Wealth, Income, and Money

My patience has been tried of late by lots of running or heedless thought at the journalist level from otherwise sensible conservatives, on the state of the US economy. Confusion appears to be rampant, if not deliberately sewn. To clear it up, I think empirical information is the best cure, along with the elementary distinctions among wealth, income, and money --- since I see so many confusing money with wealth, and debt with negative net worth, to pick two outstanding common errors.

To see that money and wealth are two different things, let's be decidedly empirical instead of relying on journalist level atmospherics about either thing.

What is the recent state of wealth in the US, and what is the recent state of money?

The Federal Reserve is the organization that tracks all this stuff. Don't get it filtered by ignorant journalists or spinners with axes to grind, get it "straight".

Wealth is covered in the flow of funds dataset, so called because the Fed is able to track these things as the clearing agent for the entire banking system. It sees all monetary flows that have even a single side in contact with the banking system. It knows the value of all accounts, of every description. It has been tracking them religiously since 1945 and publishing the results for anyone interested, suitably aggregated to avoid disclosing anything that anyone might consider private.

There are five main sectors involved. The main one is the "household sector", which means final owners of all claims. Because everything else is claimed or is a claim on, that sector. Next there are 2 sectors for business - non-financial corporate business, and non-corporate business. The latter means mostly small businesses, professional practices, etc. Then there is the government. The finance sector is a special case of its own, because it is a giant mass of intermediaries - but all of the accounts in all of them are for one or another of the other sectors, directly or indirectly.

Let's not look at the whole thing, just the balance sheets for the most recent period, for households and the 2 business sectors, and their changes from statement to statement. That is a digestible amount of data, and I've attached it, but you can find where it came from here -

Now, this is a snapshot at various times, and changes between those times, for *wealth*. Not *money*.

Notice, for example, that the household sector had *assets* of $70.5 trillion at the end of the 2nd quarter of 2008. That is every claim *owned* by the household sector. The same sector had *liabilities* of $14.5 trillion at the same point in time - that is everything *owed* by the household sector. The difference between them, $56 trillion, is the *net worth* of the household sector.

Now scan back to the 2002 entry for the same figure. It is $39.2 trillion. The net worth of the US household sector increased $16.8 trillion over the 5 1/2 years from the end of 2002 to the middle of 2008. That is a rate of increase of slightly over $3 trillion per year. That is a net worth increase, so it is *after* additional debt.

Now look at the household liabilities line item. You will see the liabilities rose from $8.8 trillion to $14.5 trillion, or $5.7 trillion. US households borrowed an additional $5.7 trillion or about $1 trillion per year rate, over this period.

Lots of people in the media will confuse US households borrowing $1 trillion a year, with US households consuming more than they are producing to the tune of $1 trillion a year, and imagine that this means household net worth is declining by $1 trillion per year. Emphatically not. The total assets line, up top, is up $22.5 trillion, and $5.7 trillion of that higher asset value was *carried* by net new debt. The rate of increase of *asset value* was $4 trillion per year, $1 trillion of it was mortgaged, effectively, and the other $3 trillion of it was owned outright, an increase in net worth.

Next point - many media commentators will point to a low personal savings rate and imagine it means household net worth cannot be increasing. This is another fallacy. Household savings are the difference between disposable personal income, and personal consumption. As you can see below the net worth line, the income side of that rose from a $7.8 trillion per year rate to a $10.8 trillion a year rate. The consumption side of it isn't in this table, but at the start of the period is was $7.9 trillion and at the end of it, it was $10.0 trillion.

Notice, the savings rate was indeed low, (in the recession at the start of the period, it was essentially zero, and it has recently climbed back from another near zero at the start of 2008), but this does not mean the change in asset value owned was correspondingly low.

Why? Because the value of assets owned changes by 2 processes, not 1. First, people may add savings to the account or spend them down. But second, the value of all the existing owned assets changes. The first of these has the scale, "difference between 2 numbers close to each other and each around $8 to 10 trillion", with the difference typically being 10% or less and sometimes zero. The second has the scale, "change in price on $50 to $70 trillion in owned assets". Guess which one is the dominant process causing changes in household net worth?

It is as though you had a stock account with $70,000 in securities in it, and each year you might add somewhere between $0 and $800 to the account. Changes in the value of the items in the account as small as 1% per year, will swamp the effect of your actual additions. Obviously this can also work in reverse, and the net worth dropped $2 trillion from 2Q 2007 to 2Q 2008, and it will undoubtedly drop much more in the 3Q and 4Q of 2008, as those data are compiled and released. (3Q will be out soon, before the end of December, by the way).

So, we've seen household wealth, we can see its breakdown in the table and the scale of the items, we can see the direction is has moved and by how much. Look at the other, following tables to see the corporate business and small business version of these things. Keep in mind, however, that all those businesses are owned by the household sector, and therefore the full capitalization of all of them, already appear in the household balance sheet. If a business borrows, it ultimately borrows from a household (with any number of financial intermediaries between). It it owns something and hasn't borrowed against it, that claim runs in favor of whichever household sector owner holds its stock, rather than its bonds or debts.

Notice that corporate business has $9.5 trillion more in assets than at the end of 2002, and $2.8 trillion more in debts. Small business has $4 trillion more in assets, and $2.1 trillion more debt. Notice that the liabilities for each are less than half the assets - we say, the leverage level is below 2. For the household sector it is lower still, around 5 to 4.

Is this the picture of US wealth and ownership you receive from journalist level coverage? It is not, not remotely.

Next let's look at money. Again the source is the Fed, this time the FRED II database kept by the St. Louis branch, which you can find here -

Let's first look at the narrowest, M1. That is immediately spendable money, meaning cash currency (in anyone's hands, bank vaults, business cash registers, consumers, under the mattress the odd suitcase, etc) plus checking accounts, a few other "checkable" accounts ("NOW" accounts etc) and travelers checks. Here is the monthly version of the series -

Notice first that it is basically an exponential curve, but with significant undulations, which are more obvious ("magnified") toward the end or present. There are wiggles earlier too, they are just dwarfed by the present ones, since the whole series is exponentially larger. If you hit "view data" you can see the actual numbers being plotted on the page above. The latest value is for October 2008 and is $1.473 trillion.

First off, notice the scale - it is only about 2% of the value of household *assets*.

Next, let's look at the first point in the series and compute an average rate of change. The first point is at the start of 1959, a hair under $139 billion. The total change is 1473.1/138.9 = 10.6055 times. The time it took for that change to occur is 2008-1959 = 49 years, plus 9 months, or 49.75 years. So the average rate of change is 10.6055^(1/49.75) = 4.86%. That is how fast M1 has grown over the long term past.

Now let's go look at a series for the size of the US economy in nominal terms. The series is here -

We see that at the start of 1959, US GDP was $484 billion per year, whereas it is now $14.4205 trillion a year. It has increased 29.8 times over the 49.75 year period, or 7.06% per year.

Next let's look at what happened to consumer prices over the same span. The series is here -

This index rises from 29.0 to 216.573 over the same time frame, a total change of 7.468 times and an annual rate of 4.12%. Thus, most but not all of the increase in the *narrow* money supply eventually showed up as price increases - but the overall economy grew a little under 3% faster than prices.

If we go look up the household assets line for the end of 1958, here (very bottom of the long PDF file) -

--- we see it was $1.881 trillion, so the household asset value account has increased 70.5/1.881 = 37.48 fold or 7.56%, half a percent per year faster than the overall economy, and 3.3% per year faster than consumer prices.

That aside was to show the *partial* truth in the quantity theory of money idea, that increasing the money supply *mostly* effects prices in the long run, but also to show it is not a close, one to one, let alone an immediate process or relationship, and that it certainly does not account for the long run increase in either the size of the economy (incomes) nor assets (wealth).

Let's go back to money, and look at a broader series that includes more "money substitutes". This series is called "MZM" for "money of zero maturity", and can be found here -

This includes commercial CDs and money market funds, the preferred *savings* forms still consider near enough to bankable money, to treat them as close substitutes for checking accounts and therefore for cash.

It starts 1959 at $274.9 billion, and it grows to $8.715 trillion by October of 2008. That is 31.7 fold growth or 7.2% annualized. Notice, considerably faster than M1, about equal to the growth in the overall economy, and marginally slower than the growth in all household assets.

Also notice its scale - 12.4% or about 1/8th of all household assets. Since it includes M1, one might further put it this way - immediately *spendable* money forms only about 2% of all household assets, while *savings* forms of money form another 10% or so.

Also notice, there appears to be no tendency in the average growth rates for the full increase in *savings* forms of money, to show up as mere increases in *prices*.

Indeed, logically, if the value of all assets grows in real terms (adjusted for prices I mean) and does so exponentially at something like a 3.3% annual rate, then *either* prices have to lag well behind the rate of growth of *broad*, *savings* forms of money, or the portion of owned assets held in liquid near money forms would have to progressively fall with time. There is no way people can keep 10% of their assets in savings or CDs or money market accounts, with their assets overall growing 7.6% per year, unless total savings and CDs and money market accounts, also grow about 7% per year.

Individual liquidity preference as to the form in which to hold their assets, can only remain constant in a progressive growing economy (growing in real terms), if the rate of growth of broad money outstrips the growth of prices, by approximately the same amount as the real economy or total asset values, outstrip prices. If people want to hold a fixed portion of their wealth in savings forms of near money, then broad money *has to* grow *faster* than prices. Materially faster, like, up to twice as fast.

When a confused monetarist thinks any change in *broad* money is "only" inflation, he is denying that real economic growth can exist. He just doesn't realize it, not having through it through. (Or, to be charitable, some of them can only imagine real economic growth as a progressive fall in prices over long time scales, with money unchanged --- but even then, they can't explain why people would *want* to carry progressively higher and higher money balances, as a portion of prices).

Narrow money growth is a different matter. Even there, there is no close time requirement that changes in narrow money result in exactly equal changes in prices.

The Fed, knowing this, legally controls the growth of M1 to a fixed multiple of the size of the Fed's own balance sheet. Since it determines the size of its own balance sheet, it controls the growth of M1. No bank can change M1 without putting reserves on deposit at the Fed, and it can decide what quantity of those reserves to make available.

The Fed does *not* control broad money, savings accounts, CDs, money market accounts, etc. Banks can freely extend those further, without requiring additional bank reserves, and regardless of what the Fed does. They are restrained by their own prudence or unrestrained by their lack of it. (There are also some Basel international capital requirements that are important, but basically those require a bank to raise its stock capital if it wants to create more money, without forbidding it from doing so, if it can and does raise such capital).

OK, so now we are operating in a true, empirical picture of what wealth is, how it is owned, its recent changes and scale, what money is, how much smaller it is than wealth, its major functional subdivisions, and the broad relationships among these things. The level of journalistic cant and ideological prescription has been blasted to atoms to reveal the realities they are gesticulating about.

Comments informed by this level of detail about what is actually happening are much more likely to be useful.

Does that mean there is $56 trillion in equity? Which is neither wealth or money.

This is the type of analysis that one would expect of someone with an actual understanding of the dynamics of finance.

My expertise is physics/math, but this work shows intellect.

Too bad that there are few (if any) journalists out there with sufficient education to trace this out.

Bookmarked! thanks.

For what it’s worth, I am SO tired of liberals talking about “the rich” as if they were some ethnic group - as if wealth were an inborn, and inalienable characteristic.

People move up and down the net worth ladder all the time.

Thanks for the breakdown. I will spend a lot of time on it later after work.

It is refreshing to see facts. I see so few of those in the media these days.

If we lack money we shall monetize things that haven’t been monetized as yet, or commoditize what hasn’t been commoditized such as a carbon debt. We can even monetize oil that hasn’t been produced and subdivisions that haven’t been built. This gives us flexibility in choice, which is happiness, and that is wealth. Money is not necessary to have flexibility in choice, and we can choose unwisely, but while we have flexibility of choice we have happiness.

Journalists can’t add.

That is why they become journalists.

The state financial reporting in this country is abysmally low and often displays a quasi-Marxist bias.

It is wealth, and it is not money. Assets of the household sector are $70.5 trillion, $56 trillion of it owned outright. That is as of the end of the summer, and both figures will have fallen with the stock market crash in the second half of the year. They were up $22.5 trillion and $16.8 trillion respectively over the previous 5 1/2 years, and the fall in the second half of 2008 will have given back part, but not all, of that prior increase.

Money is whatever commodity is more readily accepted by the entire commercial world as a medium of exchange, and it gets and keeps that status when and because lots of people stand ready to accept it in payment for other things people want. Few are prepared to accept a 4 bedroom house in Phoenix as payment for a vanilla latte, so it isn't money. Everyone is ready to accept US dollars in the form of banknotes or a bank credit card, so those are money. Wealth is a much broader thing, and is what we are really after. The point, precisely, is to cut off money the transaction medium item, from wealth the much larger aggregate of valuable stuff, that it merely serves to measure. And to see in empirical detail, their respective size, and relationship over time.

We are probably in alignment WRT money and income. As for wealth, property can add to it. My interest is what happiness might be. Wealth has a dimension of wealth, and poperty and money might be dimensions of wealth but not he only dimensions.

Fair enough. Money can't buy happiness. People scared into thinking they are all going to die because they have been led (erroneously) to believe that all their money is evaporating into mysterious pits in the sky can, however, destroy their own happiness with reckless, panicked decisions. Let's not.

destroy their own happiness with reckless, panicked decisions

As soon as one makes a decision, the choices are reduced, and the happiness with it. The only saving grace is that a decision can move one into a region where more and better choices are made available and happiness in the longer view thereby increased. Harvard or Podunk U? In the short term one reduces wealth considerably and the other moderately. In the longer term possibilities are enhanced considerably for one and the other leads to maybe a position as loan officer in a bank needing FDIC bailout.

Money, wealth, and income are easy to understand by anyone who thinks. If I own property then I have wealth but no income or money. If I get a loan using the property as collateral, then I have money, and I have income when I rent out the property. Seems that a lot of people don't think though.

However a major problem comes up when we talk about "value" AKA "worth".

Do we say the value of a piece of property is the latest bid price, the asking price, or the last transaction price? Worse yet is the case where some property produces an income of say, $10k per month, but the latest bid/ask/transaction prices were just $5k for the whole thing. I'd argue that with this kind of situation that market prices just don't make sense, but I'm stuck for a good alternative.

“the fall in the second half of 2008 will have given back part, but not all, of that prior increase.”

More specifically, net worth at the end of second Q 2008 was at the same level as first Q 2007. During that period, what went up came down. It is as if we are treading water, wealth-creation-wise.

If the government were really honest, they would provide a corresponding tally of the net present value of unfunded entitlements: that figure is $99.2 trillion, representing future obligations for Social Security and Medicare that are not covered by projected payroll taxes intended to finance them [http://www.dallasfed.org/news/speeches/fisher/2008/fs080528.cfm]. In other words, we will have to rely on either future borrowing or general taxes to cover these promises OR we will have to dramatically reduce the amounts promised to ourselves, our children and grandchildren.

“Money can’t buy happiness.”

I’m not sure science would support that statement:
“In the United States, about 90 percent of people in households making at least $250,000 a year called themselves “very happy” in a recent Gallup Poll. In households with income below $30,000, only 42 percent of people gave that answer.”
http://www.nytimes.com/2008/04/16/business/16leonhardt.html

Even cross-nationally, higher-income countries TEND to have greater levels of happiness than those with lower incomes.
http://www.nytimes.com/imagepages/2008/04/16/business/20080416_LEONHARDT_GRAPHIC.html

The good alternative is well known, it is the discounted present value of the future cash flows the asset will generate. If you know those likely future cash flows and can put a reasonable interest rate on it, one that reflects your own time preference for savings and takes into account alternate investments available in the market, then the fair price is just that DPV. If the cash flows will continue indefinitely without change, that means you just divide by the interest rate. E.g. 10 times rent means a 10% rate of discount if you will get that amount forever. If it will rise a few percent a year, that is effectively added to the return.

Market prices are *not* an adequate guide to the value of things. This is particularly true when interest rates are far from the level you expect to see over the lifetime of the asset. One of the problems in bubbles is you see people capitalizing at 4% interest rates, properties that will have to produce income for 25 or 30 years, when the actual interest rate on alternate investments will *not* stay that low for such an extended period.

Fair question.

False on the government accounting issue. That is only a liability to the household sector to the extent it is an asset to that sector. If the government doesn't pay us a dime on its promises, we won't pay for a dime of it. If the government charges up $20 trillion, we will get $20 trillion. OK, maybe they waste 5% (or 25%...) That is something to worry about, sure. But just the transfer payment, emphatically is not.

It is absolute vital to avoid the media's ridiculous instances of *one entry accounting*, where they pretend something is *owed* without asking *who* it is owed *to*, or they pretend everyone is going to die because so-and-so doesn't repay a debt, without noticing that so-and-so doesn't mind not needing to repay it, so much.

There is no such thing as a net debt.

There *are* debts to foreign holders of financial claims, and they total about $13.5 trillion gross - but they are almost matched by our holdings of foreign financial claims running in our favor. The net is under $4 trillion, and dwarfed by household assets.

TYVM for this excellent article.

Now to my questions.

Let’s suppose that M1 is under-reported. Would real wealth then be higher or lower? How does the Treasury Department account for the difference between dollars issued and dollars destroyed when an old currency series is taken out of circulation? Are these differences published? What I’m trying to get at is the magnitude of cash being hoarded such that it is essentially uncirculated and what sort of risk this could pose for our financial system.

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