The Wealth Effect: More Money, More Spending—But Is It Sustainable?
March 8, 2025
The Illusion of Prosperity: How Wealth Shapes Behavior and Controls Nations
Wealth is power, influence, and an intoxicating drug that bends the will of individuals, societies, and entire civilizations. The wealth effect refers to the phenomenon where people spend more when they perceive themselves to be wealthier, even if their actual economic fundamentals remain unchanged. This effect has dictated market cycles and government policies and led both individuals and nations to their rise or ruin.
But is it real wealth or just an illusion? And how do rulers, philosophers, and manipulators harness this psychological force throughout history?
The Machiavellian Grip: How Leaders Exploit the Wealth Effect
Machiavelli understood human nature better than most. He knew that power is not just about having wealth but about the perception of it. In The Prince, he stated that rulers must appear generous and prosperous—even if they are neither. “Men judge generally more by the eye than by the hand,” he wrote, arguing that illusion is often more powerful than reality.
This is the essence of the wealth effect. When people feel rich, they act rich. When the stock market soars, real estate prices climb, or governments inject liquidity into the system, people spend more—even if their disposable income hasn’t actually changed. The result? A booming economy, but often an artificial one, propped up by psychological tricks rather than true economic strength.
Consider the Roaring Twenties—a period of unrestrained spending and prosperity in the U.S. fueled by soaring stock prices and easy credit. The illusion of wealth drove consumption, but when the facade collapsed in the Great Depression, millions were left bankrupt, and the nation plunged into chaos. Perceived wealth is not real wealth.
Cicero’s Warning: The Fragility of Illusory Wealth
Cicero, the great Roman statesman and philosopher, warned against mistaking temporary prosperity for permanent stability. In his works, he criticized Rome’s elite for indulging in luxury while neglecting the foundations of true wealth—productive labour, discipline, and civic virtue. He foresaw how Rome’s overreliance on imported wealth and extravagant spending would lead to decay.
And he was right. Rome fell into the same trap as Spain centuries later. It bathed in the wealth of conquest, its citizens enjoying an illusion of prosperity, all while production dwindled and the empire grew dependent on external riches. When those sources dried up, Rome imploded from within—not because it lacked gold, but because it lacked the infrastructure to sustain real economic strength.
The lesson? The wealth effect creates a mirage. It convinces people, businesses, and even entire empires to overextend and overspend and to believe that fortune is eternal. But all illusions eventually break.
Montaigne’s Perspective: The Madness of the Masses
Michel de Montaigne, one of history’s greatest skeptics, understood the dangers of herd mentality. He noted that people tend to follow crowds rather than think critically, making them susceptible to collective delusions—especially about wealth.
This explains why bubbles form. The dot-com bubble of the 1990s, the housing crash of 2008—both were fueled by the belief that prices could only go up, that wealth was infinite and permanent. Montaigne would have laughed at such foolishness.
In one of his essays, he wrote, “Nothing is so firmly believed as that which we least know.” This describes financial euphoria perfectly. When people feel wealthy, they do not question it. They spend, they leverage, they celebrate—until reality intrudes and the illusion shatters.
The Mass Psychology of Spending: Why the Wealth Effect Works
To understand why the wealth effect grips people so powerfully, we must dive into the psychology of cognitive biases and herd behavior.
- The Anchoring Bias: If people see their stock portfolio rise from $100,000 to $200,000, they anchor their lifestyle expectations to that new number—even if the wealth is not realized. They begin spending based on their paper wealth, not actual cash flow.
- The Availability Heuristic: If everyone around them is upgrading cars, buying expensive dinners, or taking extravagant vacations, they assume wealth is abundant. They justify spending because they see others doing the same.
- Loss Aversion: People hate losing wealth more than they enjoy gaining it. Once they get accustomed to a higher standard of living, they will do almost anything to maintain it—even going into debt.
These biases explain why economic bubbles are not just financial phenomena but psychological ones. People feel wealthier, so they act wealthier, inflating the economy—until reality catches up.
Real-World Examples: How the Wealth Effect Drives Markets and Crashes
- The 2008 Financial Crisis: Homeowners felt richer as property values skyrocketed. They borrowed against their homes, spent lavishly, and fueled an economic boom. When the bubble burst, they were left with massive debt, collapsing home equity, and a ruined financial system.
- Japan’s Lost Decade: The late 1980s saw a meteoric rise in Japanese real estate and stocks. The Japanese people, believing themselves wealthier, spent at unprecedented levels. But when the bubble burst, Japan entered a decades-long stagnation because the perceived wealth had vanished overnight.
- Cryptocurrency Mania: Bitcoin surging to $60,000 led people to believe they had new, permanent riches. They spent recklessly, assuming their assets would keep appreciating. When the crash came, those same people were left in financial devastation. The wealth was never real—it was psychological.
The Common-Sense Solution: How to See Through the Illusion
If history has proven one thing, it is this: wealth is not what you perceive—it is what you sustain.
How can individuals and nations avoid falling for the wealth effect?
- Measure wealth by cash flow, not assets. A stock portfolio means nothing if it isn’t generating real, spendable income.
- Live below perceived means. Just because assets rise in value doesn’t mean spending should rise proportionally.
- Recognize that all markets are cyclical. Boom and bust cycles have been happening for centuries. The wise prepare for downturns.
- Invest in production, not speculation. Real wealth is built through productivity, innovation, and sustainable businesses—not by chasing asset bubbles.
Final Words: Wealth That Moves is Wealth That Lasts
The wealth effect is a seductive illusion, luring individuals, corporations, and even entire nations into spending what they do not truly have. Machiavelli taught us that perception is power, but Cicero and Montaigne warned against mistaking perception for reality. Those who see beyond the mirage—who understand that true wealth is sustainable, productive, and resilient—are the ones who thrive.
Confucius put it best: “The cautious seldom err.“ Wealth that moves—through disciplined investing, reinvestment, and strategic allocation—is wealth that lasts. Those who chase fleeting riches, living as if tomorrow will fix today’s excesses, find themselves at the mercy of forces they never bothered to understand.
Consider Japan’s real estate bubble in the late 1980s, when Tokyo’s land values skyrocketed beyond reason. The illusion of limitless prosperity blinded many, but the collapse was inevitable. Conversely, those who followed Warren Buffett’s wisdom—buying when others were fearful, reinvesting profits, and holding for the long game—built fortunes that stood the test of time.
Gold may glitter, markets may surge, and assets may inflate, but only real, earned, and reinvested wealth endures. The question is simple: will you be a gambler chasing illusions or a strategist building a fortress?
