The Crisis of Wealth Destruction

By Roosevelt Institute |

downarrow-money-150Henry C.K. Liu argues that the poorly targeted stimulus and bailouts have caused long-lasting damage to global wealth.

The financial crisis that first broke out in the US around the summer of 2007 and crested around the autumn of 2008 had destroyed $34.4 trillion of wealth globally by March 2009, when the equity markets hit their lowest points. On October 31, 2007, the total market value of publicly-traded companies around the world reached a high of $63 trillion.  A year and four months later, by early March 2009, the value had dropped more than half to $28.6 trillion.  The lost wealth, $34.4 trillion, is more than the 2008 annual gross domestic product (GDP) of the US, the European Union and Japan combined. This wealth deficit effect would take at least a decade to replenish even if these advanced economies were to grow at mid single digit rate after inflation and only if no double dip materializes in the markets.  At an optimistic componded annual growth rate of 5%, it would take over 10 years to replenish the lost wealth in the US economy.

In the US where the crisis originated in mid-2007 after two decades of monetary excess that encouraged serial debt bubbles, the NYSE Euronext (US) market capitalization was $16.6 trillion in June 2007, more than concurrent US GDP of $13.8 trillion. The market cap fell by almost half to $7.9 trillion by March 2009. US households lost almost $8 trillion of wealth in the stock market on top of the $6 trillion loss in the market value of their homes. The total wealth loss of $14 trillion by US households in 2009 was equal to the entire 2008 US GDP.

As the financial crisis broke out first in the US in July 2007, world market capitalization took some time to feel the full impact of contagion radiating from New York which did not register fully globally until after October 2007. In 2008 alone, market capitalization in EAME (Europe – Africa – Middle East) economies lost $10 trillion and Asian shares lost around $9.6 trillion.

Government Bailouts, Stimulus Packages and Jobless Recovery

As a result of over $20 trillion of government bailout/stimulus commitments/spending that began in 2008 worldwide, the critically impaired global equity markets finally began to show tenuous signs of stabilization only two years later by the end of 2009. Yet total world market capitalization was still only $46.6 trillion by the end of January 2010, $16.4 trillion below its peak in October 2007. The amount of wealth lost worldwide in 2009 still exceeded 2009 US GDP of $14.2 trillion by $2.2 trillion. The NYSE Euronext (US) market capitalization was $12.2 trillion in January 2010, recovering from its low at $7.9 trillion in March 2009, but still $4.4 trillion below its peak at $16.6 trillion in June 2007.

US GDP in first quarter 2009 fell 6.3% annualized rate while fourth quarter of 2009 surged 5.7% mostly as a result of public sector spending equaling over 60% of annual GDP. The US government bailout and stimulus package to respond to the financial crisis added up to $9.7 trillion, enough to pay off more than 90% of the nation’s home mortgages, calculated at $10.5 trillion by the Federal Reserve. Yet home foreclosure rate continued to climb because only distressed financial institutions were bailed out, but not distressed homeowners. Take away public sector spending, US GDP would fall by over 50%. This is the reason why no exit strategy can be expected to be implemented soon in the US.

It took $20 trillion of public funds over a period of two and a half years to lift the total world market capitalization of listed companies by $16.4 trillion. This means some $3.6 trillion, or 17.5%, had been burned up by transmission friction. Government intervention failed to produce a dollar-for-dollar break-even impact on battered markets, let alone generating any multiplier effect which in normal time could be expected to generate a multiplying effect of between 9 and 11 times. In the mean time, the real global economy, detached from the equity markets, with the exception of China’s, continues to slide downward, with rising unemployment and underemployment.

This massive government injection of new money managed to stabilize world equity markets by January 2010, but only at 73.5% of its peak value in October 2007. Still it left the credit markets around the world dangerously anemic and the real economy operating on intensive care and life support measures from government. This is because the bailout and stimulus money failed to land on the demand side of the economy which has been plagued by overcapacity fueled by inadequate workers income masked by excessive debt, and by a drastic reversal of the wealth effect on consumer demand from the bursting of the debt bubble. The burst of the debt bubble had destroyed the wealth it buoyed, but it left the debt that had fueled the bubble standing as liability in the economy.

Much of the new government money came from adding to the national debt, for which taxpayers would still have to pay back in future years. This money went to bail out distressed banks and financial institutions which used it to profit from global “carry trade” speculation, as hot money that exploited interest rate arbitrage trades between economies. The toxic debts have remained in the global economy at face value, having only been transformed from private debts to public debts to prevent total collapse of the private sector. The debt bubble has been turned into a dense debt black hole of intense financial gravity the traps all lights from appearing at the end of the recovery tunnel.

Much criticism by mainstream economists in the US has been focused on the controversial bailout of “too-big-to-fail” financial institutions that have continued to effectively resist critically needed regulatory reform by holding the seriously impaired economy hostage. Some critics have complained that government stimulus packages are too small for the task at hand. Only a few lonely voices have focused on public spending being directed at wrong targets. Yet such massive public spending has left many economies around the world with looming sovereign debt crises.

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Roosevelt Institute Braintruster Henry C.K. Liu is an independent commentator on culture, economics and politics.

The Roosevelt Institute brings together thousands of thinkers and doers—from emerging leaders in every state to Nobel laureate economists. We reimagine the rules that guide our social and economic realities. Follow us on Twitter @rooseveltinst and like us on Facebook.