(Promoted from the diaries. Edited to bring the introduction above the fold. -- georgia10)
For the last few months, various rightwing websites and commentators have complained about the media's coverage of the U.S. economy. Their complaints are based on the large number of poll respondents who continually say the economy is doing poorly. The RWNM argues the media's negative tone in covering the U.S. economy is responsible for these poll responses. Below I will argue that the majority of respondents who give the economy low marks do so because from their individual perspective the economy is doing poorly.
In addition, the following reasons are why I am still concerned about the U.S. economy. Some people have justifiably observed I have been overtly bearish for about a year and a half, yet there has been no economic meltdown. My response to these well-founded observations is an unhealthy economy can continue for a long time before falling. In addition, just because something bad has not happened does not justify a poor economic foundation. I would compare this to learning you have an early stage cancer that is easily treatable, yet not seeking treatment. Eventually the cancer will become fatal.
Because of the length of the material presented below, I was originally going to write several essays. However, after some thought on the matter, I concluded it was better to have everything in one place. I realize this is a very long and fairly involved explanation. I wish I could write in convenient soundbites, but the complexity of the information prevents that type of format. If you read the first installment, please scroll down to the section titled "consumer debt".
Weak Jobs Growth
Before we go any further, here are some definitions to help clarify the Bureau of Labor Statistics terminology:
Unemployed persons. All persons who: 1) had no employment during the reference week; 2) were available for work, except for temporary illness; and 3) had made specific efforts, such as contacting employers, to find employment sometime during the 4-week period ending with the reference week.
Participation rate. This represents the proportion of the population that is in the labor force
The unemployment rate often quoted in the financial press only includes people who have looked for work in the mast 4 weeks. So, if somebody hasn't looked for work, they're not included.
The basic problem with the current economy is the drop in the labor participation rate or the percentage of the U.S. population in the labor force. During the 1990s expansion, the lowest reading for the labor participation rate was 66.3%. Throughout the 1990s, this number increased to roughly 67%. The number crossed the 67% threshold in October of 1996, indicating the high participation rate was not merely the result of the high-tech bubble, but instead the result of a growing economy.
The problem with the current expansion is the labor participation rate has dropped, not increased. The Bush administration continually uses May 2003 as the starting point for their employment figures (largely because this was the lowest point of total establishment jobs on their watch). Using the same "Bush friendly" starting point for the labor participation rate shows a decrease in the number of people who are in the labor force. In may 2003, the labor participation rate was 66.4%.
Starting in May of last year, a series of papers highlighted the above mentioned situation. This report from the Boston Federal Reserve and this report from the New York Federal Reserve offer a more complex explanation of the above mentioned trends.
Comparing Bush's establishment job growth to all other expansions since 1960 indicates Bush's job creation is the weakest of the last 40 years. The economy has created 2.318 million jobs after 62 months of Bush's presidency. At the same time in Clinton's presidency (62 months) that number was 15,089,000 - not total jobs, but jobs created (that's six times the amount establishment jobs under Clinton compared to Bush). In fact, when you compare Bush's average annual percentage change in the employment numbers to all the other economic expansions in the last 40 years Bush's record of job creation comes up dead last. Bush's average annual percentage change in payroll employment is .6%. The next lowest is Clinton's expansion, where the average annual percentage change in payroll employment was 1.9% -- three times higher.
And the quality of those jobs is poor. According to this study prepared by Global Insight for the National Conference of Mayors, the top ten areas of job creation during the 2003-2005 recovery paid $9,000 less per year than the top ten areas of job losses in the preceding 2001-2003 period. You see - you guys are well-paid lawyers (who fill frivolous lawsuits against corporations driving up their costs) who obviously don't socialize with the "little" people much. If you did - you would hear all about these great new jobs.
Wages
Would you be happy if you were making the same amount of money this year as you were five years ago?
That's the basic problem with non-supervisory wages, which represent the pay for about 80% of the workforce. Non-supervisory wages were $14.28/hour in January 2001 and $16.47% in February 2006 for an increase of 15.33%. Over the same period, the national inflation index increased from 175.1 to 198.7 for an increase of 13.47%. This makes the total, inflation-adjusted increase in wages for the Bush administration 1.86%, or a compound annual growth rate of .36%. So, currently about 80% of employed people are making about what they made when Bush took office. Would this make you happy?
The Federal Reserve has also noted this trend:
The survey shows that, over the 2001-2004 period, the median value of real (inflation-adjusted) family income before taxes continued to trend up, rising 1.6 percent, whereas the mean value fell 2.3 percent. Patterns of change were mixed across demographic groups. These results stand in contract to the strong and broad gains seen for the period between 1998 and 2001 surveys and to the smaller but similarly broad gains between the 1995 and 1998 surveys.
Again, I ask the question: If you hadn't seen a good raise in 5 years, would you be happy?
Consumer Debt
However, consumers have continued to spend beyond their paltry wage gains. Consumer spending was $6.955 trillion in the first quarter of 2001 and $8.927 trillion in the fourth quarter of 2005, for a total increase of 28.35%. Over the same period, the GDP consumer expenditures price deflator increased from 105.051 to 112.583, for an increase of 7.169%. Therefore, consumers have increased spending a deflator adjusted 21.18%. This rate of increase is far higher than the 1.86% inflation adjusted increase in pay for 80% of US consumers. Where is the new money coming from?
A decrease in personal savings (which we'll get to in a minute) and massive debt acquisition are the two sources for money for this spending binge. According to the Federal Reserves Flow of Funds Report, total consumer debt outstanding was $7.102 trillion in the first quarter of 2001 and $11 trillion in the third quarter of 2005. This is a 41.41% inflation-adjusted increase. As Merrill Lynch economist David Rosenberg recently noted the consumer debt to income ratio currently stands at 126% -- an all-time high. He also noted that this ratio increased as much in the last 5 years as it did during the preceding 15 years, indicating household debt-acquisition is clearly accelerating at a very high level. He finally notes that consumer spending as grown for 56 consecutive quarters. At some point, consumers will have to slowdown their purchases.
Rosenberg is not the only economist to express concern with the current debt-financed strategy of the US consumer. Stephen Church compiled consumer cash flows from the same Flow of Funds Report cited above. He concluded:
Our analysis of the Statement of Cash Flows shows that U.S. households require access to new cash sources in excess of 13% of GDP in order to maintain a strong economy. Since current operating cash flow generates only 2% of GDP, households depend on minimum debt financing needs of about 11% of GDP.
The bottom line is consumers are relying on debt to finance consumer purchases. The level of consumer debt is increasing at an alarming rate. At some point consumers will have to repay this debt. Considering the low labor-participation rate, it is doubtful pay increases will help the consumer repay this debt. As a result, consumers (whose purchases represent about 70% of U.S. GDP growth) will have to slow their rate of purchasing at some time.
The Poor Savings Rate
Savings is deferred consumption. If a person earns $100 per period and spends $70, the person has saved $30. Economically, savings has 2 purposes. The first is to provide a person with a financial cushion in case of financial hardship such as losing a job or having a large, unexpected expense. The second is to transfer capital to financial intermediaries such as banks who in turn pool individual savings into loans to business. Business uses this money to invest in capital plant expansion, increasing the economies overall productive capability.
Economists define savings as all the money that is left over after a person purchases all his stuff for a particular period. According to the Bureau of Economic Analysis, the US savings rate was 1.59% in the first quarter of 2001. It has decreased since then, turning negative in the last three quarters of 2005. This means the US consumer was spending most of his money in the first quarter of 2001 and is now dipping into a paltry pool of personal savings to finance his expenditures.
The RWNM has used several tactics to obfuscate this issue. The first is to point to the rise in total household assets from the Flow of Funds report. This argument misses the first above-mentioned point of savings - that savings is deferred consumption. To obtain an asset, a person must spend money. Secondly, the RWNM has pointed to the total amount of assets in U.S. deposit institutions which is currently about 5.5 trillion. However, dividing this figure by the total US population (roughly 300 million) yields $18,333/person. Considering the extreme nature of wealth stratification in the U.S., I find it highly unlikely that every person in the country has $18,333 in the bank. Finally, the RWNM has argued that contributions to various types of retirement accounts should count as savings. First, they are partially accurate in this statement; retirement savings are put aside for future consumption. However, this argument misses the first point of savings - creating a financial cushion in case of financial hardship. Retirement savings are heavily penalized for early withdrawal, making them less than advantageous as a pure savings vehicle. However, even including retirement accounts in national savings figures does not yield positive results. Of 401(k), defined benefit and IRA's, IRA's had the largest contribution in dollar size over the last 10 years and the largest percentage of GDP contribution was around 3%. (This information is from the Flow of Funds Report)
The bottom line is if a person has an unexpected financial problem (loss of a job, high medical bill etc...) he typically has very few liquid assets to help him through the rough times. Should the economy experience a shock that negatively hurts many people who have little savings, the lack of preparation will further exacerbate the problem.
National Debt
President Bush inherited a budget surplus and a slowdown in the growth of total national debt outstanding. He was in a prime position to put the U.S. Federal Government's finances in a better position by paying down the then outstanding government debt.
Instead, Bush moved the U.S.'s national finances closer to the economic ledge.
Essentially, Bush decreased government revenue with his tax cuts and increased total federal spending at high rate. According to the Congressional Budget Offices Historical Budget Data, revenues from personal taxpayers has deceased from $994 billion in 2001 to $927 billion in 2005. Over the same time period revenues from individual taxpayers decreased as a percent of GDP from 9.9% to 7.5%. From 2001 to 2005 discretionary spending increased from 649 billion to 967 billion, or a percent of GDP increase from 6.5% to 7.9%. As a result, Bush has never balanced a budget and total federal debt outstanding has increased from 5.8 trillion to 8.2 trillion.
This creates several problems. First, talk of the "twin deficits" has once again entered international financial discussions (I'll get to the trade deficit in a minute). While higher US interest rates have propped up the dollar for the last year, discussions and new reports still mention the growing level of US debt as a problem for the US dollar. And the longer the US does not deal with this problem, the greater the possibility of international markets correcting the situation for us - perhaps unpleasantly. The second problem is the government's ability to ease the pain from a recession. The higher the amount of federal debt, the less fiscal ammunition the federal government possesses in case of an economic slowdown. This increases the possibility the next recession might be worse than it could be with the aid of federal spending.
The Trade Deficit
Former Federal Reserve Governor Paul Volcker explains this problem:
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.
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.
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.
The trade deficit in goods simply means the US buys more than it makes. To pay for this, a country starts by drawing down its national savings. However, as mentioned above, the US savings rate is now negative. As a result, foreign creditors essentially lend the US money to buy their goods and services. At some point, foreign creditors will start to demand higher compensation (higher interest rates) for their loans to the US. In addition, the magnitude of the US' consumption of the world's capital (which is now about 70%) can't go on forever. As foreign creditors start to find more attractive investment opportunities around the globe, they will divert some of their money to those opportunities. This will again decrease the US' available credit line, increasing US interest rates.
Volcker goes on to note he does not know when or how it will end, but that eventually this pattern must correct. Historical evidence indicates this is the case - it must end, but we do not know when or how.
Conclusion
The US economy's foundations are weak. Current job growth is poor by historical standards. This has lead to weak wage growth, forcing consumers to fund their purchases with a massive increase in debt acquisition. Because consumers have spent beyond their means, they have little savings to help them through economically difficult times. In addition, their increased use of debt makes them more susceptible to insolvency should they experience a financial problem.
At the national level, the federal government has returned to deficit spending, decreasing its effectiveness in the event of a recession. And finally, the trade deficit which is financed by foreign capital inflows could correct violently, spiking US interest rates, slowing the US economy and creating a huge financial problem.
These are foundational economic issues which the current expansion has only made worse. While I have no prediction when or if a painful correction will occur, should the US experience an economic shock we are ill prepared to deal with it. In fact, the current US economic foundations may make an economic shock much worse.
Update [2006-3-25 18:28:24 by bonddad]:: A poster downthread has correctly noted a miscalculation in this diary. When calcualting the labor participation rate, I mistakenly assumed the US population was constant. This is obviously not the case. As a result, the figure of 900,000 people leaving the labor force was incorrect. However, the fact still remains that the percentage of people actually participatiing in the labor force has decreased under Bush's economic leadership.