Asset Values as Claims on Goods and Services (Part II)

In the 1980s and 1990s the savings rate fell to 5% while real GDP growth averaged close to 3% for the two decades. A society that generates that type of savings rate and real growth should see HHNW/GDP level out at around 270%. A curious thing happened however, as HHNW shot up towards 440% of GDP at the end of 1999.

Artificially low interest rates create an imbalance between the value of assets in the system and the amount of real goods and services that are available to back them up. Artificially low rates crush the incentive to save, the primary driver of wealth creation over time, while the money and credit created from thin air by the Fed and the financial system creates new claims on goods and services which can also drive up existing asset values.

By the end of the 1990s it is clear in hindsight that a bubble had developed in asset values relative to the size of the economy and the savings rate engendered by low interest rates. We have crashed the system twice since then, with the Fed responding more forcefully each time with money creation from thin air. This is doing nothing to rationalize the imbalances in the system. It is actually further destroying the incentive to save, which is pushing down the secular growth rate in real GDP while driving asset values to absurd levels.

For the past decade real GDPgrowth has been a bit less than 2% while the savings rate has plunged towards 1% of GDP. These types of numbers should generate HHNW/GDP of around 150% over time. My guess is that when we see the HHNW/GDP number released in March it will have come close to the all-time high valuation of 2007 at around 470%. We have the lowest growth rate in real GDP since the period from 1930-40, the lowest savings rate since that time too and we have the highest valuation levels ever. Does this make sense?

The bottom line is that this is the biggest asset bubble ever. One of the great insights of Austrian economics is that assets that aren't backed up by savings and output are the definition of malinvestment. It would be wise for investors to remember this.

 Disclaimer: Nothing on this site should be construed as investment advice. It is all merely the opinion of the author.