Debt Deflation and the Illusion of Wealth

rcwhalen's picture

Listening to our friends in the financial media, one is tempted to think that skillful investors are somehow able to dodge the flaming asteroids of inflation as they fall to earth.  See the last few minutes of the latest David Twohy film “Riddick” starring Vin Diesel for the visuals. Should Katee Sackhoff be the next Fed Chairman?  

The idea of an object falling from space as a metaphor for inflation may surprise some readers of Zero Hedge, but our friend Marc Faber likes to remind us there are many ways to lose money -- or really wealth -- from inflation.  Chief among them are asset bubbles instigated by the monetary emissions of reckless central bankers who pretend, at least, to believe that they can solve problems like unemployment by merely debasing our beloved fiat currency.

The whole notion of value and wealth in a fiat monetary system is relative, especially following a major catastrophe such as the Second World War.  The history of the US of course paints the WWII period as a victory for democracy, but the fact is that the disruption and dislocation caused by that conflict and the subsequent surge in population we loving refer to as the baby boom is still being felt.  My friend and mentor Alex Pollock, Resident Scholar at American Enterprise Institute, puts it nicely in a draft essay entitled appropriately “Wealth” and Illusion:

“Before 2007, central bankers convinced themselves they had created a new era, “The Great Moderation,” but what they actually presided over was the Era of Great Bubbles.  In the U.S. we had first the Great Overpaying for Tech Stocks in the 1990s, then the Great Leveraging of Real Estate in the 2000s,” Pollock writes.  “Inevitably following each of the great bubbles was a price shrivel.  Then many commentators talked about how people “lost their wealth,” with statements like “in the housing crisis households lost $7 trillion in wealth.”  But since the $7 trillion was never really there in the first place, it wasn’t really lost.” 

To the real estate bubble of the 2000s, we could add the more recent rebound of the housing sector and stock prices.  But in truth, if you take the distressed transactions out of the time series, the rebound in home prices over the past 24 months is probably in single digits.  Meaning no offense to the investors in Invitation Homes 2013-SFR1, a rent securitization collateralized by one floating rate loan secured by 3,207 single family rental residential properties, the peak in US home prices in this “cycle” probably coincided with the initial public offering of RMAX.  

More to the point of wealth illusions, consider the latest run up in the Dow and other equity market indices.  Somehow commentators in the financial media are able to talk into the camera with a straight face about investor gains in stocks, this even as the central bank is robbing consumers of real purchasing power via a steady inflation of the currency.  If the major stock market indices are at all-time highs, but the supposed risk free rate is zero, what does this imply?  Are we all wealthier because the Dow is at 15,000 or is the whole point of quantitative easing merely to boost “confidence” as the Fed’s own policy statements suggest?  Again Pollock:

“Common calculations of aggregate ‘wealth’ take the entire stock of an asset class and multiply it by the bubble prices, on the theory that financial value is what you can sell something for.  Of course, some clever or lucky individuals succeed in selling at the bubble highs, but the aggregate bubble prices can never be realized by sale.  As soon as any very great number of the owners of a bubble asset try to sell it, the bubble collapses, the evanescent “wealth” disappears, and the long-term trend reasserts itself.”

And what is the long term trend for wealth creation in America?  Pollock suggests that it is about 2% a year in real, inflation adjusted terms.  “The rate of increase may seem modest, but in fact represents a miracle of the market economy,” he notes. While this rate of increased in aggregate wealth may reassure those who care about long terms trends, it also suggests that the latest increase in equity market valuations are greatly exaggerated and probably not sustainable.

Of course the neo-Keynesian socialists who dominate the economics profession like us all to believe that the “wealth effect” of rising home or stock prices is real, but in fact, like most economic notions, it is merely an illusion foisted upon all of us by a servile financial media. Income and production, not asset prices, are the real bases of wealth.  

If you tell people the truth; that real wealth can only ever rise 2% per annum on average, nobody would give a hoot about the global equity or bond markets.  Humans, like dogs and fish, prefer to chase the shiny object rather than let time and hard work grow wealth slowly.  The whole notion of the “wealth effect” is a canard and should not be mistaken with real affluence. 

Home prices, as with aggregate wealth, only really ever increase at the rate of population growth.  So if the population of households and home owners is actually declining, as it is today, what does this imply for future home price appreciation and personal wealth?  If Case-Shiller is rising at a 12% annual rate, does this not imply that home prices must soon decline to be consistent with long-term price trends?  

But as Pollock notes, “per capita wealth of the sustainable kind grows at 2%, with the inflations and shrivels of bubbles netting themselves out.  With this trend increase, in a lifetime of 83 years, Americans will on average grow five times as wealthy.  Along the way, they should avoid confusing the ‘wealth’ of bubbles with actual aggregate wealth.” 

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no more banksters's picture

The illusion of the self-regulating society through the deregulated market

pashley1411's picture

For my money, one of the more straightforward, common sense articles on ZH.

zebrasquid's picture

With what's coming, why would you want to be debt free, and not the opposite? The marauders or govt. will be coming for your stuff, whether you own it or whether you borrowed to get it, so, might as well feel less attached to it when you have to give it up. The lenders are the ones that will lose it when it goes away. You'll be down the road. The banks will not still be there to come after you.

TIMBO Anti-Castro's picture

It is a compelling option.  We seem to be experiencing the death throw's of our empire before our very eyes so outright and discriminate(from the rich) siezure of property is not a fantastical illusion.  The powers that be have been showcasing their blatant disregard for personal freedom and have done some pretty scary things already.  What happens when we cannot pay our debts, the unions don't have BS pay and benefits any more, entitlements cannot be given out, etc..?  Get your guns. 

HardlyZero's picture

This is exactly the compounding of corruption.  Some would say the corruption started 100 years ago in the USA.  It takes 80 years or so to 'top off'.  Jubilee.  Its part of the natural order if there is nothing new, and nothing new has been seen this supercycle (so far).  But, pure fiat allowed all this all to happen since 1971.

atomicwasted's picture

+1 for Katee Sackoff being in charge of the Fed.  At least she'd be hot, and from a policy standpoint she can't be any worse than Yellen.  I'd vote to confirm.

Fuh Querada's picture

Sack off... a castratrix? The movie trailer looks like 150% CGI.

TBT or not TBT's picture

Why not Star Buck? The Sackhoff character was a genocidal killing machine executing on pure faith. Starbuck was pro-human at least, if more than a little nevrotic, and almost as hot

NoTTD's picture

OK, but how doe we work Katee Sackhoff into this?  Not that I care how she's in, as long as she is.   


By the way, I"ve always thought that "Sackoff" was  the perfect name for her. 

Truthseeker2's picture


Asset deflation always occcurs before debt deflation.


Withdrawn Sanction's picture

That's interesting, except that your debt or my debt is someone else's (an investor's) asset. It's the nature of double-entry bookkeeping.

Asset deflation automatically implies debt deflation, as, for example, in the recent real estate unpleasantness. The decline in house prices impaired the associated mortgages secured by the houses, and simultaneously impaired the MBS, and CDOs derived therefrom.

And it does not appear to be a chicken or egg dilemma.  Rather, the impairment is simultaneous.  

HardlyZero's picture

Now many of the corporate debts are 'public' debts by government bailouts, so we owe (and own) ourselves in this situation ultimately.   Egg meets road, kicking the can down the same fiat road which society built.  Its like a hall of mirrors, but each supercycle the mirrors get larger.

MrBoompi's picture

 But since the $7 trillion was never really there in the first place, it wasn’t really lost.” 

Oh but it was there!  Many people sold their real estate at the top of the market.  And the banks who lent money created out of thin air now are proud owners of a lot more real estate, even if it is worth less now.  Not to worry, any "losses" were transferred to the taxpayers anyway.  Ask the people who have been foreclosed upon if they think anything was lost.  The people who cash out on their stocks right before the bubble bursts will be smiling.  The rest of us will be forced to say "I guess that money was never there in the first place".  LMAO

shovelhead's picture

There's always another side to a trade but the point was if enough people sell then prices drop. The bubble becomes unsustainable.

A $250,000 house in a real market zooms up to $950,000 during a bubble that then bursts and becomes a $250,000 house again but the same owner lives there. He hasn't lost a dime. To him the 'wealth effect' was fictitious inflation.

To the guy who bought at $950 K, the loss was real. Now the bank can sell the note at par to US taxpayer and everyone is happy.

Except the guy whose credit is ruined and the taxpayer, but who gives a shit about them?

It's a POV kind of thing and a sucker is born every minute.

John_Coltrane's picture

It's a zero-sum game.  That's why trading (i.e. gambling) is such a parasitic activity.

All of our 2% average real wealth gains in the llast 100 years are due to a single root cause-the scientic method and the technological and labor leverage that result.  The cost is that brute human physical labor isn't very valuable, but the IQ curve is still Gaussian with half having IQs below 100.  Any correspondence to the 47% who pay no income tax is likely co-incidental (ha ha).

The only real wealth is your skills and abilities and of course, your health.   Which is why the only truly useful education is in the physical sciences.   Its not about a job, its about the ability to solve problems for yourself. Suddenly, no need to hire plumbers, electricians, computer repair people, programmers, carpenters etc.  Self-sufficiency, the source of true self-esteem and the greatest store of wealth.

moneybots's picture

"Along the way, they should avoid confusing the ‘wealth’ of bubbles with actual aggregate wealth.”


Aggregate wealth should not be confused with aggregate debt.  Debt is not wealth.

dunce's picture

Even this insightful article has an embedded premise that each year the real growth is exactly 2%. With obama as president, ZIRP, and QE4ever, real growth could well be only half of that.

Carl Popper's picture

Not each year, but averaged over a lifetime.

Unless we have a real growler of a secular bear market like the dark ages.

falak pema's picture

As that guy Haim Bodet said in the video :  "those who believe like obsessed maniacs about their all in strategy to save their necks; and ostensibly ours in the same process; sitting in the FED, in Congress as in the WS squid;  are picture perfect in their media image of "we know what's what" and panic shit scared in private on a day to day basis; caught in the nightmare of their own paranoia. 

Two sides of the same face, two hands of the same body, where each never talks to the other! 

Gee golly miss Molly, your two titties are hot bitties on separate agendas. Now repeat that Miss MSM.

lordbyroniv's picture

How much longer LORD?  Please deliver us from this evil.



falak pema's picture

Which lord do you pray to, if its lord of the flies he only listens to lies.

eddiebe's picture

I think the working class would take issue with the statement that they are 5 times wealthier than they were since they started working 40 years ago. The wall street boyz would have to agree though ( the whole time sniveling about being underpaid/valued ). Besides, taking into account inflation how high is the dow really?

Carl Popper's picture

Thank god for money illusion!

Our population would be a lot angrier if they were smarter. As it is, the wrong ones are angry for the wrong reasons.

Dick Buttkiss's picture

"per capita wealth of the sustainable kind grows at 2%..."

Sustainable meaning real wealth growth, as in production-based savings and investment, not consumption-based borrowing and lending with money created ex nihilo.

A bullshit article, in other words, that couldn't be farther from the truth.

Carl Popper's picture

This 2 percent is obviously not divided up equally "per capita" but it is real. This is inflation adjusted real growth rates over the last 100 or so years, in spite of all of the machinations of authoritarian politicians on both sides.

Dick Buttkiss's picture

What's real is that the 1% owns/controls almost all the hard assets — the real wealth — while the lumpen multitudes don't own shit, don't know shit, and don't give a shit in any way that can possibly help them through what's to come.

A bullshit article, in other words, that couldn't be farther from the truth.

Carl Popper's picture

The proles have become caught up in material culture and need nice new kitschy things, cars, nice apartments, expensive luxury dormrooms, etc.

I am glad i know my family history in all its boring details. You can eat cheap on beans and rice by the 100 pound sack, or cornflour by the 100 wt.

Asians save money on poverty level salaries because they eat a ton of rice and buy in bulk. They reuse things. They will buy at resale shops.

Dont go into debt. Live beneath your means. What is your freedom worth?

Ben Franklin as a young man lived on bread for days at a time. We are such pussies compared to the people who came before us. Debt is slavery. That is how the one percent enslaves us

PT's picture

Yes, we can be rich!  Just don't buy anything.

Dick Buttkiss's picture

"The proles have become caught up in material culture and need nice new kitschy things, cars, nice apartments, expensive luxury dormrooms, etc."

What they have "become caught up in" is government policy, as consumption is considered the key to prosperity, even if it means turning the people as a whole into debt slaves. That's the goal, in fact, no matter that it is unsustainable on its face and can only end in disaster.

Good that you and yours have managed to avoid it. I and mine have, too, the question being whether, for all our preparations, we can survive what's to come. After all, the longer the inevitable is delayed, the words it will be. And delay is Job One for a government that long ago went rogue.