The TMX stock index fell by more than 11 per cent during 2011, and similar losses around the world have produced estimates for lost wealth world wide of some $6.3-trillion. These look like big numbers -- how worried should we be?
Certainly these losses are cause for concern for those who rely on the stock market to generate a significant share of their current income -- but I'm not sure just how many people are so indifferent to risk that they would adopt such an aggressive wealth-management strategy.
But from a macroeconomic perspective, the losses in what is more properly thought of as wealth are much smaller. Shares -- the assets that are traded on stock markets -- are a small fraction of total wealth.
Unlike consumption goods, assets are not valuable in themselves; they are valued for the future incomes that they can generate for their owners. Equity shares in a company -- which provide the owner the right to shares of its profits -- are only one way to acquire future income.
According to Statistics Canada's estimates, shares form roughly one-third of all financial assets. When you take into account non-financial assets including housing and land, less than 20 per cent of StatsCan's estimates for total assets are in the form of shares.
But looking only at tangible assets gives only a partial perspective on total wealth. The largest source of income is from working, and estimates for human capital -- that is, the asset that generates labour income -- are much larger than those for tangible wealth. Retrieving estimates for human capital typically requires making forecasts of lifetime earning potential for the entire population and the actual numbers will vary according to the modeling strategy used. (Then again, similar things could be said for estimates of the value of tangible assets.)
Available estimates -- for example, here and here -- for human capital are roughly four times as big as estimates for tangible assets. So if tangible assets are roughly 20 per cent of total wealth and shares are 20 per cent of tangible assets, equity accounts for something like 4 per cent of total wealth.
Shaving half a percentage point off of our wealth is by no means good news, but neither is it as alarming as the losses that made the headlines.
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