Friday, February 07, 2014

Economic Squeeze: Americans Don't Have Enough Income to Drive Demand

Our economic model is based on demand and consumption. In order for the economy to continually grow, people must continually buy more stuff.

Of course, there are the everyday staples that everyone will always buy because they must, such as food, toilet paper, tooth paste, soap, etc. Spending on these basic life-essentials is considered non-discretionary because there is no choice involved. Paying for the roof over one's head is also considered non-discretionary.

Yet, what businesses and the broader economy really need is for people to also make lots of discretionary purchases. This includes things such as household furniture, appliances, cars, luxury items, vacations and entertainment, plus all other non-essential goods and services.

The problem is that household income has been shrinking for many years, leaving people with less to spend.

For many years, Americans made up the difference by using credit cards and going into debt. In essence, people were spending money they didn't have to fiance their lifestyles. But people are now taking on less debt than during the bubble years.

For example, credit card debt outstanding is 7% lower than its level in 2010 and 16% below its peak in 2008.

The debt-to-income ratio for American households is now down to 109% – well below the peak of 135% reached in late 2007. But it's still 35 percentage points above the average of the final three decades of the twentieth century, according to Yale economist Stephen Roach.

In other words, Americans still have a lot of work to do to pay down their rather substantial debts.

The personal savings rate also remains below past levels. The savings rate fell to 4.48 percent in 2013, according to the Bureau of Economic Analysis.

After turning negative in 2005 for the first time since the Great Depression, and staying that way for about two years, the savings rate then began to climb, reaching a high of 6.1% in 2009.

After witnessing the collapse of the debt bubble, Americans were trying to pay down their debts as the financial crisis was still unfolding.

But the savings rate quickly returned to a downward trajectory the very next year, falling to 5.6 percent in 2010. It stayed relatively stable for the next two years: 5.7 percent in 2011, and 5.6 percent in 2012.

So, the decline to 4.48 percent in 2013 was rather substantial, amounting to a 20 percent drop.

As the Baby Boomers continue to retire each year and draw down on their retirement savings, the savings rate will be driven down even further.

There are a couple of different perspectives on the savings rate.

On the one hand, if people are saving, they are not spending, which tends to hold back economic growth. On the other hand, if people aren't saving, there is less money for national investment, meaning money is instead borrowed from overseas. As it stands, that's already a big problem for the U.S.

People haven't been able to save because they don't have the means. Incomes have fallen considerably. In past decades, people made up for that fact by going further into debt. This helped prop up economic growth. But there was an eventual and inevitable reckoning, as people came face to face with an enormous pile of debt that had become overwhelming.

So, Americans are now spending less now than in the bubble years of the last decade. Home equity has been crushed, leaving nothing for them to extract and spend.

This is all bad news for retailers and for the economy in general, since consumer spending accounts for more than 70 percent of GDP.

However, our economic decline was quite predictable. Real median household income is now at 1990 levels. Yes, that's how far backward the typical American household has fallen.

In 1970, the inflation-adjusted median household income was $45,146.
In 1980, the inflation-adjusted median household income was $46,024.
In 1990, the inflation-adjusted median household income was $49,950.
In 2000, the inflation-adjusted median household income was $54,841.
In 2010, the inflation-adjusted median household income was $50,831.

This means that household incomes barely budged for a couple of decades, and then they went backward in the last decade. Americans are making roughly the same amount today, in inflation-adjusted terms, as they were making back in 1990.

Yet, the problem of falling incomes stubbornly persists. Median household income after inflation fell again in 2011, to $50,054. After falling 0.5% in 2011, inflation-adjusted wages declined 0.4% in 2012.

Simply put, wages aren't keeping up with inflation.

Yet, the cost of everything continues to rise. For example, the price of gasoline over the last three years has been at its highest point ever. Gas prices in 2013 were the second highest in history, trailing only 2012, which saw the highest average price. And the third highest average price was in 2011.

Oil prices have surged from $25 per barrel in 2003 to $100 per barrel today. That has raised the cost of virtually everything in our economy. All goods that are transported are more costly as a result.

Outstanding student loan debt has reached a whopping $1.2 Trillion, which means that more than 40 million Americans are not buying houses or cars, starting businesses or families, or otherwise creating demand in the economy.

As previously noted, there are fewer people spending because they have less income to spend. But, additionally, there are fewer people working. The labor participation rate is at its lowest level in 35 years, a time when the economy was in recession.

There are 247 million working age Americans between the ages of 16 and 64 (those not in the military, jail/prison, mental facilities or homes for the aged). Only 155 million of them are employed. This means that 92 million working-age people are not working.

While some on these people are retiring, once someone turns 65 they are no longer counted in the work force. Yet, the number of 'working age' Americans is continually growing since thousands of teenagers turn 16 every day and are considered part of the labor force.

It's a sad fact that the labor force participation rate was just 62.8 in December. The figure hasn't been that low since at least 1978. Again, a whopping 92 million working age people simply aren't working.

The problem is there are too many people looking for too few jobs. At present, there are three applicants for every available job nationwide.

Then there's the additional problem of low-paying jobs. Nearly two out of three new jobs created from January through August last year were part time.

During the supposed recovery, there have been far more low-wage jobs created than high-wage jobs.

Between 2009 and 2013, low-wage jobs outnumbered high-wage jobs by some 800,000, with 1.7 million versus 1.1 million jobs. Though low-wage jobs made up less than one in five (19 percent) of all employment in 2009, they accounted for nearly 40 percent (39 percent) of all new jobs created out to 2013.

Put all these pieces together and you realize why demand and consumption are so low, and why economic growth has been so weak.

Growth rates in the U.S. have been decreasing for decades. In the 1950’s and 60’s, the average growth rate was above 4 percent. But in the 1970’s and 80’s, it dropped to around 3 percent. And in the last ten years, the average rate has been below 2 percent.

In fact, the U.S. economy has not surpassed 3 percent annual growth since 2005. Last year likely continued that trend. The advanced estimate for economic growth in 2013 is 2.7 percent, according to the White House. That number will be revised a couple of times in the coming months.

Think of it as the new normal.

There is, however, plenty of money still in the U.S. economy. It's just being siphoned off to the richest 1 percent.

The average CEO-to-worker pay ratio in 2012 was 354 to 1. That is far more than the ratio in other developed countries.

In the 1970s and early '80s, the U.S. ratio was roughly 20 to 1.

While most Americans continue to struggle financially, and even regress, the rich just keep getting richer.

The United States has led a worldwide growth in wealth concentration, according to a recent Oxfam report, titled "Working for the Few."

The percentage of income held by the richest 1% in the U.S. has grown by nearly 150% since 1980. That small elite has received 95% of wealth created since 2009, after the financial crisis, while the bottom 90% of Americans have become poorer, Oxfam said.

The new normal is plainly abnormal, even despicable.