Tuesday 25 October 2016

Wealth effect is boosting confidence - but not the Coalition

Published 30/08/2015 | 02:30

‘The net worth of all Irish households combined was just shy of €600bn in the first quarter of the year’
‘The net worth of all Irish households combined was just shy of €600bn in the first quarter of the year’

On average, every man, woman and child in Ireland was worth just under €130,000 in the early months of the year, according to figures released by the Central Bank 10 days ago.

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That number - which includes the value of property, pensions, bank accounts and the like after debts are accounted for - is up by almost one third from 2012, when the economy was at rock bottom.

The sharp rise in the 'net worth' of Irish households over the past three years has reversed more than half of the massive destruction of wealth that occurred in the five years after 2007.

What economists call the "wealth effect" of being better off is likely to go a long way to explaining why the fortunes of the economy and the fortunes of the Government have completely decoupled, as this columnist discussed recently in the main section of this newspaper.

To recap very briefly on that discussion: over the past two years, both long-established monthly surveys of people's views on the economy have shown a sharp rise in positivity. By contrast, every political opinion poll has shown that support for the government parties has been flatlining, at best.

By far the most plausible explanation for the unwillingness of voters to credit the Coalition for the turnaround is that while people see forward momentum in the economy and no longer believe times are getting tougher, pay rates have yet to pick up in any meaningful way.

The 'growthless' recovery in wages and salaries butters nobody's parsnips.

If this explains the dismal poll ratings of the government parties, it doesn't explain the surge in consumer confidence, which has returned to Celtic Tiger levels.

As it happens, the figures cited at the beginning of this column go a long way to doing so.

Before looking at the numbers in detail and at how the wealth effect can aid an economy, consider for a moment the mechanics of household balance sheets and, importantly, the difference between income, which is a flow, and wealth, which is a stock.

A 24-year-old whizz kid who lands a high-paying tech job provides a good example.

He suddenly becomes income rich as a juicy salary flows into his back account each month. But if he owns little more than the contents of a suitcase and owes money from his student days to his parents or the bank, he is not wealthy. In fact, he is in negative equity, because the value of his debts exceed the value of his assets.

Economists have traditionally focused much more heavily on economies' incomes, in form of GDP, than they have on the stock of wealth - even though the latter is very important, as the cash-rich but asset-poor chap in the example above hopefully illustrates.

Here in Ireland, it is only in recent years that the State's number crunchers have even generated figures on everything that is owned and owed in the economy.

Happily, what those numbers show is that since 2012, all of the three main components that determine household wealth have been moving in the right direction.

As the first chart illustrates, the net worth of all Irish households combined was just shy of €600bn in the first quarter of the year - equivalent to between three and four times the economy's annual income, as measured by GDP.

As the chart shows, the aggregate net worth of households is well up (+€144bn) on the post-crash low point registered in 2012, but still well below the peak (-€123bn) reached in 2007.

Of the three main components of household balance sheets, property assets have traditionally been the biggest. As the second chart shows, they soared in value during the bubble, only to collapse. The bounce-back in prices over the past three years has undone some of the damage to balance sheets - but the aggregate value of peoples' housing assets is more than €200bn below peak.

The small dip in the first quarter of this reflects the flattening out of price increases, representing what can only be hoped to be the beginning of a more stable trend in property price trends for the future.

Non-property assets, including pensions and savings, account for just a little less than half of household wealth.

Despite the crash of 2008, they were much more stable than housing assets. In the period 2006-12, the total value of all Irish households' non-property hovered around €300bn, as the second chart illustrates.

More recently, they, too, have been rising in value, in part because stock markets have been doing suspiciously well (something that will go into reverse if the carnage on the trading floors of the last two weeks continues).

The third part of the household wealth picture is debt.

Irish households more than tripled the total they collectively owed in the half-decade to 2008. The disastrous consequences of this now need little reiteration. Suffice to say that paying down debt is always much harder than taking it on in the first place. And so it has been since the crash.

Despite Irish households having reduced their debts by a quarter since 2008, paying off almost €50bn, the €166bn they still owe means that they remain the third most indebted households among the 19 countries in the eurozone. So households, much like our debt-laden government, are not out of the woods yet.

But, overall, as debt is down and the value of assets is up, net worth has recovered strongly. This is likely to be generating a positive 'wealth effect' as people feel better off, even though they may not have more income coming in. And this can spur spending, as is to be seen most clearly in the surge in new car purchases that has been so marked in 2015.

It also generates a feelgood factor, which is likely to have driven the very sharp increase in positive sentiment over the past two years and more. Sadly for the government parties, this wealth effect may be making people more upbeat, but it is not making them look more favourably on their rulers.

With so little time left before the election and limited scope for big increases in pay and disposable incomes before polling day, it doesn't appear as if the recovery and its accompanying wealth effect will see the Coalition re-elected.

Sunday Indo Business

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