As we learned in the section on debt, our nation has a historic, never-before-seen level of debt and a historic failure to save.

Now some would say that it’s not reasonable to look only at debt and savings; one also has to consider assets. After all, does it really matter if you have no savings and a million dollars of debt if you have assets worth $10 million? That’s a great point, and so we’re going to take a look at assets here.

All right, so what is an asset? One definition is items of ownership convertible into cash: total resources of a person or business, as cash, notes and accounts receivable, securities, inventories, goodwill, fixtures, machinery, or real estate.

So an asset is something of value that can be converted to cash or provides access to, or enhances, a flow of cash. If we simply said assets are deposits, real estate, a stock or a bond, and the stuff we own, we’d pretty much cover the vast majority of what we consider to be our assets.

We’re only going to look at the assets of households, because, as we saw earlier, the liabilities and assets of the US and state governments are really the liabilities of its citizens. But do remember, as we noted in Chapter 13, the US government has a total net worth of negative $50 to $85 trillion. In fact, that mismatch between assets and liabilities does not belong to the US government, it belongs to you and me and everybody else. Our national debts and liabilities are, well, ours. On the private side, the assets of companies belong entirely to the bondholders and shareholders of the company, not the company itself. And who holds those? Ultimately, private citizens do. Since we can pool citizens into households, we could examine household assets, deduct some relevant liabilities, and get a decent view of where things stand.

And we do this because the Federal Reserve tracks net worth at the household level, and this data is routinely and widely reported in the media. In fact, according to the Federal Reserve, household net worth has exploded by nearly $20 trillion in only five years – an astonishing feat – and it represents more ‘wealth’ than our country managed to amass from its inception until the late 1980s. And these are net assets, so the Federal Reserve, and many in the media, take the position that, with just under $60 trillion in net worth, Americans are doing just fine and our rapidly climbing debt levels are no cause for concern.

But before we get too excited about the astonishing wealth indicated here, there are two key oversights and a fallacy hidden in this report of which you should be aware. As always, the devil is in the details. Before I address those, I want you to observe this period here, spanning from 2000 to 2003. That dip in the net worth of households was due to the stock market collapse that ran from 2000 to 2003 and caused such great panic at the Fed that Greenspan lowered interest rates to the emergency rate of 1%, thereby igniting the greatest of housing and credit bubbles in all of history. And this decline in total net worth leads to this observation: Debt is fixed. When you take on a debt, there it placidly sits, growing larger, until you make payments on it. Debts do not vary with general economic conditions, or whether you get a raise or lose your job. Assets, on the other hand, are variable, sometimes gaining and sometimes losing value. And so this leads to the 8th Key Concept of the Crash Course: Debts are fixed, while assets are variable.

Okay. Where did that $19.8 trillion in new wealth come from? About 80% of that growth came from a rise in financial assets and the remaining 20% came from growth in real estate and other ‘tangible’ assets.

When we look at how much of each type there are, we see that 72% of the total net worth consists of financial assets totaling about $41 trillion, while the tangible assets are the remaining 28% and total around $16 trillion.

If we examine these assets a little more closely, we see that the $41 trillion dollars worth of financial assets consist of things like pension funds, the assets of privately held businesses, deposits, stocks, and bonds, which we can roughly recompose into these four main classes: stocks, bonds, cash or deposits, and the assets of privately held businesses.

The other bucket of $16 trillion in tangible assets consists primarily of real estate, which is 75% of this bucket, and consumer durables, which would be your car, your dryer, and your snow blower, if you have one. For every single one of these assets except cash, in order to liberate the wealth from these assets you’d have to sell them first.

One general rule of asset markets goes like this: Things go UP in price when there are more buyers than sellers, AND things go DOWN in price when there are more sellers than buyers. Hold onto that thought for when we get to demographics.

Now let me expose a great fallacy of the household wealth report. I’ll use real estate to make the point. Suppose you have a house that you bought for $250,000, and over time, say the last five years, it went up in assessed value to $500,000. The Fed would record this as a $250,000 increase in your net wealth. But there’s really no way for you to easily get to that wealth. Sure, you could borrow against that, but that does not liberate the wealth, it only exchanges an amount of it for debt. But suppose that you sold your house. Well, if you wanted to move into an equivalent house, guess what? They’ve all gone up in price along with yours, and so you have to spend $500,000 for an equivalent house, so nope, no wealth was liberated there. In fact, the only way to liberate the wealth in your house is to downsize and buy a smaller one (or rent). So here’s the rhetorical question of the day: How can everyone downsize? You might be able to, but, on balance, everyone can’t. At least not without creating a massive glut of large homes and a desperate shortage of smaller ones. And if everyone can’t do this, then it means that it is impossible to ever release the full value, or embodied wealth, of all the houses. So the wealth number is fun to look at individually, but it is more or less meaningless as a whole. This same dynamic is true for other assets as well: Sufficient buyers are essential, or the wealth is as good as stranded.

I mentioned that there are also two big oversights in the household wealth report, and the first is that the Fed mysteriously does not include the general liabilities of the government when calculating the household net wealth. Wouldn’t it make sense for the Fed to offset these against household wealth? After all, who else besides taxpayers living in households are going to pay off those liabilities? Nobody, that’s who. If the Fed did perform this offset, household net worth would plunge below zero, so I can guess why this comparison is never made. But I would argue that a careful steward of a nation’s monetary policy would be interested in representing the true situation as accurately as possible.

The second oversight is that the data is presented as if it applied to our entire country in a fairly even and useful manner. It does not. The top 1% owns 35% of ALL net household wealth AND, looking at stocks, only owns 56% of ALL stock (by value). If you can’t see it, I apologize; the top 1% is represented by a very thin red smear at the top of the column there. So it’s great that our stock market keeps powering higher, but for every trillion dollars it goes up, $560 billion of that goes to only one out of a hundred households.

The top 20%, which includes the top 1%, owns 85% of ALL net household wealth and 80% of ALL stock (by value). This means the bottom 80% of the citizens of this country, represented in yellow, holds only 15% of the total wealth of this country, and even there the distribution of wealth is weighted to the top.

Remember, an imbalance between rich and poor is the oldest and most fatal ailment of all republics. More immediately, this tells us that our credit crisis is going to be worse than advertised. Just as was true of the wealth gap in the late 1920s before the onset of the Great Depression, the severity of the crisis will not depend on average wealth but the distribution of the wealth. If a large swath of the population lacks the means to weather the storm, then the storm will be longer and harsher than otherwise would be the case. So what does it mean that 80% of our population possesses a meager 15% of the total wealth? For one thing, it means that the recent efforts by the Fed to provide massive amounts of liquidity support to the biggest and wealthiest banks at the inflationary expense of the lower classes were not only misguided, but they were cruel and unusual. This leads to an easy prediction to make: The wealth gap in the US will hamper our recovery and deepen the downturn.

In order to really understand why I have been harping on this notion of assets being variable and their value being dependent on the ratio of buyers to sellers, we’ll need to take a quick trip into demographics.

Recall that the US government has not saved in any of its entitlement programs, and that it has a massive shortfall in them, measuring in the tens of trillions of dollars. That situation comes about because the entitlement programs are wealth transfer programs, not savings accounts, and they depend on a significant surplus of current workers to retirees. The shortfalls in these programs are being exacerbated by a troubling trend. In 1950 there were seven workers per retiree and the system was balanced. By 2005, that ratio had dropped to only 5 to 1, and the system was already exhibiting signs of distress. By 2030, that ratio will have plummeted to a thoroughly unworkable value of less than 3 to 1.

And this trend comes about as a feature of the so-called Baby Boom . This is a demographic chart of the United States. Each bar represents a clustering of all the people who are within a five-year-wide ‘age window,’ as seen on the left axis, and shows how many millions of them there are along the bottom axis. The baby boomers number around 75 million strong and roughly occupy these four bands. While it may not seem like much, the ‘hole’ that exists in the population behind the baby boomers represents an enormous challenge, and even threat, to our entitlement programs, and will greatly complicate our efforts to resolve our levels of debt and our national failure to save.

A more ‘normal’ population distribution, and the kind that humans evolved with over countless millennia, looks like this. A pyramid. Again, this shows five-year-wide age brackets, with men in red and women in yellow. This distribution is capable of supporting an entitlement program such as the one in the US that is based on transferring wealth directly from workers to retirees.

But when we cast this chart forward to 2000, the baby boomer bulge is quite apparent. Besides the challenge that this demographic profile offers to the entitlement programs, an even larger challenge is presented to both the debt and savings issues I painted in previous chapters and even to the value of our assets.

Here’s what I mean. The boomers are the wealthiest generation ever, they hold nearly all of the assets, and they will need to dispose of those assets to fund their retirements.

Who exactly are the boomers planning on selling their assets to? This guy? Even if his generation somehow could afford to buy all these assets, there simply aren’t enough people in his generation to buy them.

In order to fund their retirement dreams, boomers are going to have to sell off their assets. And again we might wonder, to whom, exactly?

And lastly , if the massive accumulation of debt over the past 23 years was predicated on the assumption that the future will be much larger than the present, we might also question how exactly that will come to pass if boomers are retiring en masse and there are fewer behind them to take their place? Man…the next generation better be prepared to work really, really hard! Too bad they are graduating with the highest levels of college debt ever recorded.

This sort of demographic profile will be with us for decades and cannot be wished away or fixed by some clever policy. It is simply a fact of life, and one that we’d do well to recognize and plan for rather than ignore.

Boomer retirement has already begun, and the pace of this will accelerate rapidly over the next 15 years, which will make the twenty-teens quite interesting and leads me to conclude that the next twenty years are going to be completely unlike the last twenty years.

Next time we’re going to discuss asset bubbles. Understanding the destructive dynamics of bubbles is critical if you want to know what’s coming next and why the Federal Reserve is panicking right now.