I have been writing often about the inability of real income to grow enough to ignite consumer spending in the U.S. Real disposable income measures the average American’s income after adjusting for inflation (as reported by the government) and taxes.
Seventy percent of GDP growth here in the U.S. is dependant upon consumer spending. It is critical that real disposable income grow in order for consumer spending to take place. With jobs scarce and almost 50% of all Americans on some form of government subsidy, it is hard to imagine how confidence can be created in consumer spending to create GDP growth.
The below chart, based on data from the United States Census Bureau, shows how real median household income is currently at the same level it was back in 1995.
As my dear reader is well aware, costs for education since 1995 have increased by hundreds of percentage points. Commodity prices, despite the recent drop, have risen significantly since 1995, which has increased food costs and the price of goods.
How is consumer spending going to pull the U.S. into an economic recovery with strong GDP growth under these circumstances? What is worse is that, with weak employment growth in the U.S., wages in general have not grown. This is natural, because companies do not feel pressure to raise wages to attract employees when there are so many looking for a job.
The consumer spending growth rate on a year-over-year basis has been less than one percent since the financial crisis hit. (Source: Bureau of Labor Statistics.) This anemic growth coincides with the drop in real median household income since 2008 in the chart above.
This is compounded by the fact that the average consumer is saddled with too much debt. Estimates have consumer debt-to-GDP in the 90% range. That means that for roughly every dollar created, the average consumer has one dollar of debt. For a household, this is too much.
Instead of consumer spending, we have consumers paying down debt. This doesn’t add to GDP growth and actually prevents the economy from growing.
With real income at 1995 levels, consumer debt levels too high, and very little in terms of jobs growth, there is no way consumer spending, which represents 70% of the economy, can grow us out of this economic contraction. (See: “The Inevitable U.S. Recession: Part II Starts.”)
With GDP growth sure to fall in the coming quarters, if consumer spending also falls and exports fall due to weak economies in Asia and Europe, then the only other component of GDP growth that can get the economy moving again is government spending. This translates into more government debt, a weaker currency and possibly the Fed needing to buy government debt (i.e. money printing): a vicious cycle getting us nowhere fast.
In Profit Confidential, I’ve been documenting the plight of municipalities and states across this great country. The obvious problem is that public pension plans are simply creating budget deficits that are ballooning out of control despite budget cuts.
I’ve written in these pages as well that the returns on the pensions that cities and states are forecasting are based on unrealistic numbers: eight percent. With interest rates at almost zero, public pension plans are desperate to make any return, let alone eight percent.
The proof can be seen in California Public Employees Retirement System, in which projections are for 7.5% returns over the next few years. Well, in its latest filing for this year, it returned only one percent!
As a consequence, working municipal and state employees in California will need to see their contribution rates increase or the budget deficits will worsen and further budget cuts in other services will be required.
Moody’s Investors Services looked into city and state pension plans across the U.S. It believes that with more realistic assumptions, the unfunded liabilities—the amount of debt in excess of assets or budget deficit—is $2.0 trillion. (Source: Bloomberg, July 18, 2012.)
Former Federal Reserve Chairman Paul Volcker and former government officials felt the budget deficits were so serious an issue that they needed to examine it. Their assumptions show that unfunded liabilities—budget deficit—in city and state pensions is $3.0 trillion.
A public think tank called State Budget Solutions was founded because of the understanding that the financial crisis facing cities and states concerning their budget deficits is a pressing, major problem facing this country. Using conservative numbers that include almost zero interest rates, State Budget Solutions calculates that U.S. cities and states face $4.6 trillion in unfunded liabilities—budget deficit.
What we can infer from this is that this is an unmitigated disaster. There is not enough money in the system to cover these budget deficits no matter the budget cuts. What it means as well is that the situation almost guarantees more bankruptcies. (See: “Fourth California Bankruptcy Comes Knocking.”)
What are municipalities doing about these budget deficits? Trying to cope and create innovative solutions as quickly as they can. Take the example of Lowell and Westfir, Oregon; small towns with growing budget deficits. They have outsourced their criminal complaints and traffic patrols to the neighboring town of Oak Ridge.
Oak Ridge is providing those services for a flat fee, but this cost is much less than if Lowell and Westfir would have to provide these services on their own, helping to reduce the budget deficit. Oak Ridge likes the idea of outsourcing instead of budget cuts so much that it is paying $93,000 a year to Lane County to take its 911 calls for it, which is saving Oak Ridge over $300,000 a year (Source: Wall Street Journal, July 20, 2012.)
This innovative and unprecedented type of service sharing and outsourcing is going on throughout the U.S. Forced by budget cuts to meet their gaping budget deficits, municipalities have had to cut their workforces, which makes outsourcing a viable solution.
One has to applaud this ingenuity under very difficult circumstances. Some municipalities are trying the best they can, but the studies that measure the budget deficits for pensions are showing that it will not be enough. This means there will come a point where states and municipalities turn everything over to the White House.
Then more money printing will have to ensue, because the White House doesn’t have the money to make up for these big budget deficits. Be careful, dear reader; this is a huge problem embedded within the struggling economy that few politicians are doing anything about and few in the media are seriously following.
Where the Market Stands; Where it’s Headed:
I continue to believe we are near the end of a bear market rally in stocks that started in March of 2009. We started reporting in January of this year that we expected the U.S. to be back in recession by the end of 2012, early 2013. Since the prediction, economic data have only deteriorated further.
What He Said:
“Despite all my ‘yelling’ and ‘screaming’ about gold, I believe only a few of my readers and a small fraction of the general public haven taken a position in gold. Why? Because gold’s not trendy…buying condominiums for investment is! If you are an investor, you need to seriously look at investing in gold stocks because gold bullion prices will likely continue to rise.” Michael Lombardi in Profit Confidential, September, 21, 2005. Gold bullion was trading under $300.00 an ounce when Michael first started recommending gold-related investments.