All is not well, Mr. Greenspanů
August 06, 2004
In his latest testimony before the Senate, Alan Greenspan
gave an upbeat review of the economy, saying that the current recovery
is broad-based and sustainable. Greenspan is undoubtedly one of the best-informed
economists on the planet, and highly revered, so he must know what he’s
talking about. But judging by their spending habits, consumers do not
necessarily share his optimistic views.
Consumer spending is important because it accounts for roughly
two-thirds of all the economic activity in the US. One way to gauge consumer
spending is to look at same-store retail sales figures over time, and
according to yesterday’s Wall Street Journal, stores catering to
middle income families have reported declining sales, or meager increases
at best, while those catering to lower income families had only anemic
increases. Only Saks, Neiman Marcus and Nordstrom (who cater to the high-end
market), showed strong increases in sales.
Are higher gasoline prices to blame? Wal-Mart has speculated
that higher gasoline prices are taking $7 a week out of its average customer’s
pocket. If you fill your car weekly, your gasoline expenditure should
be around $1560 a year per car, and for the typical American family with
two cars, the annual bill would be roughly $3,120. Using the latest US
Census figures from 2002, the median household income, after state and
federal taxes, is about $37,000 a year, so for a median household, gasoline
represents more than 8% of income.
While we’re on the subject of household incomes, it’s
worthwhile to note that incomes peaked in 1999 and have been declining
Judging from the retail sales figures, middle and lower
income families are feeling the pinch of a weaker economy. The only bright
light for the economy seems to be the wealthy, and that hardly makes for
a broad-based recovery.
At what point is someone considered wealthy? Only 5% of
US households have annual incomes of $150,000 or more, and a mere 10%
of households earn more than $114,000 per annum. If the US economy is
dependent on rising consumer demand, and if the only sector of retail
sales showing strong increases is the more affluent, then the whole economic
recovery could be hinging on the consumption habits of less than 10% of
households. And many of them are accumulating debt at a rapid clip.
But these, so-called “rich”, are not really
that rich at all. I moved out of San Diego County because real estate
prices there became insane. In June, San Diego County hit an all-time
low in housing affordability: only 14% of county residents can afford
the median priced house. The median house in Sand Diego County cost $527,320
in April, and according to the California Association of Realtors, it
would take $119,222 in annual income to qualify for a conventional 5.42%
Now, San Diego County may have slightly above-average household
incomes, but from the Census Bureau data we know that less than 10% of
American households earn $119,222 per year. And according to the San Diego
Association of Realtors as many as 75% of all home-buyers are taking out
interest only loans to buy their houses.
In case you’re not familiar with an interest-only
home mortgage, it’s just what its name says. You pay only the interest
on your loan, and you don’t pay off any of the principle amount
until you either sell your house, or the loan is called. But the catch
is that these loans are all variable rate loans, meaning that the mortgage
interest increases as medium to long-term interest rates increase. Guess
what? Medium to long-term interest rates in the US are increasing.
The implication is that the wealthiest households in America,
the ones we are counting on to spend us out of recession, are overloaded
with debt and, in many instances, not quite as wealthy as one might think,
considering that many of them don’t even qualify for the median
house in San Diego County, which is certainly not the most expensive county
in the country.
Now enters the Budget Deficit -- it has to be financed,
somehow. Since only 1% of all taxpayers pay almost 30% of all taxes, and
5% of all taxpayers pay a full 50% of all taxes, the logical conclusion
is that we can expect an increase in taxes in addition to any and all
other means of financing the government’s unrestrained spending
If spending by the “rich” is the only thing
keeping the economy growing, will higher taxes finally kill the last vestiges
of this consumer-driven economic expansion?
The War on Terrorism assures us that the Budget Deficit
will grow. The Budget Deficit assures us that interest rates will rise.
Higher interest rates assure us that the debt burden (public and private)
will hurt more and more. This, in-turn, will reduce discretionary cash
available for consumers to spend. And if that is not enough, the Budget
Deficit also assures us of higher tax-rates and more taxes.
In the meantime, the not-so-rich will face higher energy
costs, higher gasoline prices, higher food prices, higher mortgage rates,
less employment, wages that don’t keep up with inflation, etc. All
of this reduces their already limited discretionary income. Will they
spend us out of recession? Given the rise in personal bankruptcies and
record high levels of credit card debt, I doubt it.
The bottom line of today’s column is that the
US economic recovery certainly does not appear to be broad-based, or sustainable,
and that far from being robust, the US economy seems precarious.
Paul van Eeden
Paul van Eeden works primarily to find investments for his
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