Repeat After Me: There Is No Wealth Effect

Barry Ritholtz explains:

Why is the wealth effect a flawed theory?

Start with that correlation error: What actually occurs during periods where stock prices are rising? As Benjamin Graham observed, over the long term, markets act like a weighing machine — valuing equities based on their cash flow and earnings. During periods of economic expansions, it is the rising fundamental economic activity that reflects the positive things wrongly attributed to the wealth effect. Companies can hire more and increase their capital spending. Competition for labor leads to rising wages. Employed, well-paid workers spend those wages on capital goods such as cars and houses, and discretionary items like entertainment and travel.

Oh, and along with all of these economic positives, the stock market is buoyed as well, by increasing profits and more buoyant psychology.

In other words, all of the same forces that drive a healthy economy, leading to happy consumers spending their plump paychecks, also drive equity markets higher. The Fed, though, seems to think that the stock-market tail is wagging the fundamental economic dog.


Or as I’ve been saying for years now, the nation is being ruled by a cargo cult. Set the Wayback Machine to 2011:

Cargo cults arose in the South Pacific during the Second World War. US soldiers and marines would arrive on an tropical island, and one of the first things they’d do was build an airstrip. Then the cargo planes would arrive and — Americans being Americans — our boys would share their loot with the half-starved locals. Candy, clothes, condoms, whatever.

The war eventually ended and the soldiers left and the cargo planes stopped coming. So the locals would make their own airstrips, using whatever tools they had — some quite elaborate. Then they’d stare at the skies and wait for the cargo planes to return.

That’s what quantitative easing is. “Print the money,” they say, staring at the skies, “and the goods will come.”

Well, no.

The goods must first be produced, and with the expectation of a profit. I know it’s fashionable for Paul Krugman to assert that “uncertainty is just a myth.” But this idea that there are Person Units called “Businessmen” who continue to produce goods no matter what government does to them is a liberal conceit. It’s the same liberal conceit that believes there are other Person Units called “Doctors” who will go on treating patients and finding new cures for diseases, no matter what government does to them.

People change their behavior as incentives change. And for the last three years, the incentive has been to hunker down and try not to get hurt.

But Krugman and the rest are immune to simple reason and plain facts, because they’re creatures of faith. They’re cargo cultists. Print the money and the goods will rain down magically from the skies.

We’ve tried that twice now. It hasn’t worked. And so the cargo cultists tell us that the gods are angry gods. We have not appeased them enough. We must print more money. We must have a third round of quantitative easing. That will make the goods appear.


The first stimulus was a little Bush-Pelosi number from 2008. Then followed the mother of all stimuli in 2009. We’ve also experienced three rounds of quantitative easy and I’ve lost track of how many twists and asset purchases and the like from the Fed, boosting its balance sheet to over $4,000,000,000,000.

And it still isn’t working, not after six years.

But the cultists never learn.


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