Final Instalment of the Review of the US Monetary System
Economists assume we all want more money. This makes analysis of their data easier. It seems to me this simplifying assumption creates misunderstanding. Money is important to the extent that it provides the things we want. While some may want the largest accumulation, most users of money don’t see simple accumulation as satisfying a higher order need. However they are concerned that they may run out. They want to ensure that their lifestyles are protected. They would like to have some financial flexibility if events don’t unfold as expected. Hording and having “the most” is usually not top of mind for consumers in general.
Users of money are concerned with purchasing power and therefore, perhaps indirectly, inflation – and rightly so. The rate of US inflation in the past 50 years has averaged about 3.3% per year. Today’s dollar has the same buying power as 8 cents in 1929 money. In the past 15 years, purchasing power of the dollar has dropped to 67 cents. By comparison, Canadian inflation has been higher in the seventies and eighties, somewhat lower since. But how have consumers generally faired in North America?
Behavioural finance is increasingly interested in relative personal consumption expenditures (PCE). The chart below suggests a strong relationship between real disposable personal income (DPI) and real consumption. This chart illustrates an inflation adjusted income of $5,000 in 1929 continues to be worth $5,000 today. Currency in this example is held constant at year 2000 levels so that the average gain in consumption to 2008 for an American is a real $22,000 (27,000-5,000). This equates to a 2% real gain in spending power each year. If you simply kept up with inflation, you would be able to consume only 20% of the amount of your neighbours and keeping up with the Joneses would become impossible.
Per Capita Real Disposable Personal Income (DPI) and Personal Consumption Expenditures (PCE) 1929-2008
North American consumers have done very well. But what has been the source of the excess buying power? Some of the gains are the result of increased wages. The attribution of wage increases can include such things as better labour participation rates and higher education levels leading to better paying jobs. Investment gains have also contributed to higher disposable incomes. Below is a review of excess returns to the public investment markets. These are positive returns after removing inflation and PCE changes of about 2% per year.
Average Annual Returns in Excess of Inflation and Per Capita Real PCE Changes 1942-2008 |
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| Index | Average Excess Return | Standard Deviation | t-statistic | |
| 30 Day Treasuries | -1.81% | 3.79% | -3.9 | |
| 90 Day Treasuries | -1.37% | 4.05% | -2.77 | |
| 1 Year Treasuries | -0.87% | 4.74% | -1.5 | |
| 2 Year Treasuries | -0.68% | 5.47% | -1.01 | |
| 5 Year Treasuries | -0.26% | 7.19% | -0.29 | |
| 10 Year Treasuries | -0.20% | 9.56% | -0.17 | |
| 30 Year Treasuries | 0.24% | 12.33% | 0.16 | |
| Long-Term Corporate Bonds | 0.03% | 10.06% | 0.03 | |
| All US Stocks | 6.07% | 17.87% | 2.78 | |
| Value Stocks | 11.04% | 22.21% | 4.07 | |
| Small Cap Stocks | 9.71% | 25.59% | 3.11 | |
Improvements in living standards are a good thing. But people who don’t fully participate in the growth can quickly start to feel left behind. Fully diversified fixed income investments have generally reduced disposable income. An investment in a fully diversified stock portfolio has added to disposable income. Taxes, fees and concentrated portfolios with higher volatility have probably reduced the benefits to consumers of this affect. Since diversification reduces volatility a sensible approach would include both stocks and bonds in the mix.
Patrick
