The “wealth effect” created by the Federal Reserve's monetary policy during the pandemic has given high-income earners more and more purchasing power from growing portfolios and rapidly appreciating homes. These consumers are the least likely to feel the effects of inflation, even if increased demand for goods stimulates inflation. Below, Sean Talley reports on his interview with Ed Pinto on the 'wealth implications' of the pandemic and discusses its implications.
Perhaps the most overlooked driver of inflation is the wealth effect. Americans felt flush and spent extra, as stock portfolios and home prices soared by trillions of dollars during the two countries' Olympic tag team. By far, the largest share of additional spending on things like new cars, home improvements, and laptops is made by Americans at the top of their income brackets. In addition to opening their wallets as their net worths swelled, the high-income earners who own the most expensive homes also used the rapidly rising values of their mansions as ATM-style fonts for cash. Due to the sudden surge in their nest egg and restrictions on cashing out, the cohort's spending continues at a much faster pace than before the pandemic hit. And because this elite class accounts for a large share of overall consumption, it is a major force driving inflation, which reached a 40-year high of 7.5% in January as measured by the Consumer Price Index (CPI). However, it is widely ignored.
Simply put, this class consists of Americans who are wealthy, highly compensated, and contribute significantly to rising prices. Even if only slightly It has been affected by rapid inflation. So far, the rising prices don't seem to be bothering them and have done nothing to curb their record buying spree. Wealthy families can afford to cut back on vacations, trim their new Chevrolet Suburbans, eat out once a week instead of twice, even if they feel the pinch of inflation one day. Dew.
Instead, massive inflation, driven in part by high-income earners, is hurting low-income Americans the most. These hard-earned people typically don't buy stocks and are often renters rather than homeowners. They are the people with older cars who top the list of budget spenders, spending far more of their income on necessities like gas and groceries. They are hit hardest by rampant inflation because they have little, if any, room to cut back on spending on fun things like restaurant meals and vacations. “Forget about supply chain issues,” says Ed Pinto, former chief credit officer at Fannie Mae and director of the American Enterprise Institute Housing Center. “The wealth effect took a big hit around mid-2021, spurring inflation, and the culprit is the Fed's easy monetary policy,” he said.As Wells Fargo analysts put it in a recent report on this phenomenon, “spending is [causing inflation] It is “run by a select few,” meaning high-income households.
Inflation is effectively a “tax” that falls most heavily on low-income households. They use much more of their income to purchase goods and services than high-income earners who accumulate savings to purchase homes or stocks that have increased significantly in value. As Elon Musk said in his recent tweet, “Inflation is the most regressive tax of all.”
Source of wealth effect
The wealth effect is a well-established financial lever that successive Fed chairmen, including Alan Greenspan and Ben Bernanke, have praised and successfully created through ultra-low interest rate policies and, more recently, quantitative easing. These policies increase asset prices, thereby stimulating consumer spending and boosting economic growth. Greenspan boosted the wealth effect to survive the dot-com crash of the early 2000s, and Bernanke leveraged the wealth effect to restart expansion after the Great Financial Crisis. Current Chairman Jay Powell hasn't talked much about the wealth effect, and he has precisely activated the tools to create it by pursuing both zero interest rates and quantitative easing during the pandemic. This time around, the wealth effect has been smaller in magnitude than at any previous time, and is now the supercharged motor driving runaway inflation.
As Pinto points out, economists generally assume that for every $100 increase in wealth, spending increases by $3, or 3%. As Americans' wealth increases, they become more confident that their economic future is secure. They are willing to buy more now because they know they can sell those assets at any time in the future for much more than they paid for them.
For Pinto, the wealth effect has four components.
- The first and biggest one is the explosion in stock prices. In the year since we recovered from the pandemic swoon, U.S. stocks have added $12 trillion in value. The wealth effect of these gains resulted in an additional $360 billion in additional consumption per year (3.0% of $12 trillion).
- The second factor is the $6 trillion home price appreciation (HPA). “In almost every economic boom, it is the affordable homes that increase in value much faster than the luxury homes in the housing market,” Pinto says. “But here he is for nearly a year, and the value of luxury homes has risen at the same rate as affordable homes.”The contribution here is another $180 billion. His AEI numbers show that luxury home prices have increased by 27% since the start of 2020, and given the wealth held by the wealthy, home price increases for the top quintile are his $6 trillion increase. This shows that it occupies a large part of the total. Highest home ownership rates, most expensive homes, and most stocks.
- Third, the sharp drop in interest rates engineered by the Federal Reserve has allowed millions of homeowners to refinance at lower monthly costs. The hiatus generated $280 billion in additional cash for the year.
- Fourth, as housing wealth expanded, Americans rushed to take advantage of it. By cashing out, the refi pocketed an additional $90 billion. The total wealth effect from increasing wealth and using your home as a cash machine is more than $900 billion. The impact hit the economy across the board late last year and will continue into 2022.
High-income consumers are a major force driving consumption booms and inflation.
To determine which income groups are making the most new spending, Pinto used data from the Census Bureau and Verisk's Commerce Signals to track debit and credit card spending by income quartile. did. Purchases with these cards account for 45% of his total personal spending and are a good guide to overall spending trends, trends that can contribute to inflation. To simplify the analysis, he tracked his two groups: the highest and the lowest. He also adjusted all numbers for inflation.
Pinto estimates that about 80% of the wealth effect falls on the highest quintile. This group owns 90% of all shares and accounts for a large share of all housing at market value. “In 2019, the spending of the top quintile and the bottom quintile was in line, simply in line with inflation,” Pinto said. Both suffered sharp declines in the early days of the pandemic, from March 2000 to the end of April. The decline for low-income groups was shallower and their recovery much faster. By September 2020, spending continued to soar, with the bottom quintile increasing by almost 12% in “real terms” compared to the “same month” in 2019. By September 2021, the lowest quintile had slowed to a still robust 6% year-on-year increase.
Why has the bottom quintile been so resilient? As Pinto explains, these families benefited greatly from government cash spending during the pandemic. Homeowners who are struggling to make their mortgage payments can now delay their mortgage payments through bank forbearance, and new regulations allow renters and those with student loans to pause payments.
In contrast, the highest quintile regained ground much more slowly. “Early in the crisis, the high end suffered a 'reverse wealth effect,'” says Pinto. “Stock markets have plummeted and luxury home valuation levels have slowed, falling from 5% to 2.8%. As both the stock and housing markets recover, high income earners regain confidence and the rise in asset prices It took months for the top quintile to return to 2019 levels of spending after the bottom broke even. It was until mid-October 2020. By March 2021, the annual price increases for the top and bottom tiers were competing, and then they both increased rapidly in parallel until late August.
From there, inflation-adjusted spending for the bottom quintile slowed dramatically, but continued to decline slightly for the highest income groups. Judging by consumption, the upper class took the lead. For the week of January 16, the bottom tier rose just 4% year-over-year, while the top tier rose more than three times faster, by nearly 12%. “Keep in mind that these numbers are adjusted for inflation,” Pinto says. “When you add in the CPI increase, the ceiling jumps to about 20%.”
Who is the culprit?
For Mr. Pinto, the main culprit is the Fed. “While it's true that home prices and stock prices rise in many markets, they rarely, if ever, rise at this pace or at the same time,” he says. “About 60% of the wealth effect is due to the Fed's zero interest rate policy and quantitative easing,” Pinto said, pointing out that the Fed's stance has significantly boosted stock prices, and cheap mortgages have pushed up home prices. Pinto believes inflation will continue to rage over the coming months due to the wealth effect. Low-income people will continue to bear the brunt of the damage caused in part by high-income people's high spending. For a long time, it seemed like money was a free ticket to prosperity. Now we're revealing its true cost and, most shockingly, who's paying for it.
Read the entire Fortune article here.
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