As the end of 2005 approaches, it is important to take stock of what has happened in the economy over the preceding 12 months. The story that I have been telling for the last few years has not changed: the economy is based on cheap money leading to asset inflation leading to debt spending at a record level. Negative after-inflation wage growth exacerbates this trend as consumers struggle to maintain their standard of living.
After inflation wage growth is still negative. Non-supervisory wages rose from $15.90/hour in January to $16.32/hour in November, for an annual increase of 2.64%. Over the same period the overall inflation gage has increased from 190.7 to 197.6, or a 3.61% increase. In other words,
after inflation non-supervisory wages dropped .97% this year.
To make-up for this shortcoming in wages growth, consumers have taken-advantage of record low interest rates. Total consumer debt increased 9.1%, 11.1% and 11.6% in the first second and third quarter respectively. Total consumer borrowing over the first three quarters of 2005 was 929 billion, 1.158 trillion and 1.235 trillion, respectively. Total consumer debt outstanding increased from 10.4 trillion to 11 trillion from the first to third quarter of 2005. Total consumer debt outstanding now stands are 87% of US GDP.
Personal savings (gross income less all monthly expenditures) dropped from 47 billion to -132 billion from the first to third quarter of 2005. Unfortunately, there are no figures for contributions to various retirement plans for 2005 yet. However, over the last 5 years, the highest contribution level of all plans (defined contribution, defined benefit and IRA's) was 2.2% of GDP. This low figure combined with the record low economic savings figure of 3Q 2005 indicates that personal retirement savings was probably abysmal this year (again).
The foundation of the current US expansion is debt financing combined with reckless spending at the expense of personal savings.
Why is this a bad thing?
5 years ago, the US consumer was basically spending his entire salary, save about 2% of his earnings. Flash forward to 2005. The average consumer's wages are .5% higher after inflation - essentially making them the same as they were 5 years ago. He is now spending everything he makes per month. Over the intervening 5-year period, consumption expenditures represented between 60%-70% of GDP growth. But, 80% of the population (those making non-supervisory wages) wasn't making any more money after inflation! Therefore, they went into debt to spend.
Now, at the end of 2005, we have the following: An entire population with little to no savings and heavily in debt. At some point, consumers will reach debt saturation, stop going into debt and start paying down their existing debt. This will be a problem for the economy as a whole because consumer spending is 60%-70% of GDP growth. In other words, when people start to act responsibly, they will slow the economy.
Compounding this problem is the lack of personal savings. When people start paying down their debt at the expenses of spending, the economy will slow leading to higher unemployment. But, people who are already heavily in debt don't have the requisite savings to survive an economic slowdown.
I should add that I don't see economic Armageddon as a result of this. I would place the possibility of that at about 10-20%. Too many events would have to line-up in perfect order for that to happen.
What I do see is a prolonged period where this debt imbalance will have to work itself out: people will have to spend a few years (at least) paying down their debt. This will slow the economy. The real question is how much of a slowdown can the US economy handle without tipping the balance? I have no idea. And that's what concerns me.