My thesis in this diary is a simple one. Wages for middle and working class Americans have not improved significantly since the 1970s, as recently demonstrated by a joint project of think tanks that incidentally included The Heritage Foundation and the Enterprize Institute, entitled The Economic Mobility Project, which found that:
To be sure, the American economy grew over this period but at a much slower pace than in previous generations. Going back to 1820, per capita gross domestic product in the United States has grown an average of 52 percent for each generation. But since 1973, overall median family income has grown only 0.6 percent per year, a rate that produces a 17 percent increase in the average family’s income for each generation.
Thus, the only way American consumers have been able to significantly improve their lifestyles is either to take on debt, using assets which have appreciated in value as collateral, or to refinance their debt at lower interest rates. If consumers are unable to tap the value of assets, or to refinance, then without improvements in wages, they will pull back and cause a consumer-led recession. Since 1980, this has only happened twice: in the deep Reagan recession of 1981-82, and again briefly from July 1990 to March 1991. In this thesis I have a simple but fundamental disagreement with bonddad. Bonddad argues that because interest rates are modest, they do not pose a problem for the economy. I say that modest interest rates aren't enough; to periodically refinance debt, consumers must have ever-decreasing interest rates.
The Big Picture, 1981-2007
As I said in the introduction, interest rates reached their highest point ever in October 1981, when the interest paid to investors buying a 30 year US treasury note was 15.21%. Since that month and until recently, long term rates relentlessly declined within a clearly defined channel, as shown in this graph in log scale of yields from 1980 to the present for the 30 year treasury bond. Take a look! This is the most important item you need to know for this dairy. The upper channel on this 27 year chart for the 30 year bond presently stands at about 5%.
In the table below, I accumulate the "big picture" economic data for American families going back to 1980. Are their incomes increasing or decreasing? Can they tap into increased asset values of houses or stocks? Are interest rates declining, giving them the opportunity to refinance at lower rates? Are they taking on more debt, or pulling in their horns to pay debt off? Click on the links in the descriptions below for the raw numbers I used to derive the table.
The first column to the right of the year is derived from median household income as tracked by the US Census Bureau. The 2006 data was just released this morning. We don't have data yet for 2007. If median income is declining, it is identified by the sign I-. (In 2005 and 2006, while income increased, it failed to surpass a previous high, and is designated with an I.
If income isn't growing, can consumers cash in some appreciating assets? That's where columns 2 and 3 come in. The second column is house prices, also as calculated by the Census Bureau. A decline in housing values is shown by the sign h-. The third column is the value of stocks, represented by the S & P 500 index. A decline of that index is noted as s-; a failure to make a new high is noted as s.
If consumers can't cash in an appreciating asset, can they at least refinance their debts at a lower interest rate? That's what column 4 is about. The fourth column is the yield on 10 year US Treasury bonds. A failure to make a new long term low in yields in the last 3 years is shown as b-.
If incomes aren't growing, and consumers can neither refinance at lower rates or cash in appreciating assets, are they significantly cutting back on their spending, and paying down debt instead? That's the fifth column. The fifth, a new high in total household debt as a percentage of income as calculated by the Federal Reserve is shown by a d*. A decline from that value of at least .5% is shown as d-.
Finally, recessions as determined by the NBER are shown in bold prefaced by the initial R.
Here's the table:
2007 ? h- b-
2006 I s b- d*
2005 I s
2004 I- s
2003 I- s b-
2002 I- s- b-
2001 I- s- d* R 3-11/01
2000 I- s-
1997 b- d*
1994 I d-
1993 I- d-
1992 I-h d-
1991 I-h- b- d- R -3/91
1990 I- s-b- d- R 7/90-
1989 b- d-
1982 I- s- R -11/82
1981 I- s- b- d- R 7/81-
1980 s- b- d*- R -7/80
Here is the simple result: when interest rates have not declined significantly in at least 3 years, and overextended consumers have decided they must pay off existing debt rather than buy new stuff, as shown by the two signs of b- d-, the economy is in trouble. The b- d- signal occurred in 1980-81, and 1989-91, presaging both consumer-led recessions. If there is another danger sign also present, recession is imminent.
The Immediate future
Applying that criteria to the most current data, we see that as of earlier this year, consumers have cut back from their 2006 spending, but not sufficiently to create a danger sign. While house prices have declined, stocks have not, and indeed briefly made a new high earlier this year. This tells us that American consumers at least as of the first part of this year, still had some room to cash in some of their stock ATM and refinance debt.
Still, the failure of interest rates to make new lows signifies that any continued deterioration in house prices, or significant and sustained decrease in stock prices, will likely give rise to an imminent recession danger sign.
For indications that either a consumer-led recession is approaching, or else that the economy is getting a second wind and expanding, watch retail sales (is the consumer still shopping?). So far this year fewer consumers are shopping, but wealthy consumers continue to power retail sales ahead. Watch weekly jobless claims(are layoffs increasing?). Watch for jobless claims to increase past 350,000 a week on a sustained basis. Continue to watch household debt reports, the next of which will be released at the end of September.
The Longer-Term: are Hard Times coming? Interest rates are no longer declining
Beyond the possibility of a recession in the very near term, a first-order danger signal for the long term future is that long term interest rates seem unlikely to move lower than 4% anytime soon. In fact, the both the 10 and 30 year bonds have not made a new low in interest rates since 2003, and both made a 3+ year new high in interest rates for the first time since 1981, in 2006 (30 year) or a couple of months ago (10 year). These problems suggest that the 27 year decline in interest rates is ending. From here we may well see fluctuating interest rates that begin to rise in sustained fashion again at some point in the next 3-8 years. A rising interest rate environment would be deadly for consumers and for other debtors like the US Treasury.
If long term interest rates do decline again, consumers may yet have one more chance to refinance their spending for the next few years. But any increase in interest rate yields for 30 year US Treasury bonds above 5.5% would likely mean that the Great Disinflation of interest rates is over, and Hard Times -- when individual and Sovereign debtors alike must "pay the piper" -- are upon us.