Saturday, March 12, 2011

Is the Glass Half Full or Half Empty?

Here's a good post by Paul Krugman showing that perspective matters. First, from the blogger Calculated Risk's viewpoint, America is now "half recovered" from the big losses of the 2008 financial meltdown:
Calculated Risk has gone through the latest Flow of Funds report, which shows that households have made up about half of the loss in net worth they suffered in the crisis. We’re almost home!

Or not.

The central insight of deleveraging models is that the distribution of wealth matters — specifically, that what is weighing down the economy in the aftermath of a Minsky moment is the debt of highly-indebted agents, which is not offset by the assets of creditors, because the debtors are forced to spend less while the creditors aren’t forced to spend more.

So, whose net worth has improved? Most of the gain reflects the recovery of the stock market — and highly indebted households are not major stock investors. The main asset price affecting debtors’ financial position, the price of housing, has not improved.

That’s not to say that rising stock prices have no effect; they do encourage higher spending — but not remotely to the extent that an equal-value fall in debt would. So the news on net worth isn’t nearly as positive as it seems. Full recovery is still a long, long way off.
The fact that most people's "assets" are tied up in homes and not stocks and home prices continue to fall means that the financial position of most people is at best bottomed out and at worst still falling.

This shows that statistics can be very deceptive. I like the story of a bunch of down at their luck guys at a bar in Seattle grousing about their financial situation. In wall Bill Gates and suddenly the average net worth of the 20 guys there jumps from $100,000 to $2 billion! Sure, statistically this is true. But the fact is that 20 guys only have $100,000 and one guy as $40 billion. The "average" is a figment of statistics. There is nothing real about the improvement of "average net worth" for the 20 guys.

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