Explaining Stagnant Living Standards in a Generalized Asset Growth Context

Abstract:

Aggregate U.S. assets have grown at an impressive rate over the past four decades, especially in recent years. Despite this, middle class living standards have remained relatively flat over the past four decades, and substantial debt has been required to maintain consumption at customary levels. We assemble the U.S. balance sheet for the past seventy years, showing how mounting debt has contributed to growth in financial assets, relative declines in net worth, and increases in assets in relation to GDP. We also calculate a financialization ratio based on our data, for which the trend line identifies a structural break circa 1980 after which the U.S. economy “financializes.” Our numbers, moreover, support the claim that the debt spiral intensified income inequality. Most remarkably, average national equity returns remained flat or even declined slightly post-1980 despite much greater volatility and debt leverage, contrary to what basic financial theory would dictate.

Keywords::

• financialization
• debt
• national balance sheet
• inequality

JEL Classification Codes::

• B500
• B520
• B590
• E0020
• G010

Acknowledgment

The authors thank three anonymous reviewers for comments and suggestions on an earlier version of this article.

Notes

¹ It is highly likely that it is precisely because foreigners have (at least up to now) stuck with the dollar that the U.S. economy has not suffered more adverse consequences.

² On this, see also Lavoie (2013) and Orhangazi (2008).

³ Although as shown by Goldsmith (1985), a significant increase in equity prices in the 1920s preceded the Great Depression, while more recent episodes—especially the financial crisis—were largely debt-fueled.

⁴ We should clarify that our definition of equity is in the more general sense of wealth instead of narrower reference to company shares. While corporate stocks are included among equities, they are also—unlike the other equity categories—classified as financial assets.

⁵ We subtract external debt from total debt because debt owed to the rest of the world can be used to finance the purchase of assets, while intra-U.S. debt acts as both an asset and a liability. The purpose of the financialization ratio is to signal when intra-country debt exceeds the wealth of the country. Total debt in excess of tangible wealth is akin to Frederick Soddy's (1926) notion of “virtual wealth.”

⁶ In other words, even assuming that all wealth is lent out, a ratio greater than 1.0 would indicate some “churn.” Since it is not (many deploy their own wealth in productive assets), our ratio in all likelihood understates the extent of financialization if we consider 1.0 to be the critical threshold. There are, moreover, other ways in which it could be understated. The financialization ratio is, for example, blind to inequality; it does not reflect the negative wealth effects and instability to segments of society that use debt to finance consumption. We also omit outstanding derivative contracts in the debt calculations. While such contracts certainly sometimes provide risk management benefits, with global outstanding balances of $493 trillion and U.S. dollar balances of $66 trillion in 2015 (Bank for International Settlements 2019), it is reasonable to propose that derivatives are increasing the churn in the financial system.

⁷ Our calculation of consumption includes the portion of government expenditures classified as consumption instead of investment.

⁸ As has been noted by, among others, Cecchetti and Kharroubi (2015).

⁹ An example can be seen in the aftermath of the housing market collapse of 2007–2008 (see, e.g., Bansack and Starr 2015).

¹⁰ See, for example, Markowitz (1952), Sharpe (1964), or Tobin (1958).

¹¹ Mazzucato (2018) takes a different position, arguing that the government could also potentially take a more “entrepreneurial” role, engaging in high-stakes investments with high risk but possibly substantial social returns. Even if such investment were mostly to lay the groundwork for future private investment, she would argue that there is nothing inherently “low risk” about the government sector. While agreeing with the premise, we see relatively few practical examples of such government entrepreneurship. Pursuing the matter further would take us far beyond our present scope.

¹² Both the inter-period decline in the return risk ratio and the increase in volatility are statistically significant at the 95% confidence level.

¹³ One particularly visible example was the Troubled Asset Relief Program (TARP), through which taxpayer money helped bail out the large banks that had incurred sizable losses during the financial crisis.

¹⁴ We are, of course, looking at the simplest, static, case. As is to be expected, value is created over time by more efficient deployment of assets, usually resulting in an increase in net worth. (The opposite could happen in the case of widespread misguided investments).

¹⁵ We must emphasize that we are not advocating the abolishment of fractional reserve banking. We merely wish to illustrate, through the use of such taxonomy, how beyond a certain critical point loans based on bank holdings of fractional reserves make the financial system unstable.

Additional information

Notes on contributors

Robert S. Goldberg

Robert S. Goldberg is a Clinical Associate Professor in the Department of Finance and Economics at Adelphi University.

Mariano Torras

Mariano Torras is Chair for the Department of Finance and Economics at Adelphi University.