Americans are now beginning to consume out of capital gains in earnest. The ratio of the increase in personal capital gains tax receipts to increase in consumption has now reached 2.5x, which would imply a marginal propensity to consume out of capital gains of 0.4 (very high, but I haven't checked these figures myself). This means I'm going to have to revisit one of my cherished prejudices -- that an equity market crash wouldn't have much effect at the margin on US consumption. Looks like a section of the US population is a) regarding its employer's stock options plan as its capital and therefore consuming more of today's income and b) double counting the 401K plan as something that can be borrowed against today and will still be there for retirement.
He suggested the following pattern for the crash when it comes:
1) Stock market falls out of bed. 2) Everyone panics about the banks' exposure to equities, finds it negligible, stops worrying. 3) Then the banks begin calling in those loans collateralised against 401K plans 4) Then the personal bankruptcies come in. 5) FInding their stock options worthless, people adjust their saving plans. The economy starts to turn down. 6) More bankruptcies. 7) Now it feeds through to the asset backed securities market (credit card and mortgage debt). NB that the ABS market has had two big crises in its life (1994 and 1998) and done pretty badly in both of them. And neither of these were connected to large scale defaults. 8) If the asset-backed market falls over, it's likely to take the money market mutual fund sector with it. A big chunk of America finds out what those letters "FDIC" mean. 9) Now we're looking at a fairly severe credit crunch. The only hope is if the commercial paper market (one of the most robust markets around) can take the strain. But commercial paper is nothing like the force it was five years ago -- securitisation of receivables is the big thing these days. And the asset backed market is already assumed dead.
Looks like the 21st century might be a very good time to have a bank-driven financial system and company provided book-reserve pensions?
ooohh, scary.
cheers
dd
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