Tuesday, September 11, 2012

Our Economy Was Just an Illusion of Prosperity, Fueled by Debt

The U.S. continues to be burdened by the fallout from the 2008 financial meltdown. That collapse, and the subsequent recession, took many people by surprise because, aside from the bursting of the dot-com/internet bubble in 2000, the economy had appeared to be humming along quite smoothly.

But that appearance was the byproduct of a lot of smoke and mirrors.

Much of the growth in corporate profits leading up to our economic collapse was driven by the financial sector. After-tax corporate profits in the financial sector were considerably better than the non-financial sector from 1997 to 20007. So the supposed "economic boom" during this period was largely limited to the financial sector, which doesn't produce anything — other than debt.

As a result, all of that financial sector growth was a sham. Our economy was nothing more than a paper tiger. Wages were stagnant for many years and Americans lived on cheap and easy credit (or debt) to make up for that fact. It made people feel prosperous, as if we were all benefitting from the supposed "economic boom."

From 1948 to 1985, the financial sector accounted for around 12 percent of American corporate profits, never reaching 20 percent nor dipping below 5 percent. After 1985, however, the profits of the sector rose dramatically, going from 19 percent in 1986 to 41 percent in 2000.

That meant that more than 40 cents out of every corporate dollar of profit was paper profit, not created by actual wealth-generating activity, but by monetary inflation and corporate gambling.

The earnings of typical Americans couldn't (and still can't) keep up with the rate of inflation. From 1914 until 2010, the average inflation rate in United States was 3.38 percent. This means that inflation has been running at roughly 33 percent per decade over the past century.

Since wages weren't keeping up in recent decades, the only way to maintain consumer spending — the engine of our economy — was to continually expand available credit, putting Americans into ever deeper debt.

With the cost of living outstripping wage and salary increases, Americans began draining their savings just to keep up. During the previous decade, the U.S. savings rate reached its lowest level since the Great Depression and actually turned negative for a couple of years. The cost of living had simply exceeded incomes.

According to Census figures, the median annual income for a male, full-time, year-round worker in 2010 was $47,715. Adjusted for inflation, that was less than in 1973, when it was $49,065. This means that the American male's income is now negative after four decades.

Yet, the problem seems to be accelerating.

Across the country, in almost every demographic, Americans earn less today than they did in June 2009, when the recovery technically started. As of June, the median household income for all Americans was $50,964, or 4.8 percent lower than its level three years earlier, when the inflation-adjusted median income was $53,508.

That's nearly double the 2.6 percent drop during the recession, which means that — when it comes to incomes, at least— our supposed recovery has been even worse than the recession.

The decline looks even worse when comparing today’s incomes to those when the recession began in December 2007. Then, the median household income was $54,916, meaning that incomes have fallen 7.2 percent since the economy last peaked.

This decline is critical because 70 percent of all U.S. economic activity (GDP) is the result of consumer spending, and retail sales account for about half of that.

For many years, Americans used credit to buy whatever they couldn't afford — including houses — which masked the decline in incomes. But now that the bubble has burst, the lingering hangover remains debilitating.

Falling home prices have slashed home equity 49 percent, from $13.2 trillion in 2005 to $6.7 trillion early this year. One-third of homes with a mortgage are underwater. And roughly 27 million workers—or about one out of every six U.S. workers—are either unemployed or underemployed.

All of this is killing demand and consumption.

Decades of easy credit resulted in significant increases in the American standard of living. But the reality is that all of those debts need to be serviced. However, there isn't enough income to do that while also maintaining past rates of spending. Consequently, less disposable income is being directed back into the economy, which is stunting economic growth.

The Federal Reserve was well aware of all of this. The Fed is responsible for the erosion of the dollar and the average American's savings by continually creating money from nothing and holding interest rates at historically low levels. That's because it has to keep us all spending in order to uphold the economy.

So, lending practices were loosened and money made cheap and easy. People were made to feel affluent by going ever further into debt, spending money they didn't actually have. But the sobering reality it that all of those debts eventually need to paid back — with interest.

This is how the masses, the common folks, were allowed to participate in the consumption economy along with the truly affluent. It was simply an illusion of wealth for millions. Accompanying the continual expansion of credit/debt was the seemingly perpetual increase in home prices.

However, all of it has now finally, depressingly, come to a crushing end. There is no re-inflating the debt bubble that propped up our phony economy. The lifestyle we maintained for more than a quarter of a century was simply unsustainable, and our crash inevitable. To double-down on our debt binge would only be an attempt to forestall the necessary de-leveraging of our economy and be even more crippling in the long run.

A recent report from the Federal Reserve Bank of New York shows that total household debt declined from nearly $12.7 trillion in 2008 to $11.4 trillion as of the first quarter of 2012. Yet, much of that has been due to foreclosures and defaults. If you default on your mortgage, you no longer have that liability, which makes total household debt look better.

Mortgage debt makes up the vast majority of Americans' household debt, so a decline in home ownership means less debt, even though it also results in a drag on the economy, as salable homes sit empty.

Yet, this decline in household debt hasn't stopped the Fed and its fellow banker cronies from trying to reinflate the bubble. The federal funds rate has been held at a range of between zero to 0.25 percent since 2008. Most incredibly, total outstanding consumer credit has increased to $2.7 trillion from $2.55 trillion when the financial crisis struck in 2008.

Economic growth is predicated on debt, so unless Americans keep on borrowing the economy will move from stagnation back to recession. The standard of living for millions of Americans has already declined considerably over the past four years. Considering the long term decline in wages and salaries, something has to give.

Either Americans realize they can never repay all of their incurred debt and stop adding to it, or they try to forestall an even lower standard of living by attempting to borrow their way into a false prosperity once again.

For many years, our national economic growth has been fictitious — an illusion of prosperity rooted in debt.

We've consumed more than we produced. We've imported more than we exported. We've borrowed more than we saved.

We've done all this for a quarter-century, and now we remain mired in day of reckoning that just won't end.

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