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This increase is partly the consequence of the country's relatively
high (by international standards) level of share ownership. But given
their even higher level of home ownership, and the fact that the
capitalisation of the average family's home greatly exceeds that of
its share portfolio, the increase of Australian households' net worth
(like that of their counterparts in these other countries) owes most
to the sharp increase of the price of residential real estate. The
family's home, most people emphatically agree, is its most valuable
asset.
Yet this rise of median household net worth – which media
coverage typically and erroneously interprets as an increase of
wealth – is largely illusory (see also
Letter 45). Why? There are two reasons. First, if time is money,
as Ben Franklin quipped, and if lack of time is dearth of capital, as
Ludwig von Mises demonstrated, then wealth is time. An appropriate
measure of a household's wealth, in other words, is the number of
years that the stream of income generated by its assets (as opposed to
the salaries of its members) can maintain a desired standard of
living. My guess, bearing in mind its innate subjectivity, is that the
wealth of the median household in these countries is no more than
three years. If so, then few are wealthy.
Second, a real increase
in the wealth of individuals and households, as Paul Kasriel
emphasises in an excellent article ("Wealth
Illusion", 22 October 2004), presupposes the expansion of the
capital stock and of the productivity of the capital that they own
(see also
Letter 41). Alas, according to Kasriel's analysis of American data
(trends for Australia, Britain and Canadian households differ in
various ways but are roughly comparable), "in recent years, growth in
our capital stock has slowed and the composition of the slower growth
has moved in favour of McMansions and SUVs, which do little to
increase the productive capacity of our economy."
Kasriel notes that a
household's net worth increases either because expenditure falls
relative to income ("saving") or the market prices of assets acquired
through past saving rise ("capital gain"). During the last
quarter-century, most people have rejected the first option. In
Australia, for example, the household savings ratio (i.e., saving as a
percentage of household disposable income) averaged approximately 10%
during the 1960s. During the 1970s it rose to 12.5% – and at one point
as spiked as high as 18% – and in 1975-1980 averaged 15%. But since
the early 1980s it has fallen steeply and almost without interruption:
during the 1980s it averaged 10%, during the 1990s it averaged 5%,
since 2002 has been below 0 and is presently as low as minus 3% – a
level not seen in this country since the 1930s.
How, then, has the median
net worth of Australian (and, by extension, other) households risen in
recent years? The liberalisation and deregulation of financial
services during the 1980s enabled – and the irregular but cumulatively
very appreciable decrease of interest rates have encouraged –
households to borrow. Households' borrowing has financed not just
current consumption (i.e., the purchase of clothes, dinners and
holidays) but also non-current consumption (i.e., the purchase of
cars, appliances and real estate). And thanks to the decrease of
interest rates, the prices of stocks, bonds and residential real
estate have generally increased. Asset price inflation, in other
words, has swelled individuals' and households' balance sheets. In
response to these developments, they have "leveraged" their balance
sheets ever more aggressively. They have borrowed, in other words,
partly to buy things whose prices have risen more quickly than income.
During the 1960s and 1970s, total Australian household liabilities
rose from 40% to 45% of average annual income. In the 1980s this ratio
rose more quickly (from 45% to 65%); during the 1990s it accelerated
even more rapidly (from 65% to 110%); and since 2000 it has rocketed
from 110% to 155%.
By borrowing against a home whose price is rising, sometimes
substantially, households have been able to "extract equity" and
consume the proceeds; and the growing magnitude of extraction has
enabled them to increase their consumption at a rate that has greatly
exceeded the increase of household income. But all financial
transactions incur risk, and the most immediate risk of this behaviour
is the sturdiness of the assumption that the prices of households'
assets, particularly houses, can continue to rise much more quickly
than income. A less immediate but ultimately much more significant
risk is the weakening of the capital structure. A weaker structure
today implies sluggishly growing or stagnant or even falling living
standards in the future.
Using American data from
1952 to 2003, Kasriel has charted the relative importance of savings
and capital gains as components of households' net worth. In the
mid-1990s, the impact of capital gains began to outstrip savings by a
wide margin. From 1995 to 1999, a steady increase in the prices of the
household's portfolio of stocks drove the increase of its net worth;
and since 2000, increases in the market price of the family home have
done so. During the period 1952-1994, capital gains on stocks or real
estate were, on average, 1.7 times greater than household saving; and
from 1995 to 2003 these gains averaged 4.4 times household saving.
Consumers, cheered by politicians, concluded that capital gains are –
and that savings are not – the route to higher net worth.
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