Thrift Helped Get Us Into This Mess

"Wealth effect" is playing out in reverse
By Sarah Quinn,  Newser Staff
Posted Nov 25, 2008 10:09 AM CST
A lot full of unsold Chrysler vehicles at a dealership in Dormont, Pa., on Nov. 11, 2008.    (AP Photo/Gene J. Puskar)
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(Newser) – Three factors are playing into the financial crisis, and it's time to recognize the culprit that accompanies the burst housing bubble and banking meltdown, Robert J. Samuelson writes in the Washington Post. The wealth effect—"the tendency of people to adjust their spending as their wealth changes"—is reversing, with Americans scrambling to save in the face of falling stock prices and home values. The consequences could be dire.

Personal wealth is down $9 trillion, and "every dollar's change in wealth causes people to change their spending by 5 cents," Samuelson notes. If that's true, the US economy will be out $450 billion in consumer spending. The only solution, says Samuelson, is new demand: We need Asian countries "to consume and spend more so that their imports increase."