Economic Stability May Take Many Decades

Friday, 01 Jul 2011 06:59 AM

By Barry Elias

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When will we experience true economic stabilization?

The Federal Reserve Bank issued a recent report indicating the U.S. household net worth (NW) is nearly $60 trillion and gross domestic product (GDP) is $15 trillion.

The ratio of net worth to GDP is now 400 percent.

In 2007, this percentage was 475 percent.

For 45 years, from 1952-1997, this ratio ranged between 300 percent and 350 percent, averaging roughly 325 percent.

Movements in this ratio of one percentage point typically took one year.

During the past 3 years, this ratio decreased 16 percent (nearly 5 percent per year). This rapid reduction has had multiplicative effects on the economic multiplier, with velocity falling 75 percent in 2008, depressing income and net worth. Velocity represents the frequency of monetary transactions in a given time period (e.g., the number of times a dollar is used). Velocity (V) and income (GDP) are directly proportional: a larger velocity generates greater income.

A more favorable economic climate would be realized if the NW/GDP ratio fell 75 percentage points, from 400 percent today to the historic average of 325 percent. This would represent a 19 percent drop. To achieve this, asset prices (e.g., real and financial) will probably fall as income begins to rise slowly.

A stable ratio of 325 percent may be reached in one decade if income rises by 1 percent per year and asset prices fall by 1 percent per year. A more likely scenario would require 10-20 years to develop a solid foundation.

During the next two decades, stabilization will be furthered as we focus more on acquiring knowledge and wisdom rather than accumulating fictitious wealth (e.g., wealth transfer instead of wealth creation).

This will allow the labor market to function more optimally: the supply and demand of productive skills permit business to compete effectively and efficiently in the global environment.

The recommended business model will probably become more vertical. This implies the integration of product conceptualization, manufacturing, and capital allocation.

Misguided societal values, imprudent public policy, and abhorrent market behavior decimated our socioeconomic fabric over several decades.

It will take several more to regroup, repair, and rebuild.

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