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Commentary: Go With The Flow

Perhaps the most important piece of economic news in the last few days was not the continued drop in the unemployment rate or the positive blurbs in the Beige Book or even the Dow reaching a new record high, but Thursday's quarterly ""Flow of Funds report,"":http://www.federalreserve.gov/releases/z1/20130307/ arguably the most detailed breakdown of personal and business finances.

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The funds report is zero-sum; that is, what is an asset for one sector is acknowledged and reported as a liability for another (or others)--income for one, an expense for another.

While a look back, the funds report also provides a look ahead to consumer spending, the most critical element of the economy.

According to the report for Q4 2012, household assets grew to $79.5 trillion in the fourth quarter, an increase of $1.3 trillion--not too shabby. Household financial assets were up $784 billion to $54.4 billion but home equity (the value of household real estate less loans against that real estate) grew $452.8 billion, the result of two moving parts: real estate values (which increased) and household mortgage liabilities, which dropped.

Once the dust settled, it meant owners' equity in household real estate assets moved to 46.6 percent in the fourth quarter from 45.2 in the third and 40.5 in the fourth quarter of 2011. At the current level, net worth is the highest it's been since Q1 2008.

While those numbers are good for mortgage lenders, they mean even more for the economy. Net worth--the difference between assets and liabilities --increased $1.1 trillion in the quarter. While it wasn't record growth--net worth grew $1.4 trillion one quarter earlier--the composition of the growth is critical, dominated by the growth in the value, both actual and net, of real estate.

Consumers spend based not on income, but on wealth, with spending increasing about six cents per year in year two for every dollar increase in wealth in year one. The effect is refined further with a dollar increase in the value of real estate contributing four cents in spending growth compared with a two cent contribution from the increase in financial assets.

Based on the increase in net worth, we should look to an increase in consumer spending, which, according to the latest version of the gross domestic product report, is about 70.8 percent--if the stock market, a contributor to net worth, doesn't get in the way.

Indeed, the new Dow Jones Industrial Average stock market record, while celebrated by market watchers, could be a downer for the economy. The stock market doesn't always reflect the economy. Stock prices are based largely on anticipated future earnings adjusted for future assumptions about inflation. Investors look for a return on their investment and make their decisions to purchase a particular stock because of their estimate of future earnings.

Those estimates put board of directors and their employees (management) under severe pressure to achieve earnings targets, which are the net of revenue increases and/or spending reductions. If net earnings don't grow appropriately to meet those investor expectations, corporate management will turn to their other option to increase profits: reducing expenses which usually means layoffs. Thus, in a very real sense, the strong gains in jobs reported for February could be temporary. While the boost in financial assets might be good for some investors, it might not be good for the economy as a whole.

An alternative argument--calculated for non-publicly held businesses by ""Sageworks.com"":https://www.sageworksinc.com/default.aspx --is revenue or profit per employee, which also governs staffing decisions whether business owners consciously realize it. Simply put, a business is not going to add (or perhaps even keep) and employee if that employee doesn't generate enough revenue or profit to cover his or her salary.

Either methodology poses the same risk to sustainability of Friday's employment report: If consumer spending doesn't continuing to grow, employment will not either, and indeed could shrink.

To share your thoughts on this commentary, send your submission to ""editor@dsnews.com"":mailto:editor@dsnews.com.

_Hear Mark Lieberman P.O.T.U.S (Sirius 124) on Friday at 6:40 am EST and again at 9:40 am EST.__

About Author: Mark Lieberman

Mark Lieberman is the former Senior Economist at Fox Business Network. He is now Managing Director and Senior Economist at Economics Analytics Research. He can be heard each Friday on The Morning Briefing on POTUS on Sirius-XM Radio 124.
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