Are Americans Really More Wealthy?

Household wealth in the United States increased in the first-quarter by the largest amount in seven years. However, instead of the new wealth coming from stable employment or a robust business environment, the majority of the wealth building was delivered by the Federal Reserve’s wealth effect policy.

Net worth for U.S. households grew $2.83 trillion to $62.9 trillion in the first three months of the year, according to a new report by the Fed. It was the biggest jump since the last three months of 2004 and the second consecutive quarterly rise. The net worth figure represents total assets such as stock portfolios and homes, minus liabilities.

House prices are still well below previous highs made in the housing bubble, but equities rallied across the board in the first-quarter. In the first three months of 2012, the Dow Jones Industrial Average climbed 8 percent higher, while the S&P 500 gained 12 percent. In fact, it was the best quarter for both indices in over a decade as Apple Inc. (NASDAQ:AAPL), Microsoft Corp. (NASDAQ:MSFT) and Netflix Inc. (NASDAQ:NFLX) led the tech sector higher.

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The financial sector also performed well in the first-quarter with banks such as Goldman Sachs Inc. (NYSE:GS) and Bank of America Corp. (NYSE:BAC) leading the way. Central banks provided more liquidity programs and continued to keep interest rates at record lows. The Federal Reserve launched Operation Twist and European swap lines in late 2011, while the European Central Bank launched a second Long-Term Refinancing Operation earlier this year.

While the gain in net worth was positive, it was induced by central banks around the world propping up equity markets. Zero Hedge explains, “As of Q1 2012, over two-thirds of household assets, or 68.8 percent to be specific, was financial assets, or $52.5 trillion: assets who value is dependent primarily on the S&P 500. Financial assets are those whose values are driven exclusively by the moves in the S&P 500. Sure enough, of the $2.8 trillion increase in household ‘net worth,’ $2.3 trillion came exclusively from the rise in the S&P.” In the U.S., there is little incentive for households to save, due to the zero interest rate policy that the Fed has promised to last until at least 2014. This encourages investors to take on more risk by seeking higher returns, which also causes a misallocation of capital and a temporary wealth effect. People generally feel better when their portfolio statements show a higher balance. However, this is not the ideal investing situation for building long-term wealth.

“In the current environment, equity-market gains won’t be a stable source of wealth generation for households,” said Paul Edelstein, director of financial economics at IHS Global Insight, according to Bloomberg. “With interest rates at rock-bottom levels, home prices unlikely to advance strongly, and incomes growing anemically, there are few options right now for households to build their assets.” Since the end of the impressive first-quarter, the Dow has fallen 5.5 percent, while the S&P 500 has declined more than 6 percent.

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