Why Housing is More Important Than the Stock Market

Posted May 27, 2022 by Ben Carlson

I know a lot of finance people want to blame the Fed for everything these days but central banks aren’t the sole culprit of the inflationary environment we find ourselves in.

The pandemic seriously screwed up global supply chains and the labor market. Governments around the world spent trillions of dollars to keep the global economy afloat while we put things on ice for a while. Consumers began spending money en masse on goods because they stopped spending on experiences and had nothing else to do.

And yes, the Federal Reserve was extremely loose with monetary policy to keep the credit markets functioning and bring the unemployment rate down.

Even though it wasn’t completely their fault, it seems like the Fed is now the only one trying to clean up the inflationary mess by tightening monetary policy.

They’re doing this in two ways:

(1) By raising interest rates and unwinding quantitative easing (bond purchases).

(2) Signalling to the financial markets they may have to throw the economy into a recession to slow inflation.

The Fed cannot fix supply chains but they can raise rates high enough that it cools demand.

Former New York Fed chair Bill Dudley says one way to do this is through the wealth effect:

In contrast to many other countries, the U.S. economy doesn’t respond directly to the level of short-term interest rates. Most home borrowers aren’t affected, because they have long-term, fixed-rate mortgages. And, again in contrast to many other countries, many U.S. households do hold a significant amount of their wealth in equities. As a result, they’re sensitive to financial conditions: Equity prices influence how wealthy they feel, and how willing they are to spend rather than save.

Effectively, Dudley is saying the Fed needs to raise interest rates high enough that stock market investors don’t feel as wealthy, and thus, stop spending as much money.

I get what he’s saying.

They don’t tell you this in the textbooks, but so much of what goes on in the economy and markets is based more on faith, trust and psychology rather than data, fundamentals and statistics.

It would make sense that households who see their net worth plummeting would start to reconsider their financial standing and spending habits.

But I think Dudley overestimates the importance of stock market wealth on American households.

For years we’ve been hearing about wealth inequality and for good reason. The top 10% of households own the majority of financial assets:

The top 10% holds 70% of the net worth in this country while the bottom 90% accounts for 75% of the debt.

There is a reason for this disparity. The top 10% owns most of the financial assets while the bottom 90% has more of their net worth tied up in real estate.

To continue reading, please go to the original article here:

https://awealthofcommonsense.com/2022/05/why-housing-is-more-important-than-the-stock-market/