecasting is to have any scientific validity.
Household wealth in SA is about 4.5 times higher than household incomes after taxation. This ratio increased markedly during the growth boom of 2002-08 and has largely stabilised since.
But the wealth of SA households is about to be challenged by a new dispensation: the right to easily draw down a third of their accumulated wealth held in pension funds and retirement annuities, the impending twopot system. The effect on spending, interest rates and on the financial and real estate markets in SA will be significant. Forecasters in and out of the Reserve Bank will be fully engaged in predicting the outcomes.
Waiting to see what happens may be the only sensible option.