When beef prices take off, many households switch to pork or chicken. When motor oil hits $1.75 a quart at the corner service station, a lot of motorists begin to buy it at a discount in drug stores and supermarkets and change their own oil.
These are just two of the myriad ways in which people adjust when inflation drives up the cost of the things they buy. The same thing has been happening over the past dozen or so inflation-plagued years as private households have made their investment decisions.
A new study by economist William Fellner, the highly respected Yale University professor emeritus now at the American Enterprise Institute, provides some measure of the extent to which an enormous number of Americans have been deserting financial assets of all kinds in favor of investment in tangible goods, including houses and so-called consumer durables such as stereos and refrigerators.
In 1965, Fellner found, American households' net financial wealth -- assets such as stocks, bonds and savings accounts -- was equal to 81 percent of their tangible wealth -- assets such as homes, real estate, automobiles and refrigerators. By 1978, the value of the financial wealth was equal to only 43 percent of the tangible wealth.
Even more startling is a comparison with household incomes. At the beginning of this period, households' net financial assets were equal to 2.15 times their annual disposable incomes. By last year, that had plummeted to only 1.26 times income. "Meanwhile," Fellner says, "The ratio of tangible household wealth to the same income measure rose moderately."
This switch in household preferences is not really news in one sense. After all, the New York Stock Exchange has been bemoaning for years the fact that the number of people holding stock fell from 30 million to nearly 25 million some years ago and has never recovered. And the huge demand for houses, both to live in and to speculate with, has received wide attention.
But Fellner, in an article in AEI's annual volume on Contemporary Economic Problems, describes its dimensions and suggests that much of the switch was an understandable, deliberate attempt to protect wealth from the ravages of inflation.
Some economists, including Phillip Cagan and Robert Lipsey in a paper done for the National Bureau of Economic Research last year, have argued that the shift in assets occurred "passively." That is, a household owning stock and owning a home has experienced an apparent shift in preference merely because the value of the stock holding may not have risen while the value of the house has soared.
Not so, says Fellner. "During the period 1965-1978 the amount of current savings allocated to the purchase of tangible rather than financial household wealth was large enough to represent about 40 percent of the net financial wealth owned by the households at the end of the period," he says.
In other words, once inflation got going, people began to put more and more of their current savings into tangible things, whatever they did with the financial assets they may have had in 1965.
The things that people no longer very much carred to hold have one of two characteristics, Feller says:
"Assets such as corporate shares involve acceptance by the household of risks that rose significantly in circumstances in which business prospects became increasingly uncertain, except for the spreading conviction that prices would continue to rise at an appreciable but unspecified rate.
"Moreover, neither graduated taxes or dividends nor capital gains taxes are adjusted to inflation; hence, the tax burden of the owner rises in relation to this real yields and real gains as the inflation rate rises."
"Aside from corporate stock, assets belonging in the financial category consist of money and of claims on money payments mostly fixed in current dollars." Bonds or certificates of deposit would be examples of the latter. "Under inflationary conditions these involve the risk of reduced, even negative, real return. This risk is substantial for pre-tax returns, and it is even greater for returns after taxes that are levied on current-dollar incomes."
So what did Americans seek instead? Assets whose prices are rising in line with inflation, or, if they are lucky, even faster than inflation. Houses, of course, are the prime example.
But if housing is a good hedge against inflation in terms of its value rising as fast as prices generally, it pays off in another way, too. Unless a buyer plans to sell again soon, the expected real yield to the owner also includes the untaxed value of using the house itself.
As housing prices have risen, many families have "traded up" by using the increased equity in their old home for the downpayment necessary to buy a larger, more expensive one. As long as they own the new home, their "investment" will be paying off in the sense that they have a more desirable place to live. And their income taxes don't go up as they would if they had taken that equity and an investment that paid a return in the form of money.
Whethere households ended up with a different mix of assets actively or passively, they have not really been able to keep pace with inflation. Fellner says that in 1965, households had 4.81 times as much wealth as they did disposable income. By 1978 that had slipped to 4.19 times, despite a modest increase in the rate at which they saved over the same period.
People were saving a larger share of their incomes but nevertheless accumulating wealth less rapidly, compared to their incomes, than in previous years. That means that some assets were losing value in real terms, and losing it fast.
All this is costing the country something. When increasing amounts of capital are being poured into residential construction, and business finds it hard or perhaps impossible to raise money by selling stock, the productive capacity of the nation is growing less rapidly than it otherwise would. This failure to invest in productive capital goods only twists the inflationary tiger's tale another turn.
What could turn all this around? Adjusting income and capital gains taxes for inflation, which Fellner has long advocated, would help, he says. But most of all, the answer is getting a handle on inflation.