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My Left Wing
The market has rallied in November. This has led me to re-examine my bearishness regarding the US economy. The basic problem in my analysis is there are certain facts that I simply cannot get around, or whose impact I can somehow mitigate. Below I will explain what these facts are. But here is the general problem:
This economy looks great on the surface. But when you dig below it's macro-numbers, you see big problems on the horizon. It's similar to a student who has a 4.0, only he hasn't taken any challenging classes.
Wages
In January 2001, the average wage of non-production workers was $14.27/hour. Now it is $16.27. Over the same time, the inflation index has increased from 175.1 to 199.2. So, wages have increased 14% and inflation has increased 13.75%, making the cumulative 5-year increase in wages adjusted for inflation .25%.
This calculation assumes inflation is correctly measured, which I also disagree with for 2 primary reasons. First, instead of using the actual cost of housing (market price, mortgage prices etc....), the BLS uses owner's equivalent rent. This statistic tries to determine how much the owner of a house could actually rent his house for if he wanted to rent it. The problem with this figure is rental vacancies are near 10-year highs. This implies that rental charges are low while actual housing prices are high. So, owner's equivalent rent understates inflation. If this economy was not completely centered on housing, I would not have a problem with this, or I could chalk it up "simple ivory-tower disagreement." But, the economies over-reliance on housing (another problem I will discuss below) makes this measure of housing prices very important.
Secondly, the CPI has no index for health insurance - they attempt to capture the price of health insurance through the appreciation of goods and services consumer's purchase with insurance. In addition, the CPI's attempted measure of health insurance represents only .366 of the CPI. According to Kaiser Health, the average monthly contribution for health insurance in 2004 was $222 or $2600/year. According to the Census Bureau, the median US income in 2004 was $44,000. This makes the health insurance percentage in the inflation calculations very under-representative of actual health inflation.
So, in short, wages for most people have not grown in 5 years after the official inflation calculations. In addition, I think the official inflation calculations are off in a fairly major way.
Debt, Debt and more Debt
Consumer spending represents about 70% of US GDP. But, wages have not increased after the official inflation calculation. So, how are consumers - who represent a majority of US economic activity - paying for their part of economic growth?
They are accumulating a massive amount of debt. Simply looking at the Flow of Funds report should scare anybody. Total household debt has increased from 613 billion to 1000 billion in the last 4 years. That's a 63% increase in 4 years. This means that consumers don't really own their purchases. Instead, the finance companies own the purchases until consumers pay off their balances.
In addition, at some point consumers will reach debt saturation, where they will not be able to take on more debt to spur the economy forward. I don't know where this level is, but I feel safe in saying we are closer to it than we were 4 years ago.
Balance of Payments Deficit
Last year, the balance of payments deficit was 5.5% of GDP. This year, it's on a course to be higher - at least over 6% of GDP. The generally accepted economic wisdom is a 5% of GDP level is where a currency correction/crisis takes place.
The current administration has used this figure to promote the "America is doing better than the rest of the world" line. This is a smokescreen of mammoth proportions. The bottom line is there is no way this can economically continue without a correction. And the longer it continues, the more likely that correction will be damn ugly for all involved.
On April 10 of this year, the Washington Post printed an editorial by Paul Volcker that summed up the basic problem. Since than, nothing has changed:
But right now, those same boomers are spending like there's no tomorrow. If we can believe the numbers, personal savings in the United States have practically disappeared.
To be sure, businesses have begun to rebuild their financial reserves. But in the space of a few years, the federal deficit has come to offset that source of national savings.
We are buying a lot of housing at rising prices, but home ownership has become a vehicle for borrowing as much as a source of financial security. As a nation we are consuming and investing about 6 percent more than we are producing.
What holds it all together is a massive and growing flow of capital from abroad, running to more than $2 billion every working day, and growing. There is no sense of strain. As a nation we don't consciously borrow or beg. We aren't even offering attractive interest rates, nor do we have to offer our creditors protection against the risk of a declining dollar. Most of the time, it has been private capital that has freely flowed into our markets from abroad -- where better to invest in an uncertain world, the refrain has gone, than the United States?
More recently, we've become more dependent on foreign central banks, particularly in China and Japan and elsewhere in East Asia.
It's all quite comfortable for us. We fill our shops and our garages with goods from abroad, and the competition has been a powerful restraint on our internal prices. It's surely helped keep interest rates exceptionally low despite our vanishing savings and rapid growth.
And it's comfortable for our trading partners and for those supplying the capital. Some, such as China, depend heavily on our expanding domestic markets. And for the most part, the central banks of the emerging world have been willing to hold more and more dollars, which are, after all, the closest thing the world has to a truly international currency.
The difficulty is that this seemingly comfortable pattern can't go on indefinitely. I don't know of any country that has managed to consume and invest 6 percent more than it produces for long. The United States is absorbing about 80 percent of the net flow of international capital. And at some point, both central banks and private institutions will have their fill of dollars.
Talk about it how you want; spin the numbers how you want. There is no way to get around the basic mal-adjustment of the current US economy. It is not based on a solid manufacturing sector, or the next new product or area of products. It is based on debt accumulation and the kindness of our trading partners.
In short, I am still a big, nasty, curmudgeonly, cantankerous bear.