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Financial Wealth: Sustained but High Gains and a Collapse for the Ages: An Estimate of Cycles of Buildup and Destruction of Wealth 2002-09

Financial wealth over the last decades has become the clearest sign of economic advancement and well-being. The collapse of financial markets in the last 2 years has been a cataclysmic event. The loss of financial wealth has been enormous, and the consequences for the economies of the world are commensurate. The loss of capital value of financial assets worldwide may have reached US$50 trillion in 2008, the equivalent of 1 year of world gross domestic product or about one-quarter of total financial wealth before the crisis. While there has been some recovery so far in 2009, conditions under which financial markets have been operated for a few decades are unlikely to be replicated soon. The generation of wealth witnessed in recent years may come back, but in a much more sedate and controlled financial system, and subject to stricter rules. The impact of the current crisis has affected all regions of the world, showing that the decoupling theory that had been prevalent during earlier years was misplaced. There were particularly large declines in the case of Developing Asia and the European Union. This is explained by the impact of the decline in stock market values by almost one-half, and the reduction in the values of financial assets and higher spreads on debts. The decline had a direct effect on the performance of economies worldwide, with the decline in activity observed in 2009 of about 3 percent a year consistent with the loss of wealth described here. The implications of the loss of wealth, even if partially reversed, for the future are complex. It has been absolutely essential for governments to continue supporting demand, in the face of the existing collapse of private demand. However, the injection of liquidity and the rapid increase in government debt has a limit, to avoid a negative reaction by the public. Otherwise, the loss of wealth already experienced may be combined with increased inflation and a loss of confidence in public debt instruments that would aggravate rather than correct the existing level of economic distress.

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