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keep dreaming. They said the same nonsense in the 20s.
While a significant market crash will not immediately, drastically impact on
the day to day economy, if history is any guide, approx 6 months after, the
real
noticable slowdown will commence. This country's reckless debt creation
(govt, corporate, and public) and the negative savings rate, coupled with
grossly overinflated asset prices will exaserbate and prolong the next
coming economic downturn. Folks are already in debt to the gills, and there
is nothing like tens of millions of unemployed citizens to really grind
things to a halt.
There should be a disclaimer on your magazine:
"Reading Barron's may be hazardous to your wallet."
----- Original Message -----
From: JW <jw@xxxxxxxxxxxx>
To: <realtraders@xxxxxxxxxxxxxxx>
Sent: Sunday, April 23, 2000 2:32 PM
Subject: [RT] Barron's says
> A friend sent me this. Seems by this explanation that even a 30%
permanent hit
> on the market will have little or no effect on life as we know it. Which
sure
> seems at odds with those pictures of people wiping sweat from their brows
and
> wringing their hands in front of the public stock tickers when the markets
were
> plunging <g>. Comments?
>
> JW
> ____________________
>
> April 24, 2000
>
> Barron's Features
>
> The Wealth Defect
>
> If stocks crumble, the economy may not be hit as hard as some theorize
>
> By GENE EPSTEIN
>
> Let's suppose the greatest show on earth really does fold its tents: The
S&P
> 500 plummets 30% from its late-March high and stubbornly refuses to
> rebound. With the euphoria suddenly gone from their lives, what will the
world's
> equity investors end up doing? What else but resort to the only other
source of
> instant gratification known to modern man: shopping. Buying that SUV,
> acquiring that yacht, moving to a bigger home (especially since mortgages
will
> also be cheaper), or trading up to a Lexus -- even though no status symbol
can
> ever produce the joy that comes with owning a dot.com that doubles in
price
> every month.
>
> For the truth is, through the last several legs of this bull market, it
looks as
> though investors were mainly keeping score. According to conventional
theory,
> there is a psychological transmission mechanism through which a rise in
share
> prices makes a person feel wealthier, even if he doesn't turn paper
profits into
> real ones by selling stock. And feeling wealthier, he then spends more on
> consumer goods. That's the theory of the wealth effect. But this time
around,
> the voltage must have been such that the mechanism blew a fuse.
>
> It does appear that equity prices have surged so far and so fast that most
paper
> millionaires haven't quite advanced to the big-spender phase. So if all
those
> gains get vaporized, maybe these investors will start going to the track
more
> often in order to fill the void, but otherwise, the rate of consumption
won't
> decline. Why? Because it never rose in the first place.
>
> A similar view can be found in a recent scholarly paper, "How Important Is
the
> Stock Market Effect on Consumption?" by economists Sydney Ludvigson and
> Charles Steindel of the Federal Reserve Bank of New York. After running
the
> relevant numbers through a standard econometric model, they wryly remark
> that "if all pre-1988 data were destroyed, we would be hard-pressed
> to conclude that there is a link between the stock market and consumer
> spending."
>
> While former New York Federal Reserve Bank research head Stephen
> Cecchetti doesn't go that far, he does take a similar view. In his own
recent
> survey of this topic, he writes: "Given that the market is currently at
11,000
> and
> people are behaving as if it is at 8500, simple computation shows that
they are
> discounting the gains of the last few years significantly."
>
> Indeed, there seems to be a disconnect between the recent surge in equity
> values and consumption growth. It may even be that the bull market has
helped
> suppress consumer spending by inducing people to put their extra cash into
> stocks.
>
> On the other side of the conceptual divide, there's the widely held belief
in
> the
> terrible revenge of the wealth effect. According to the rule of thumb
codified
> by
> the utterances of Alan Greenspan, every $1 of additional stock-market
wealth
> has been boosting consumer spending by three to four cents; so every
dollar of
> lost wealth will clobber it by that amount.
>
> But as we'll soon see, the Fed chairman has been snookered by a faulty
model.
> While Jason Benderly of Benderly Economics does believe there has been a
> wealth effect from the bull market, he puts it more plausibly at one and a
half
> cents.
>
> And we're not just quibbling over pennies. One and a half cents on the
dollar of
> a sustained $3 trillion loss in household holdings of equities, which is
what
> would happen if the market plunged 30%, translates into a $45 billion hit
to
> consumer spending. That $45 billion would shave a mere one-half of 1% from
> gross domestic product, which is now valued at more than $9.5 trillion.
Assume
> instead that the hit comes to as much as three or four cents on the
dollar, and
> then you might be talking real money.
>
> But we're not talking real money, because even that cent-and-a-half
estimate
> could
> easily be too high. If Wall Street analysts would only look beyond the
Hudson
> or,
> in the Fed chairman's case, the Potomac, they'd stop attributing so much
of the
> consumption boom to the bull market. Two other far more note-worthy trends
> have done the heavy lifting: the lowest unemployment rate in 30 years and
the
> highest housing affordability in a quarter-century.
>
> The tight labor market has brought a surge in wages and salaries, putting
huge
> amounts of cash in the hands of the lower 80% of consumers who live
> hand-to-mouth, and who can be counted on to spend it -- and then some.
> Amazingly enough, some economists don't even bother to consider the
effects
> of soaring wage-and-salary income on recent consumer behavior, as though
> most households somehow live off their capital gains.
>
> Ironically, the capital-gains effect lies at the heart of one of the fatal
> errors
> committed by Chairman Greenspan's model-builders. They do look at rising
> incomes, but they walk away thinking that this factor isn't nearly as
important
> as
> it really is. And that's because their estimates are artificially
suppressed by
> the
> influence of capital-gains taxes.
>
> There's no good way to explain this subtle point without a bit of math.
(But
> it's a
> relatively painless way to be smarter than the Fed chairman.)
>
> Suppose a salaried investor earns $100,000, out of which he pays a $30,000
> tax, which leaves him with an after-tax income of $70,000. But now
suppose,
> as has been common these days, he realizes a $50,000 capital gain on stock
he
> owns. So he pays the $10,000 tax out of that cash and reinvests the
remaining
> $40,000.
>
> Now, what happens in the national income accounts, and hence in the data
> used by the Fed, is that this person's after-tax income gets reduced by
that
> extra $10,000 tax on the capital gain. So he is credited with only $60,000
in
> income, instead of the original $70,000. That's because the accounting
> perversely factors in the tax, but completely forgets that he had plenty
of
> extra
> cash with which to pay it! And with capital-gains taxes recently bulging,
this
> distortion makes it look as though after-tax incomes aren't rising nearly
as
> fast
> as they really are.
>
> Fed economists also overlook the way consumer spending has been boosted
> by the strong sales of new and existing homes.
>
> The bull market in stocks has obviously helped fuel the housing boom. But
the
> more important factor has been the rise in the National Association of
Realtors'
> housing affordability index, which has been hovering at 25-year highs.
>
> This index tracks the ratio between median household income and the true
cost
> of buying the median-priced home. The rise in costs has slowed mainly
because
> of the long-term decline in mortgage interest rates, while growth in
income has
> accelerated because of the tight labor market. This, in turn, has pushed
the
> nation's rate of homeownership to a record high, and has meant that sales
of
> new and existing homes have been running at nearly six million units a
year, or
> twice the level of the early 'Nineties.
>
> And the point is, when people purchase homes, they also invest in rugs,
> furniture, appliances, linens and dishes. Street economists are well aware
of
> this
> spill-over effect, but what they overlook is that it also boosts the
actual
> level of
> consumer spending. Since homeowners think of this kind of spending as a
form
> of investment, which in a very real sense it is, the dollars come out of
funds
> that
> otherwise would be saved.
>
> The decline in the personal savings rate to a record low is, of course,
the flip
> side of the leap in consumption, and it's been caused by exactly the same
> factors.
>
> To begin with, the savings rate has been understated because of the same
> capital-gains distortion that befuddles the Fed. To go back to the same
math, if
> a taxpayer has an after-tax income of $70,000 and spends $60,000, he has a
> relatively high savings rate. But if his after-tax income is put at
$60,000
> because
> he paid a capital-gains tax of $10,000, his savings rate is misleadingly
pegged
> at
> zero.
>
> The savings rate has also declined because a higher proportion of
household
> income has been coming from wages and salaries, out of which consumers
> spend heavily. (They spend a lot less out of interest and dividend
income.) It's
> also fallen because of the spill-over effect on consumption from rising
home
> sales.
>
> In addition, the wealth effect from rising house prices has served to
depress
> the
> savings rate. But, as noted, there's a wild card in the role played by the
bull
> market in equities. Perhaps it helped reduce the savings rate via the
wealth
> effect: Feeling wealthier, investors spent more on consumer goods. But the
> rising market must have induced many investors to save more and consume
> less. Cash taken out of income to buy stocks is counted as savings.
>
> But as noted, even if the wealth effect from equities really has run as
high as
> one-and-a-half cents on the dollar, the hit to GDP growth from a 30% bear
> market isn't likely to be very great.
>
> Trim a half-percentage-point off GDP from the direct effect on
consumption.
> Then, take another half from indirect effects: Wall Street will start
laying off
> its
> workers, the high end of the housing market will suffer and the tax take
from
> capital gains will contract, wiping out much of the budget surplus.
>
> On the other hand, if people really are behaving as though the Dow is at
8500,
> it won't be even that bad.
>
> URL for this Article:
>
http://interactive.wsj.com/archive/retrieve.cgi?id=SB956364196179064205.djm
>
>
> Copyright © 2000 Dow Jones & Company, Inc. All Rights Reserved.
>
>
>
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