Fake Wealth

Michael Munger writes,

If you measure from the peak of the bubble, we lost a lot of wealth. But that wealth was entirely fake, created by a revved up demand for houses as assets expected to appreciate rapidly.

Pointer from Mark Thoma. As Tyler Cowen would say, “We’re not as wealthy as we thought we were.”

If you are a Keynesian, fake wealth is a good thing. It is well known that deficit spending is pretty much useless if there is “Ricardian equivalence,” meaning that people realize that in the future their benefits have to go down and/or their taxes have to go up. However, I am a firm non-believer in Ricardian equivalence, as you might have noticed when you read Lenders and Spenders.

So if I thought that economic activity consisted of spending, then I would expect deficits to increase spending and economic activity. Instead, I think of economic activity as patterns of sustainable specialization and trade, and I do not think that deficit spending is helping, because it is so unsustainable.

To put this another way, I think that long-term government bonds are fake wealth these days. There has to be some kind of default on future government commitments. There is an off chance that the future commitments that get cut will be entitlements. There is an even more remote chance that the government will find tax revenue to cover all of its commitments. We can inflate away some of our past debt, but since our projected future deficits are even higher, inflation does not make the problem go away. So I think that it is likely that we will get some sort of default. The fake wealth will be marked down at some point in the future, either through inflation or default.

Once upon a time, we had an Internet bubble that gave us dishonest stock prices. Let us stipulate that it was caused by private sector shenanigans. When that collapsed, it was followed by a housing bubble. There were private sector shenanigans involved in that one, too, but I think that some of the fingerprints on the housing bubble belong to government officials. The fake wealth that is being created now? Pretty much entirely government-generated.

Happy New Year.

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