January 16, 2022
by Stephen Stofka
Analyses of wealth and income inequality engage policymakers and economists and provoke lively discussion on social media. Thomas Piketty (2013) stirred up debate with the publication of Capital in the Twenty-First Century. Five years later came the publication of After Piketty (Boushey et al., 2019), a series of essays by prominent economists. I wanted to tackle a different aspect of this subject – why the ratio of wealth to income has become so erratic in the past two decades. The answers are too complex for a blog post and beyond my capability to understand. But let’s take a short journey down the rabbit hole.
In the past ten years both stocks and housing prices have more than doubled, moving in a synchronized dance. In the graph below I’ve plotted the two series on top of each other to show the similarity in trend.
The Federal Reserve charts a ratio of household wealth to disposable income, which is income less taxes plus transfer payments like Social Security. Although there are some similar components, the ratio is different than the capital-income ratio that Piketty uses. Housing represents the majority of wealth for many households. Many workers own part of the stock market through mutual funds, 401K plans at work or IRA retirement plans. The doubling of these two asset classes has led to a rise in household wealth and raised the wealth-income ratio to historically elevated levels.
In the graph above I have highlighted past decades where this percentage found a level and remained there. For almost 50 years following WW2 household wealth was about 5x disposable income. Beginning in the mid-90s, this percentage turned erratic, unable to find any stability until the violent recession following the fiscal crisis. In 2013, stock prices and housing began a steady climb that endured the pandemic shock and continues to this day. Will we establish a new level of wealth at 8x disposable income in the next few years? I doubt it. Such a growth curve is unsustainable.
As I search for the underlying causes, I look back to the mid-90s when the wealth-income ratio first turned erratic. The internet first began to grow into our commercial and personal lives. Heady expectations of rocketing business profits led many investors to make wild bets on companies who had little history, a lot of hype and little profit. Out of the carnage of mis-investment emerged an internet platform that has transformed our personal lives. Apple and Amazon are two success stories. In 1997 giant Microsoft made a $150 million investment in failing Apple Computer that kept Apple out of bankruptcy. This year Apple’s valuation passed the $3 trillion mark, about 13% of the entire GDP of the U.S. That same year Amazon went public. It’s business model? Selling books. For years it struggled to make a profit. Amazon’s market capitalization is now over $1.6 trillion. The so called FAANG stocks of big tech have surpassed the industrial and financial giants of the 20th century. Two researchers at Morningstar studied the decade long impact of the ten largest stocks and the impact they made on the overall return of the entire stock market (Solberg & Lauricella, 2021). Perhaps that concentration of market power is contributing to a more erratic wealth-income ratio.
Low interest rates and leverage have affected household wealth. In the mid-90s, bankers at JP Morgan developed the collateralized mortgage to spread risk. In ten years, misuse and overuse of that idea led to a historic meltdown in housing prices and caused a worldwide fiscal crisis. Since then the supply of new housing has not kept pace with demand. Fueling that demand is a large Millennial generation which is settling down. Persistently low mortgage rates have increased the pool of qualifying buyers. Low rates have raised the present value of the future housing services a homeowner receives from the house they buy. Not enough supply to meet demand has led to higher housing prices.
High inflation this year has grabbed headlines and stirred up comparisons to the stagflation of the 1970s. There are too many differences between now and then but that is a subject for another blog post. A rising federal debt has certainly contributed to a rising level of wealth but does not account for the erratic behavior of the ratio itself. In the mid-90s, the federal debt began falling and the wealth-income ratio rose dramatically.
I suspect that finding an equilibrium in this ratio will be a painful process. To reestablish a sustainable ratio, there are two possibilities. The first is a hard landing where asset valuations fall more than incomes fall. The second scenario is a soft landing in which incomes rise more than valuations rise. Let’s hope for the soft landing.
Boushey, H., Bradford, D. L. J., & Steinbaum, M. (2019). After Piketty: The agenda for economics and inequality. Harvard University Press.
Cautero, R. M. (2021, December 28). What is disposable income? The Balance. Retrieved January 15, 2022, from https://www.thebalance.com/what-is-disposable-income-4156858
Piketty, T. (2013). Capital in the Twenty-First Century. (A. Goldhammer, Trans.). The Belknap Press of Harvard University Press.
Solberg, L., & Lauricella, T. (2021, December 1). The FAANG Market is Fading. Morningstar, Inc. Retrieved January 15, 2022, from https://www.morningstar.com/articles/1070180/the-faang-market-is-fading