“The US consumer is altogether shopped out, over-indebted, with negative savings and now bombarded with high oil prices, fluttering housing and rising short and long rates. The poor consumer also suffers from a slumping labor market generating a pathetically low number of jobs, flat real wages and suffering of the redistribution of income from labor to capital (as the profit share of the economy has surged); on top of it all, the equity market downturn has negative wealth and consumer confidence effects.”
Personal spending rose 0.4 percent in June after a 0.6 percent rise in May, the smallest increase this year.
“It’s clear that the two sectors that have contributed the most to economic growth in the last year and a half — housing and consumer spending — are the two sectors that are showing the greatest weakness,” said Bernard Baumohl, executive director of the Economic Outlook Group.
Mr. Baumohl noted that interest payments were taking a much bigger bite out of household income than they were two years ago, and were dragging down consumer spending.
“As interest rates go up, that increases the debt service burden on households,” he said. “And I expect we’ll continue to see more of this in the second half of the year.”
2006 will mark the 13th time since 1929 that we would run a household deficit if the trend continues. Other notable years that this had happened were 1932 and 1933 (the Great Depression), and 1947, 1949, and 1950 (WW II). Except for the year 2000, we have also run household deficits every year since 1999. Low interest rates contributed to this by inflating asset prices, thereby increasing collateral value for loans.
According to safehaven.com:
In the first quarter of this year, households ran an annualized deficit of $566.2 billion. In the second quarter, this annualized deficit increased to $588.0 billion. Based on this first-half data, households are on course to run a 2006 deficit of $577.1 billion, which would break the 2005 deficit record of $476.7 billion.
We subtract from disposable personal income (after-tax income) the sum of expenditures on consumer goods/services and residential investment (value-added in housing). If households’ total expenditures are less than their after-tax income, then they are, in effect, running a surplus. This implies that they are advancing funds to other sectors – businesses, governments and/or foreign entities. If households’ total expenditures are more than their after-tax income, then they are running a deficit. This implies that they are borrowing from or selling assets to other sectors.
By the way, these deficits are not just records in absolute terms, but relative to their disposable incomes as well – e.g., 6.15% of disposable income in the first half of 2006.
This brings us to the “modern” era. With the exception of 2000, households have racking up large deficits starting in 1999. By the way, these deficits are not just records in absolute terms, but relative to their disposable incomes as well – e.g., 6.15% of disposable income in the first half of 2006. These “modern era” household deficits also are not that difficult to explain. Generational low nominal and real interest rates, in part engineered by the Fed, have had the effect of inflating the prices of assets – equities in the second half of the 1990s and houses in the first half of 2000s. Why should households spend less than their after-tax incomes when the value of their assets is skyrocketing? And, of course, with asset prices inflating, there is all the more collateral upon which creditors can advance loans. So long as asset inflation continues, we guess households can continue to run record deficits. We can’t wait to see how the adjustment works out when the asset-price music stops.
And according to the federal reserve, “total outstanding household debt was $7.568 trillion in the fourth quarter of 2001; it was $11.840 trillion in the first quarter of 2006”.
Heavy debt burdens can make wealth accumulation more difficult, because funds used to repay debt cannot be put into savings.
By various measures, household debt has risen significantly. For example, household debt outstanding has been increasing steadily as a percentage of disposable personal income, from 70 percent in 1980 to 122 percent as of third quarter 2005. Further, the proportion of families with very large debt payments relative to income is also rising. In 2004, 13.1 percent of families headed by persons ages 45 to 54 had a debt-to-income ratio greater then 40 percent, an increase of 1.5 percentage points since 2001. This compares with 12.2 percent of all families with a debt ratio above 40 percent, only a 0.4 percentage increase since 2001.
“Since 2001, mortgage equity withdrawal has replaced wages as the primary source of income gains for U.S. consumers,”.
Indeed, if Americans no longer can use their houses as ATMs, think what that will mean for future spending. That home equity is shrinking after existing home prices posted their biggest monthly decline in 20 years, as ISI Group notes.
“Higher interest rates will affect millions of adjustable-rate mortgages. Rates are expected to increase on a quarter of all outstanding U.S. mortgages either this year or next, according to Economy.com. Many recent buyers’ adjustable mortgage payments could double.”
Cagan’s report estimated that one in eight adjustable mortgages sold in the past two years could default. About 5 million households nationwide and $300 billion in loans could be affected.
“This quarter we saw $81.0 billion cashed out, up from a revised $74.1 billion cashed out in the first quarter of 2006,” Cutts said in the release.”
“Cash out activity should remain strong throughout the rest of the year as interest rates are expected to continue to gently climb,” she said.
Interest rates on HELOCs have risen to 8.25 percent or higher, so borrowers are looking to cash-out refinance as an inexpensive way to finance home improvements, business investments, consolidate high cost debt. It was the second consecutive quarter in which the median refinance borrower increased the rate on their first lien mortgage rate, she said.
With all of the spending and borrowing that has taken place, it is no surprise that our savings rate has also been affected.
“Our personal savings rate has been steadily falling — from almost 10 percent in the 1970s to about 5 percent in the ’90s. Since June of last year, our savings rate has been in the negative numbers — meaning that month after month, we keep spending more money than we take in.”
The last time we had a sustained negative savings rate was during the Great Depression.
“The U.S. economy slowed in the second quarter, growing at a real 2.5% annual rate after a torrid 5.6% pace in the first quarter, the Commerce Department reported Friday. Consumer spending weakened, residential investment fell further and business investment slowed to the lowest growth in more than two years. … Meanwhile, core consumer prices rose 2.9%, the fastest pace in 12 years. Core consumer prices have risen 2.3% in the past year, the fastest growth since 1995. The 2.5% real growth was weaker than the 3.1% gain expected by economists.”
As a nation, we are spending more than we can afford. Our household debt is rising. We are saving in negative numbers, and holders of adjustable rate mortgages better brace themselves for the near future.
It’s time to get those credit cards and other debts paid down, save money if you are able to, and get those finances and spending priorities in order. If the current trends hold, this could help save you from some very painful hardships down the road.