Towards the tip of a financial bubble, the individuals who profit from the bubble’s continuation — politicians hoping to be reelected, bankers hoping to finish the following deal, money managers talking their books — start touting “record household net price” as an indication of societal health.
But they’re flawed, for the next reasons:
Deceptive leverage. Pretend that you simply borrow $1 million to purchase some JPMorgan Chase shares and that this transaction pushes the worth of the stock higher. Without realizing it, you’ve just raised the web price of hundreds of thousands of other JPMorgan Chase stockholders. Total household net price — that’s, assets minus liabilities —increases by vastly greater than the cash you borrowed. Society gets “richer” and the economy gets more robust and “safer” due to its growing net price cushion.
To this point so good. But since leverage works each ways, as soon as you switch around and sell your stock, thus pushing down the value, that incremental net price vanishes, since it never really existed.
False comparison. Most adults understand that their stocks, bonds, and houses fluctuate in price, rising in good times and falling in bad, while their mortgages, bank card debts, and auto loans only fall as they’re paid off. Which is to say as an alternative of falling, these obligations mostly just rise as latest debts are incurred and old debts are rolled over. A statistic derived by combining things that may evaporate (asset prices) and things that generally can’t (debt balances) doesn’t measure what they are saying it does.
The takeaway: In a society of borrowers and speculators, asset values increase due to borrowing and speculation, which makes rising household net price each a negative indicator of future growth and an indication of fragility relatively than strength. But until people figure this out, it stays an amazing tool for convincing consumers that all the things is high-quality when it’s actually not.
The next chart (courtesy of European money manager Gavekal Research) shows household net price peaking just before the onset of recessions and/or brutal bear markets.
Notice how because the economy becomes an increasing number of hooked on leverage, the volatility across the trend line increases, indicating that the following downturn — which we’ve already entered — will lop around 40% from household net price via plunging asset prices.
And that’s assuming that the trendline itself is an actual thing. If the credit supercycle that began within the Seventies is now ending, we’re facing a generational, not a cyclical, mean reversion through which the opposite fringe of the leverage sword cuts financial assets much more deeply.
Here’s how CNBC covered the topic last 12 months, noting the rise in debt without exploring the link between debt and net price:
Household wealth tops $150 trillion for the primary time despite surge in debt
Americans got considerably richer as 2021 got here to an in depth, due to a pleasant boost from their stock market holdings and a rise in real estate values, the Federal Reserve reported Thursday.
Household net price within the fourth quarter eclipsed $150 trillion for the primary time, rising at a healthy 8.2% pace from the previous quarter for the fastest growth period for the reason that first quarter of 2020. The rise got here due to a combined $4 trillion rise in holdings from corporate equities and housing.
The overall level — $150.29 trillion, to be exact — represented a 14.4% increase from a 12 months ago. The boost got here with U.S. economic growth running at its fastest pace since 1984 and the stock market having fun with one other robust 12 months.
The move got here despite a rapid increase in debt in any respect levels.
Total nonfinancial debt got here to $65.1 trillion, including $17.9 trillion on the household level, $18.5 trillion within the business world and $28.6 trillion from government. Each category saw substantial rises.
Household debt jumped at an 8% annual rate, owing to a 6.9% rise in consumer credit and an 8% surge in mortgages. Nonfinancial business debt increased at a 6.7% clip, while federal government debt leaped by 10.8% after declining 1.3% within the third quarter.
The important thing sentence: “The move got here despite a rapid increase in debt in any respect levels.”
The CNBC author is outwardly bemused that net price would rise together with debt as if the 2 are unrelated, when if fact rising debt is the source of rising net price. Americans didn’t get “considerably richer in 2021.” They got considerably more leveraged and fragile, and one step closer to the mother of all mean reversions.