Benson's Economic
& Market Trends
Debt vs. Income:
At the Point of No Return
Richard Benson
February 13, 2004
At the beginning of 2003, the
level of debt that American's owed as an absolute amount, and
as a ratio of income, was already approaching levels never seen
before. Debt can be handled in a number of ways:
1) earn enough money to pay
it off;
2) default;
3) borrow even more; or,
4) pray for inflation so you can earn more dollars (but really
pay back less).
Where are we now?
Last year, personal income
increased about 2%. Individual debt increased about 10%. Personal
debt for autos, credit cards, etc., topped $2 Trillion - up about
$120 Billion despite massive debt consolidation and mortgage
refinancing. Mortgage debt rose about $800 Billion, and total
individual debt rose over $925 Billion, while wages and salaries
rose only $190 Billion. Retirees and savers saw their interest
income shrink, as interest paid on savings dropped by $30 Billion.
Indeed, given the Fed's low interest rate policies, it doesn't
pay to save.
In December, the savings rate
dropped to a new low of 1.5% and in the 3rd quarter of 2003,
the only reason financial assets were acquired is because they
were bought with borrowed money. The low savings rate is even
more astounding when you consider the increase in Disposable
Personal Income of around $200 Billion from the tax cut. The
economy needs $500 Billion in government stimulus from tax cuts
and increased spending just to keep employment from falling and
to help consumers roll over their credit cards for another month.
The savings rate is actually
materially overstated. Personal Income, according to the Bureau
of Economic Analysis, includes a few hundred billion dollars
in "imputed income" for owning your own home and receiving
value for other "non-cash services." Imputed income
is significantly greater than the 1.5% savings rate! Unfortunately,
debt can only be repaid with actual cash flow. In January, Personal
Income rose at about a 2% annual rate and very few jobs were
created. Consumers are spending every last penny to live, and
many are "tapped out."
What is perfectly clear from
simple arithmetic is that without a sudden increase in the number
of jobs and the wages they pay, individual debt can not be serviced
by personal income. Worse yet, not only are people not saving,
but their financial reserves are not in real cash. The only thing
keeping the "national ponzi scheme" going is the illusion
of wealth created by the Federal Reserve's low interest rates
and liquidity that has allowed stock market valuations and housing
prices to artificially inflate.
The market value of homes in
2003 rose about $1 Trillion and stock market values rose about
$1.5 Trillion. The rising asset prices look like they balance
rising debt on household balance sheets. Tragically, the increase
in asset prices
will vanish the day that interest
rates rise, but the debts will still remain. Indeed, not only
will the debt remain, but the cost of servicing it will go up
dramatically. As interest rates rise, wages and salaries must
increase or massive debt defaults will follow.
Income and job growth are so
low that we have certainly passed "The Point of No Return."
There cannot be an easy resolution to the debt bubble and resolution
will only come when a crisis forces change. Perhaps, for this
election year, crisis can be postponed by continuing to facilitate
an increase in borrowing so that debts can be rolled over, but
increased. By 2005, the ultimate outcome to resolve the debt
problem looks like it will be a combination of inflation, rising
interest rates and debt default.
The reason we do not believe
that job and income growth will save the day for the American
worker is we have never before seen in history such increases
in government spending, tax cuts, federal budget deficits, consumer
spending and borrowing, with so little job growth. The massive
fiscal and monetary stimulus has mostly been spent. There will
be some nice tax refunds this spring, and that's it! The peak
of mortgage refinancing is already past. Construction spending
is at a peak and the percentage of people who own their homes
is at a record 69%. Mortgage underwriting shows that 5% of homebuyers
in 2003 really couldn't afford to buy a home, and another 5%
could lose their home if one spouse becomes unemployed.
While the industrial sector
is recovering, employment in the manufacturing sector has not
increased since the start of the recession - there has been job
loss in manufacturing for the past 42 months in a row. The United
States has been in an economic recovery for over a year and a
half and continues to lose manufacturing jobs every month! This
is unprecedented!
Capacity utilization in the
US remains about 76%, while massive new investments in production
capacity are being made in Asia. The drop in the dollar has primarily
affected trade with Europe, and Europe isn't stealing our jobs.
As long as Asia buys our dollar debt and continues to hold their
currencies down against the dollar, job growth will happen there,
but not here. Even when China and the rest of Asia "finally
float" their currencies, few jobs will come back to America.
In the United States,
we only produce 45% of the manufactured goods we consume and
much of that production is in electricity, petroleum refining,
chemicals etc., that are capital intensive, with few workers
required. Critically, many of the workers listed as employed
in manufacturing are not engaged in manufacturing at all but
in design, marketing, and distribution. Even if the Chinese currency
doubled in value, the labor cost for a worker in China would
still only be a fraction of the cost for an American in America.
The sad fact remains that Personal Income growth will not happen
because of job growth. Personal Income remains under pressure
as higher "valued added" manufacturing jobs are exchanged
for lower paying part-time and service jobs. America is losing
manufacturing jobs paying $45,000 - $60,000 a year so it needs
three new service jobs paying $15,000 - $20,000 a year just to
replace the one manufacturing job that was lost.
So, where are Americans and
their mountain of debt headed?
If the days of borrowing more
- courtesy of both the Federal Reserve and Asia's Central Banks
- are winding down later this year when Asia revalues its currency,
it looks like there will only be two ways out: increased inflation
and debt default. Both are likely. When those Chinese goods at
Wal-Mart go up 30% in price, Americans will see inflation. The
Fed will accommodate most of the inflation, but there will be
a rise in interest rates. Inflation, if allowed and encouraged,
will save the wage earner so he can continue to service his consumer
debts. Rising interest rates will smash into housing prices like
a tornado in Kansas. Homeowners who have a 30-year fixed rate
mortgage will come out in the end, if they don't have to sell
their home for at least 10 years. Anyone who wants to sell their
home will see some "asset deflation," and financial
institutions will experience substantial "debt default."
The Federal Reserve will "print money like crazy" to
fight asset deflation and encourage inflation. Sometime before
or after the Presidential election, the financial markets will
be interesting, but painful to many.
Richard Benson
February 12, 2004
President
Specialty
Finance Group, LLC
Member NASD/SIPC
2505 S. Ocean Boulevard
- Suite 212
Palm Beach, Florida 33480
1 800-860-2907
eMail: rbenson@sfgroup.org
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321gold Inc
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