Those who enjoyed annual income growth of 5 percent, please raise your hands

Tuesday, April 19, 2005

The Prudent Investor begins to wonder whether the Federal Reserve enjoys itself too much with the punch bowl which it normally is expected to take away when the party gets going. A series of declining consumer confidence, now in it's fourth month, is according to Governor Susan Schmidt Bies' latest speech "favorable". Consumer spending, gauged by retail sales figures, which came in at a paltry .3 percent vs. expectations of .8 percent for March, is also on the expansive side, she said. But the best part is about personal debts and incomes. "It is true that households have taken on quite a bit of debt over the past several years. According to the latest available data, total household debt grew at an annual rate of about 10 percent between 1999 and 2004; in comparison, after-tax household income increased at a rate of about 5 percent over this period. This rapid growth in household debt largely reflects a surge in mortgage borrowing, which has been fueled by historically low mortgage interest rates, strong growth in house prices, and an increasing share of households owning their home rather than renting."
Citing from her speech, will please all those who now have roughly 30 percent higher incomes than in 1999, please raise your hands! Raise your hands please! RAISE YOUR HANDS, PLEASE! Didn't you hear me!? Why is nobody raising their hands except for that real estate agent and her banker in the far corner?
Let's try her other statement. Those who have 60 percent more debt than 1999, please raise their hands! Hey, what a happy crowd this must be, suddenly all arms are up in the air!
The growing number of American homeowners who are buying their houses with loans where they have to pay the interest only, hoping that a future sale of the house will bring a price that will cover the principal will at least be happy to hear that the Fed plans to stay on its measured pace of quarter point rate hikes, as the Fed sees the economic expansion on a solid pace.
Question here: Is an economy expanding when it borrows more than 2 billion dollars a day?
Higher interest rates can bring it all to an end rather quickly. As the Fed concedes, savings rates remain low at a level of around 1 percent of disposable incomes. Disposable income, that is after consumers paid their mortgage or rent, their health insurance and all other regular bills like electricity and so on.
Add in the higher gas and petrol prices and the outlook for the US economy, still the biggest in the world, is overshadowed by ever more problems. I liked a story in one of my favourite reads, the Wash. Post, NY and LA Times, that said that people were not able to move up into bigger homes because there were no takers for their by now grossly overinflated "starter" homes which are selling north of 250,000 dollars. If that effect ripples through to wooden houses selling now for a million on the east coast and the infamous NY apartments who have been selling at 1.2 million apiece, shareholders beware.
Consumer spending being the single most important pillar of the US economy with a share of 75 percent of all outlays will come to a grinding halt once interest rates move into the "neutral" zone that is described by economists at somewhere between 4 and 5 percent. Talk is about the Fed funds rate, not the consumer mortgage loan rates and credit card rates, which are way higher. Is this the reason Congress went for the new bankruptcy law because it is foreseeable that higher interest rates will suffocate millions of homeowners in the near future?
As long as the bank gets its money there should not be a problem. But credit card juggling has become a national necessity. The Survey of Consumer Finances (SCF) data shows that 18-to-24 year olds experienced on average about a 100 percent increase in credit card debt between 1992 and 2001.
Moreover, there are indications that some of these younger households are having difficulty managing their debt successfully. The 2001 SCF indicates that delinquency rates (one debt payment more than 60 days past due) were twice as high among households headed by someone less than 35 years old than for households in the 35-to-44-year age group. Finally, surveys continue to indicate that many workers are not currently saving for retirement, and many that are saving, by their own calculations, are not saving enough. The data from the SCF indicates also that among workers with a retirement savings plan, nearly 60 percent of workers aged 25 to 34 were covered by a defined-benefit plan in 1989; by 2001, this share had declined to 31 percent.
Not exactly what one can call the basis for an economic upturn.
But inflation does not stop just because consumers are not in the position to pay more for the same goods and services. As stated in an earlier post here, higher oil prices will inflate all other prices because all economic action is based on the consumption and resale of energy. And as you should know by now, four billion people in the developing countries with their desire for at least a small bike or car will likely more than offset any production increase the OPEC countries can manage in the next years.
Addendum: To get a graphic picture of the growing US household debts, go to Prudent Bear's chart library.


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