Tuesday, May 29, 2012

The American Condition: Debts Remain High, Disposable Incomes & Savings Remain Low


The U.S. is a consumption-based society. It is also a materialistic society. After all, we have entire TV networks dedicated to shopping.

In addition to overwhelming debt, our consumption and materialism produced another rather remarkable result: In 2005, the savings rate actually turned negative for the first time since the Great Depression, and it stayed that way for about two years.

However, after the financial collapse in the fall of 2008, the U.S. savings rate started to climb. Although those who lost jobs or took pay cuts had nothing to save, most Americans began to change their spendthrift ways.

The savings rate jumped from 1.3 percent in January of 2008 all the way to 6.9 percent in May of 2009 — the highest level in 15 years.

The resulting fear and panic from the Great Recession led people to stop the frivolous spending of the bubble years and instead begin paying down debts and saving. Those were wise and, perhaps, expected choices given the economic environment.

Historically, savings rates tend to increase during times of recession.

During the early 1980s, when the economy was in a severe double-dip recession, the annual personal saving rate (effectively, income minus spending) averaged around 10%. But by the time of the 1990-91 recession, it had fallen to an average of 7%.

However, that savings rate now seems quite high, given how far it fell over the next 15 years, or so.

By 2001, the rate had fallen below 2 percent and as the decade progressed it fell below 1 percent multiple times. Finally, in 2005, at the height of the American spending and debt binge, the savings rate turned negative. Americans were actually spending more than they were earning.

All of that spending and consumption resulted in a whole lot of debt; total U.S. household debt reached a whopping $13.8 trillion by 2008.

A higher savings rate is critical because it makes more money available for business investment. And it can reduce the need to borrow from overseas. The downside is that it also leads to a slow down in a consumption-based economy.

Since consumer spending accounts for 72 percent of our GDP, it's a good indicator of how the economy is faring. If people are saving instead of spending, the economy will tend to shrink — unless the government leaps in to fill the void, as it did with the stimulus in 2009 and 2010.

Consumers have long been the engine that continually powered the ever-expanding U.S. economy. However, for many years, American consumers propelled the economy with debt-based spending. If Americans don't maintain their high-level of spending, the economy will fall into recession once again.

In the previous decade, Americans fueled their spending binges with home equity extractions.
From 2003 to 2007, people extracted more than $2 trillion from their properties in the form of home equity loans and cash-out refinancing — about 20 percent of which went to fund personal spending.

The obvious question now is, Where will Americans find the money to continue spending at a rate that will keep the economy humming along at a sufficient level?

According to the Federal Reserve, household real estate assets rose by more than two-thirds from 1999 to 2005. Americans used all that home equity to finance an unprecedented spending spree. Those days are long gone and now the economy has come back down to reality as a result. All bubbles eventually burst.

By the end of 2009, total household debt was nine times what it was in 1981 — rising twice as fast as disposable income in the same period.

Fed data also shows that the end of 2011, household debt was down to $13.2 trillion. Meanwhile, total disposable income was $10.7 trillion.

Household net worth—the difference between the value of assets and liabilities—was $58.5 trillion at the end of 2011. Though that was about $1.2 trillion more than at the end of the third quarter, for 2011 as a whole, household net worth fell close to 3/4 percent, the first annual decrease since 2008.

Perhaps falling wages and salaries have driven Americans to save less and instead spend what they must on necessities. The U.S. savings rate plunged from 4.7 percent in December to 3.7 percent in February, the lowest level since December 2007's 2.6 percent.

The lower savings rate is problematic for a number of reasons. For instance, it leaves people unprepared for retirement, or even an emergency.

The percentage of workers who said they had less than $10,000 savings grew from 39 percent in 2009 to 43 percent in 2010, according to the Employee Benefit Research Institute's (EBRI) annual Retirement Confidence Survey. That excludes the value of primary homes and defined-benefit pension plans.

Consequently, the EBRI found that many workers' retirement saving will run out too soon.

In this year's Retirement Confidence Survey, 60 percent of workers reported that the total value of their household's savings and investments, excluding the value of their primary home and any defined benefit plans, is less than $25,000.

Perhaps this is why just 14 percent of Americans polled in this year's survey said they were “very confident they will have enough money to live comfortably in retirement.”

A recent study by LIMRA, a life insurance and financial services research organization, found that nearly half of American workers are not contributing to any form of retirement plan.

Outside of those who work in government, most people no longer have an employer pension plan to fall back on. The shift from defined benefit to defined contribution retirement plans has put the responsibility for saving solely on the employees. Apparently, that's not working out so well.

Even more worrisome, just 36 percent of workers said they had $1,000 in emergency savings in 2011. This means that nearly two-thirds of workers don't even have $1,000 set aside for an unplanned expense. That could prove crippling should an unexpected medical cost, home repair, or personal disability arise.

In another survey last year, 24 percent of respondents said they had no emergency savings whatsoever.

With interest rates running well below the rate of inflation, money in a savings account or other deposit vehicle is actually losing purchasing power with each passing day. Perhaps that's part of the reason that Americans aren't saving.

As interest rates have fallen, many Americans have sought a higher rate of return form other investments, shifting out of savings accounts in the process.

Other Americans simply have nothing left to save; adjusted for inflation, wages have been stagnant since the 1970s.

It's clear that the hard times we're living in have made it quite difficult for many Americans to plan for retirement, or even a family emergency. Long term unemployment has long since dried up the savings of millions of Americans who now live day to day.

According to financial planners, most people need three to six months of living expenses in emergency savings, amounting to about half of one's gross income.

However, for a vast majority of Americans, it seems this is nothing more than a pipe dream.

And when you're struggling to get by, trying to make ends meet from week to the next, retirement can seem a long way off... until it isn't.

Then what?


Thursday, May 24, 2012

Economic Growth Is Predicated On Debt

Though the national debt already exceeds $15.7 trillion, and is bigger than the entire U.S. economy, it is projected to just keep on growing.

According to the latest estimate from the Congressional Budget Office (CBO), the government will run a $1.2 trillion deficit for the current fiscal year, which ends September 30. The new projection is about $100 billion higher than the previous estimate and is due primarily to the renewal of a 2 percentage point cut in payroll taxes and extended jobless benefits for people languishing on unemployment rolls for more than six months.

There have been persistently large deficits every year since the start financial crisis and subsequent Great Recession. Tax revenues fell nearly 17 percent in fiscal 2009, the biggest decline since 1932. That year, the deficit was $1.4 trillion, followed by $1.3 trillion deficits in both 2010 and in 2011.

According to the CBO, President Obama‘s proposed budget would produce a deficit of $977 billion in fiscal year 2013.

The problem stems from a huge collapse in personal and corporate tax revenues and a commensurate rise in safety net payments for things like unemployment, food stamps and Medicaid.

Last year, federal spending amounted to nearly 24 percent of GDP. However, federal revenues fell to 14.8 percent of GDP, the lowest intake relative to GDP in 60 years. The shrunken receipts were part of a continuing trend; revenues were 14.9 percent of GDP in 2009 and 2010.

It's evident that Washington has a revenue problem in addition to its spending problem.

U.S. corporations now contribute just 6.6 percent to the federal tax base. In the 1950s, US corporations contributed a 30 percent share.

Revenue from corporate income taxes was between 5 percent and 6 percent of gross domestic product back in the early 1950s. However, federal corporate tax collections made up only 1.3 percent of U.S. GDP in 2010.

Confronted by these historically low revenues, Congress will seek a combination of budget cuts and tax hikes. However, due to strong Republican opposition, the latter may amount to nothing more than allowing the already legislated expiration of the Bush tax cuts at the end of this year.

But, as Europe is painfully learning, austerity (aka budget cuts) can push a struggling economy right off the rails. The U.S. economy has become heavily reliant on government deficit-spending to maintain growth. Absent government deficit-spending, our economy would still be in recession (more likely a depression) and would have entered one years earlier, long before the financial collapse of 2008.

Think about what would happen to the economy if federal spending were halved right now, from 24 percent of GDP to just 12 percent. Even if spending were cut by a quarter, the economy would grind to a halt. Sadly, the U.S. economy has become wholly dependent on government deficit-spending.

As it is, economic growth remains sluggish. The U.S. economy expanded at a 2.2 percent annual rate in the first quarter after expanding at a 3 percent annual rate in the fourth quarter of 2011. That's not nearly good enough.

Growth would need to equal 5 percent for all of 2012 just to lower the average jobless rate for the year by 1 percentage point. Clearly, that's not going to happen.

Too many Americans are unemployed or have dropped out of the workforce altogether. In April, the number of people not in the labor force rose from 87,897,000 to 88,419,000, a whopping increase of 522,000. This is the highest on record. The labor force participation rate recently dipped to a new 30-year low of 63.6%.

Until employment improves considerably and genuinely (not some phony government accounting that ignores all the millions who have dropped out of the workforce), tax revenues will remain perpetually low.

So, without jobs there will be no economic growth. But if the economy isn't growing, companies won't hire. It's a chicken and egg conundrum.

To make matters worse, the U.S. will find it increasingly difficult to service its mammoth debt without robust economic growth.

The U.S. paid $454 billion in interest on its publicly held debt in fiscal 2011, which ended September 30. However, the National Commission on Fiscal Responsibility and Reform, better known as the 'debt commission', projects that the interest on the debt could reach $1 trillion by 2020 if Congress doesn't act immediately.

With a debt so massive, the U.S. desperately needs growth. Yet, the private sector isn't capable of doing it alone.

Despite this, Congress plans significant budget cuts next year, in addition to allowing the payroll tax holiday and the Bush tax cuts to expire. That combination will lead to a recession, the CBO announced on Wednesday.

If these planned tax hikes and budget cuts aren't changed, the CBO says it will result in a fiscal contraction (commonly referred to as a "fiscal cliff"), that will shrink the economy by 1.3% in the first half of 2013 (a technical recession) before expanding 2.3% in the second half.

However, the CBO projects that this combination of tax hikes and budget cuts will reduce the budget deficit by 5.1% of GDP. Yet, last year, the CBO projected a budget deficit of $1.1 trillion in 2012, or 7.0 percent of GDP.

So, even if those budget cuts and tax increases are enacted as planned, they would still result in a continued deficit and even more debt.

How's that for an outcome? This fiscal "solution" would not only result in a recession, but would still leave the federal government with a budget deficit as well. That's what you call bad medicine.

Our economic system is predicated on debt. Since all money is loaned into existence, money equals debt. The economy can't grow without an expansion of debt, meaning that debts can never be fully retired. If debt isn't accumulating, then money isn't being created and the whole system locks up and shuts down.

It's for this reason that you can expect continued deficit spending and a perpetual expansion of the federal debt. It's been going on for many decades, with the exception of a brief respite during the Clinton years. When the government finally runs out of foreign lenders, the Federal Reserve will just ramp up its printing and further devalue the dollar.

This fiscal mess comes at a particularly bad time for a nation confronting a long term wave of retirements by its Baby Boomers, one-quarter of the population. This will dramatically raise expenditures for things like Social Security and Medicare, even as the nation's productivity suffers a parallel and resulting decline.

Such a decline in productivity is a recipe for disaster to a nation so reliant on the perpetual-growth economic model.

As I've said repeatedly, there are no good solutions to our economic woes; only very difficult choices. We have entered a debt trap that presents an enormous conundrum; do we continue to mortgage our nation's future by becoming even more grossly indebted? Or, do we show fiscal restraint and suffer the consequences of lowered growth, economic stagnation or even the possibility of another depression?

My guess is that the government maintains its deficit spending because it has no other choice. The economy must grow or it will die. Stasis equals death. Some entity must attempt to spend the economy into a more robust pattern of growth, which will result in even more debt. If it's not the private sector, then it will be the public sector.

There are some really serious and difficult challenges ahead us as a nation. And I'm not talking about ten years from now either. Some really unpleasant realities will have to be confronted starting next year, and again each year thereafter.

You could say there's a shit storm a brewin'.

Friday, May 18, 2012

European Crisis Has Global Consequences

What has been clear to me for quite some time is that Greece is going to exit the eurozone, either willingly or unwillingly. The nation is in a full-on depression and there is no way for it to ever repay its debts.

The Greek unemployment rate was last measured at 21.7 percent in February, a new record. More than half of young people (15-24) are without a job, a recipe for social disaster. In a population of 10.7 million, 1.1 million are jobless and only 3.87 million are employed, a decline of 8 percent, year-over-year.

Even the nation's population is in decline, which will thwart any lingering hope of long term economic growth. Absent a growth in population, energy supplies and credit, there can be no economic growth.

As it stands, the Greek economy is projected to contract by about 20 percent from 2008 to 2012. That's just brutal.

There has been a wave of corporate closures and bankruptcies across Greece. Tax collections, already poorly enforced prior to the economic meltdown, have collapsed.

Under these conditions, there is no way for Greece to grow its economy and service its debts.

Fearing a banking collapse, Greek depositors withdrew €700 million ($890 million) from the nation’s banks on Monday. This is creating a self-fulfilling prophecy and putting enormous strain on the Greek banking system, which will need even more funding from the European Central Bank.

The ECB is just one of the entities to which Greece is heavily indebted and will likely be unable to repay. At a minimum, given its plight, Greece may simply refuse repayment since this payment scheme will keep it permanently indebted.

At its heart, a debt crisis is really a crisis of confidence. In Greece, and elsewhere in Europe, there is no confidence whatsoever.

The failure of Greek party leaders to reach an agreement to form a unity government is raising fears that Greece could soon be ousted from the euro zone. It may even choose to leave voluntarily. Such a possibility is rattling global financial markets. There is no legal mechanism for a nation to leave the euro zone and that is a vexing problem. Apparently, the architects of the euro zone never imagined such a scenario.

Any sign that Greece is preparing to exit the euro zone would trigger contagion in the more vulnerable euro zone bond markets, such as Spain and even Italy. The trouble in Europe is expanding and worsening. Leaders have been delaying some rather ugly outcomes for years, but they are now running out of time. They can no longer kick the can down the road because they have finally run out of road.

This week, Moody's downgraded the ratings of 26 Italian banks. But that's only half the story.

Moody's also downgraded 16 Spanish banks in what was the latest blow for a country already facing economic recession, surging unemployment and a property bust. There is a legitimate fear that the run on Greek banks will shift to Spain next.

The contagion in Europe has been continually spreading, from Greece, to Ireland, to Portugal, to Spain and even Italy. The yields on Spanish and Italian government debt are again rising to unsustainable levels. If unchecked, that could raise the crisis to an entirely new magnitude. Italy and Spain are the third and fourth largest economies in the euro zone.

As it is, there are now debt and/or bank problems in countries that have been traditionally viewed as safe and stable: Holland, Austria, Switzerland and Sweden, for example.

The continent's recession will have global consequences. It will dampen demand and hurt exporters that rely on the European market, such as the U.S.

The European sovereign debt crisis and slowing global economy have driven the dollar to its longest rally since 1985, as investors seek to reduce risk. The strength of the dollar is weighing on dollar-priced commodities such as gold and oil, making them more expensive for holders of other currencies.

In essence, the purchasing power of the dollar is rising, making commodities cheaper. So, commodities aren't really going down in value; the dollar is going up in value.

On the one hand, this is good for the U.S. and American consumers. Lower pump prices would be a welcome outcome. However, while oil/gas prices are dropping here, they are rising elsewhere in the world. That will hurt other economies, and this is ultimately a global issue.

Furthermore, the strength of the dollar will make U.S. goods more expensive overseas, ultimately hurting American exporters. That's not good for the country's whopping trade deficit, or the economy in general. So the rising dollar can be viewed as a tradeoff, or a mixed blessing.

The global economy is just creeping along, reacting to one crisis after another. Even the giant Chinese economy is slowing. That's bad news. The world needs robust economies to spur trade and growth.

Ultimately, the nations of the world are grappling with unsustainable debts. And the whole world needs economic growth to service all those cumbersome debts. The trouble is, there can be no growth without debt. Growth equals debt. In order to grow, the world's economies will have to incur even more debt. But that's like adding more disease to an already sick patient.

Furthermore, there can be no economic growth without an abundant supply of oil, particularly cheap oil. Neither exists.

The global economy is inextricably linked due to trade, finance and the competition for finite resources, such as oil. That's why the pain in Europe will be felt worldwide.

Not every nation can be a net exporter, meaning that huge trade imbalances will not only continue, but will worsen. This is simply unsustainable.

As credit risk rises, lenders will become increasingly scarce and the cost of borrowing will reach unmanageable levels, as is already the case in parts of Europe.

When the price of oil drops, that means the world economy is slowing or stagnating. That's a bad tradeoff. And, as previously stated, if oil prices are dropping only in the U.S. due to a rising dollar, that has an opposite effect to the rest of the world, which must buy oil in dollars.

We are witnessing a slow motion train wreck, or even collapse. Europe's leaders, as well as the central bankers around the world, are attempting to hold back the tide.

How this ends is open to speculation, but one thing is certain; it won't end well.


Monday, May 07, 2012

U.S. Will Bounce From One Economic Crisis To The Next


The U.S. economy appears to be stalling.

Gross domestic product rose at a 2.2% annual rate between January and March, slower than the 3.0% pace in the prior three months. The first-quarter growth reading was lower than expectations.

Economic growth needs to be at least 2.5% to improve the nation's dismal unemployment situation. Anything lower won't even keep up with population growth.

The Commerce Department reported that durable goods orders tumbled 4.2 percent in March, the largest drop in three years. Durable goods range from appliances to aircraft. And recent data also showed that industrial production was flat in March for a second straight month. These are sure signs that the U.S. economy is slowing.

Even before this latest round of bad news, the nation was already grappling with the worst recovery since the early years of the Depression era. For tens of millions of Americans, there has been no recovery at all. And consumer sentiment reflects this.

Consumer confidence remains stuck in recession territory. The consumer-confidence index fell to 69.2 in April from a revised March reading of 69.5, according to the Conference Board. Generally, when the economy is growing at a good clip, confidence readings are at least 90.

Here's the central problem for the U.S. economy: the middle class — the nation's economic engine since the end of the Second World War — is vanishing. And the economy is suffering as a result.

The long term erosion of the middle class has triggered a major loss of purchasing power. The result is chronically inadequate demand for goods and services. Consequently, the economy struggles to grow, leading to further shrinking of what's left of the middle class.

The nation's relentless unemployment issue is only one part of the problem.

From January through April, the economy added an average of about 200,000 jobs a month. Though job growth of any size is obviously a good thing, that pace is not nearly fast enough to recover the losses from the Great Recession and its aftermath in the foreseeable future.

At that rate of job growth, it would take us until 2019 to get back to full employment. The trouble is, the country should actually have even more jobs given population growth and the current size of the economy.

Here's some perspective: the U.S. labor market started 2012 with fewer jobs than it had 11 years ago in January 2001. The only reason the unemployment rate keeps dropping is because people continue dropping out of the labor force. They're too discouraged to continue looking for work. Most worrisome, the largest drop in U.S. labor participation is coming from men 20 years of age and older.

That's a troubling trend.

Believe it or not, the U.S. economy is now producing more goods and services than it did when the recession officially began in December 2007. However, it is doing so with about five million fewer workers. Employers have learned how to produce more with fewer workers. That's good for employers, but bad for workers and the unemployed.

Unemployment aside, the other major issue is stagnant or declining wages for those who still have their jobs.

U.S. corporations are reporting record profits. In fact, they are sitting on a huge pile of money — an excess of $2 trillion — and yet the unemployment / underemployment rate stubbornly remains at 22%.

Clearly, there is still plenty of money in the U.S. economy. The problem is that far too much of it is concentrated at the top and is not being spent into the economy.

American CEOs saw their pay spike 15 percent last year, after a 28 percent pay rise the year before. That's in line with a trend that dates back three decades.

CEO pay spiked 725 percent between 1978 and 2011, while worker pay rose just 5.7 percent, according to a recently released study by the Economic Policy Institute. That means CEO pay grew 127 times faster than worker pay.

Last year, CEOs earned 209.4 times more than workers, compared to just 26.5 times more in 1978.

As long as all of that money remains concentrated at the top, instead of being fairly paid to workers in the form of salaries and wages, the nation will remain in decline.

Wealthy Americans spend a much smaller portion of their incomes than does the large, but shrinking, middle class. There are only so many houses, yachts and exotic sports cars the wealthy will buy.

Big U.S. companies have emerged from the deepest recession since World War II more productive, more profitable, flush with cash and less burdened by debt, says the Wall Street Journal.

An analysis by the Journal of corporate financial reports finds that cumulative sales, profits and employment last year among members of the Standard & Poor's 500-stock index exceeded the totals of 2007, before the recession and financial crisis.

But judging by the way the economy is performing, and by the number of people requiring unemployment and other government assistance, you'd never know it. These huge corporate profits haven't translated into an adequate number of good-paying jobs.

Instead, companies have driven their employees — fearful of losing their jobs — into becoming increasingly more productive.

Overall, the Journal found that S&P 500 companies have become more efficient, and more productive. In 2007, the companies generated an average of $378,000 in revenue for every employee on their payrolls. Last year, that figure rose to $420,000.

While corporations and CEO's prosper, ordinary Americans continue to suffer, many of them toiling away in low wage jobs.

Out of 34 industrialized countries, the U.S. had the highest share of employees doing low-wage work in 2009, according to OECD data.

One-in-four U.S. employees were low-wage workers in 2009, according to the OECD. That is 20 percent higher than in the number-two country, the United Kingdom. Low-wage work is defined as earning less than two-thirds of the country's median hourly wage.

There are far too many low-wage earners for the economic well-being of the country. That's not good for a country in which 70 percent of the economy is driven by consumer spending. That sort of consumption seems unsustainable.

According to a recent study by University of California economist Emmanuel Saez, based on an analysis of American tax returns, in 2010, 93 percent of all new income growth went to the top 1 percent of American households. Everyone else, the bottom 99 percent, divided up the remaining 7 percent.

Again, as long as the middle-class continues to shrink and doesn't have adequate wages to spend back into the economy, this predicament will not only continue, but will worsen.

There is a widespread feeling of foreboding that the economy is not just stalling, but may in fact be headed for yet another contraction, resulting in a double-dip recession.

Famed economist Nouriel Roubini said the U.S. economy could fall into stagnation in 2013 and ultimately put the nation into the second half of a double-dip recession. Roubini, who correctly predicted the housing-market crash and recession of 2008-09, noted that real wages for U.S. workers are not growing and that America’s crushing debt is strangling growth. Roubini said that GDP will be “lucky” to grow 2% this year and the U.S. could retreat into near-zero growth next year.

And prominent Yale economist Robert Shiller, the designer of the Standard & Poor’s/Case-Shiller house price index, says that the global economy is mired in a "late Great Depression", despite the stimulus policies of central banks. Shiller says the world is in a “new age of austerity" and also says housing prices will drop by a further 20 percent as the downturn gripping the United States deepens.

All of that sounds quite stark. Yet, these two guys know what they're talking about. They've made accurate calls in the past. Both men can see the writing on the wall. And it isn't good.

Due to the financial crisis, the Great Recession and the subsequent stagnation, the federal government is dealing with a huge falloff in revenues. Meanwhile, there has been an enormous increase in consequent safety net payments for unemployment, food stamps and Medicaid. This is the reason for our continued annual deficits.

Government spending has actually fallen for six straight quarters as Recovery Act funds have been exhausted and state and local governments have struggled with tax revenue shortfalls.

Congress will be forced to act to address its fiscal crisis, or else the nation's credit rating could be downgraded yet again. Such a downgrade may inevitable no matter what Congress does. Yet, the legislative branch is now so dysfunctional that it would surprise no one if they fumble yet again.

The failure of Congress and the White House to agree on taxes and spending next year could spell doom for the economy.

Early next year, the government is set to enact huge budget cuts, while allowing the Bush tax cuts and the payroll tax cuts to expire. The likely result will be a choke hold on the already struggling economy.

We are finally seeing the limits of fiscal and monetary policies.

The Fed has pumped $2 trillion into the financial system, slashed overnight interest rates to zero and made the unprecedented promise to keep them there for an extended period. Yet, this is the best that monetary policy can do.

For good reason, Americans have little confidence in any of the institutions pulling the strings on the U.S. economy: Congress, the Federal Reserve or corporate America.

Europe is already in recession, and the U.S. is almost certain to follow. It is against this backdrop that the U.S. braces for yet another storm. We can only hope that we are not dashed upon the rocks like an old ship.

Given our structural deficiencies, it now seems that the U.S. is doomed to bounce from one economic crisis to the next. This seems to have become a way of life for us. It's a tough thing to get used to.