Who Owes and Who Owns

June 24, 2018

by Steve Stofka

Total debt levels are high relative to income, but the payments on that debt, the Debt to Income ratio, are at historic lows. Why? The absurdly low interest rates of the past decade play a significant role. What could happen as interest rates rise?

An explanation of terms first. The Debt to Income ratio (CFPB  page) measures the monthly flow of debt service payments to the flow of monthly income. Lenders use this ratio to judge the capacity of a borrower to repay a loan. Let’s call this ratio DTI.

The aggregate household debt to income ratio measures the pool of total debt to the flow of yearly income. Lenders and economists use this measure to assess the leverage of income, i.e. how much debt can the average income buy? Let’s call this ADTI.

As the DTI rose to historic highs before the recession, the average household was paying more than 13% of their disposable income to service their debt.  7.2% of that was mortgage payments. After the recession, the DTI has fallen to historic lows just above 10%. 4.4% of that was mortgage payments, which are near historic lows. Rock bottom interest rates have been the chief factor in that reduction. The percentage of disposable income going to non-mortgage debt payments have remained stable at 6%.

The ADTI shows the leverage of income to debt. Before the recession, each household had debt to income ratio of 1.2:1 (1.2 to 1), as shown in the chart below. (Federal Reserve paper).  The aggregate debt to income ratio is now 1:1. During and following the recession, some households reduced their debt voluntarily; some had their debt reduced involuntarily through home foreclosure and credit card debt write-offs. Although the current ADTI level is just about 1:1, this is far above the debt levels of the 1980s and 1990s when the ratio fell as low as .6:1. Households have transitioned from overleveraged before the recession to fully leveraged after the recession.

DebtToIncomeAgg

Households with higher incomes are more leveraged and raise the aggregate ratio of debt to income. Those with lower incomes have less credit available to them and less debt. They lower the aggregate ratio. Lower income households may not qualify for a mortgage, the greatest source of most household debt and a point of high leverage. The current mortgage leverage is more than 3-1; a $77K income is needed for a $260K mortgage at 4.5% for thirty years (calculator).

To reach the average 1:1 ratio of debt to income using the example above, there must be $183K of income with no debt. For one $77K household to get overleveraged to get that mortgage, there must be fifteen households with $50K incomes who are underleveraged (.25:1 debt to income). Where are those people? Many of them are in rural areas, particularly in the vertical middle of the country and several mountain states. See the 2006 county map of aggregate debt to income in the Federal Reserve paper linked above.

“It’s the economy, stupid!” read the banner that James Carville posted in Bill Clinton’s campaign office during the 1992 election race. In a series of articles published in 2004, journalist Bill Bishop coined the term “the big sort” and published a book by that name in 2009. This is one more example of the sorting that is taking place in this country.

Many people in rural areas live a penny-wise life because they don’t like to be in debt. Some are living frugally because credit is not available to them. In either case, their low levels of debt relative to income are enabling those in urban and suburban areas to maximize their debt leverage. Those living in urban areas may complain – quite rightly – that they must borrow more than they would like because the cost of living in some cities is so high. Regardless, people in one set of circumstances and making do with less are effectively enabling the income to debt leverage of another set of people who are enjoying more. That dissonance adds to the cacophony of the current debate in this country.

The Un-Crash

February 18, 2018

by Steve Stofka

The stock market did not go down 4% this past Wednesday.  It could have. The annual inflation reading for January was above expectations and confirmed fears that inflation forces are heating up. January’s retail sales report was also released Wednesday. It showed the second weakest annual increase in the past two years. If consumers are moderating their spending a bit, that would counteract inflation pressures.  Instead of dropping 2 – 4% on Valentine’s day, the SP500 went up 2.7%.

The labor report and the retail sales report each month have a significant sway on the market’s mood because they measure how much people are working and getting paid, and how much they are spending.

On a long-term basis, I think (and hope) that consumers will remain relatively cautious in their use of credit. Families today carry a higher debt burden relative to their income. By 2004, household debt levels had surpassed their annual level of income. As housing prices continued to rise, many families overextended themselves further and paid a horrible price when jobs and housing prices declined during the recession.

Families during the 1960s and 1970s carried far less debt relative to their income. People saved their income and bought many items when they could afford it. High inflation in the late 1970s and more relaxed lending standards in the 1980s helped cause a shift in thinking. Why wait? Charge it. Businesses learned that consumers are more likely to spend plastic money than real money. Consumers were encouraged to take another credit card. Buy that new car. Your family deserves it. We have a good interest rate for you.

Following the recession, families have kept the ratio of debt to income at a steady level, so that their debt is slightly below the level of their annual income. Prudent consumers will help keep inflation in check.  Here’s a chart of the debt to income ratio.  See how low it was during the decades after World War 2.

BuyingPower

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Housing

In the past year, tenant groups in California have been lobbying to loosen rent control laws in that state. You can read about it here (Sacramento Bee). To illustrate the economic pressures on many middle-class California residents, I’ll show you a few graphs. The first one is per capita income in six cities. All of them are above the national average. San Francisco and New York top the income list, followed by Denver, Chicago, Los Angeles and Dallas.

PerCapIncomeMSA

Now I’ll divide these income figures by an index of housing costs, the largest expense in most household budgets. In the past few years Chicago has edged into the top spot.  San Francisco is still in the top 3, but has shifted downward as housing costs have climbed.  The housing adjusted income of Los Angeles has dropped even further below the national average.

PerCapitaIncomeHousingMSA

Feeling the fatigue of keeping up with escalating costs, some Angelenos are reaching out to their local politicians for help. Some have thrown up their hands and left the state.

Vulnerable

September 3, 2017

Hurricane Harvey invaded the lives, homes and businesses of so many people in Houston and the surrounding area of southeast Texas. People around the world watched the plight of so many who were caught in the rising waters. I was cheered by the dedication of first responders, by those who came from near and far to help with their boats, with food and clothing. I have never been in a flood. Some of those interviewed had been in several. Why do they stay there, I wondered? The answer is some or all of these: their family, their church, their job, their school, their culture.

Watching so many vulnerable people reminded me of my own. If given a few minutes to leave my house, what would I put in a garbage bag? In the urgency and stress of the moment so many people in Houston forgot their medications.  My list: Pets, papers, clothes, medications. Food? Will the shelter have food? Pet food, as well? Where are we going? Oops, what about a phone charger? And the laptop. What about the list with all the passwords? That too. What about the photos in the closet? I was going to get those scanned in and uploaded. No time now. Take a few of the smaller framed photos on the shelf in the living room. Out of time. Gotta go. All the questions that must have been bouncing around inside the heads of those forced to evacuate as the brown water took possession of their house.

If I don’t call it Climate Change, I could call it Flood Frequency, or Flood Freak for short. Here is a chart showing the increased frequency of flooding during the past century. This was from an article in the WSJ (paywall).

FloodFrequency
This week’s theme – vulnerability. The signs of it and what we can do to lessen it. Debt is a vulnerability. For the past three years, households have been increasing their debt load in mortgages, auto and student loans. Here’s a breakdown of household debt from the NY Fed. (As a side note, this report gives a breakdown of the different types of debt by credit score. For example, the median credit score for an auto loan is about 700).

DebtBalance2016.png
Mortgage debt is more than 2/3rds of total debt. Despite the rise in home prices, more than 5 million homes, or 7%, are still badly “under water.” (Consumer Affairs)

Credit card debt has stayed stable for the past thirteen years. Households are only using 10% of their after-tax income to service their debt.

DebtService2016

Despite low interest rates, households are continuing to deleverage, to decrease their vulnerability. The ratio of household debt – the total of that debt, not the payments – to income climbed above 2.5 in late 2007. It has fallen below 2.2 but is still high. We are still up to our eyeballs in debt.

HouseholdDebtIncomeRatio

Debt reduction will curb economic growth for the near future. According to several cabinet members, Trump is focused on GDP growth in discussions about trade policy, defense policy, infrastructure spending, and the regulatory environment. How does this or that policy get us to 3% growth? he asks.

2/3rds of the nation’s economy is based on the public willingness to spend money. Jobs helps. Higher wage growth helps. Low interest rates help. But without the willingness to take on more debt relative to income, policymakers may feel like they are trying to goad a stubborn mule to go faster. Tough to do.

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Unemployment

Continuing the theme of vulnerability.  As a percentage of the unemployed, the number of long-term unemployed remains stubbornly high at close to 25%.  I call them the 27ers because 27 weeks of unemployment is the cutoff that the BLS uses to determine whether someone is categorized as long term unemployed. 27 weeks or six months is a long time to be actively looking for work and not finding a job.  Eight years after the end of the recession, today’s percentage of 27ers is at the same level as the worst of most past recessions.

LTUnemploy

During any recession the number of long term unemployed climbs higher. When these past few recessions have ended, the number of 27ers doesn’t start to decline.  Instead, they continue to increase and reach a peak several months after the recession is officially over. In the last three recessions, the peaks came later than previous recessions.

UnemployLTPctCLF
This more vulnerable cohort in the labor force struggles to recover after a recession.  Manufacturing is the more volatile element in the business cycle.  As manufacturing has declined, recessions are less frequent. However, manufacturing used to put a lot of people back to work at the end of recessions.  In a recovery, the service sectors are not as quick to add jobs.

The structural shift in the labor force will continue to leave more workers and families vulnerable and needing help just as many older workers are claiming retirement benefits. More than half of voters, both Republican and Democrat, have received benefits from at least one of the six entitlement programs (Pew Research). Elected officials offer promises of future benefits in exchange for taxes, and votes, today. When circumstances force a clash of priorities and promises, Congress seems incapable of resolving the conflict. President Trump’s approval ratings are in the low thirties, but his popularity far exceeds the public’s dismal ratings of Congress.

In a crisis, Americans come together to help each other but why do we wait till there is a crisis? Have we always been a nation of drama queens?  Maybe that’s the American charm.

A Choice of Money

July 30, 2017

Gresham’s law states that an overvalued form of money will drive out an undervalued form of money. Let’s say that both gold and silver are accepted as money and the government fixes a ratio of 1:20 between the two metals. One ounce of gold thus equals twenty ounces of silver. Let’s say that people and businesses hold ten times as much silver as gold. The exchange ratio that the government has set is higher than the ratio of the stores of the two metals. Gold is overvalued. Gresham’s law states that people will start using gold as an exchange medium to the extent that eventually silver will be driven out of circulation.

I wanted to explore this concept and substitute two things that are not currencies or commodities: liquidity and debt.  Liquidity is today’s money.  Debt is tomorrow’s money. Today’s money is stable and available.  Tomorrow’s money is not. As soon as money is loaned, it can’t be readily converted to cash.  It’s future money.

Gresham’s law is about people’s preferences and the value of money.  When millions of individual circumstances are added up,  a preference for liquidity or debt emerges. When tomorrow’s money is overvalued, people use it, and drive down the use of present money. “Don’t save up to buy what you want.  Buy it now with future money.  Here I’ve got some,” say businesses and banks.

Let’s look at two representations of present and future money.  M2 is a broad measure of the money supply that includes cash, checking and savings accounts, as well as money market accounts and CDs that can be quickly converted to cash. Future money is the amount of business and household debt.

During recessions (gray areas in the chart below), M2, the numerator in the ratio, goes up and debt goes down. Economists call this a greater preference for liquidity. Banks are more reluctant to lend money, which tightens credit and restrains the growth of debt.  People charge less and stick more money in checking and savings. Businesses don’t borrow to expand their operations and keep more cash on hand to pay present obligations.

In the chart below, I chart the ratio of the yearly change in today’s money, or what the Federal Reserve calls M2 money, and tomorrow’s money, the amount of business and consumer debt.

M2DebtCLIRatio1960-2007

In the recessions of the 1970s and 1980s, the graph shows what I would expect. There was a greater preference for liquidity and the ratio of present to future money rose above 1, a clear sign that people and businesses were worried about the future.  As the recessions ended, the ratio declined as debt, the denominator in the fraction, grew at a faster rate than M2 money, the numerator. The recessions of the early 1990s and early 2000s were fairly mild in comparison and the uptick in a preference for liquidity was mild.

The chart ends in 2007, just before the recession and financial crisis. Let’s now turn to that period. During the early part of 2008, the ratio began to climb to 1, indicating that people and businesses were preferring liquidity over debt. During the first six months of 2008, 700,000 jobs had been lost but this was only 1/2% of the workforce. Almost 300,000 of those lost jobs were in construction, which had become overheated by the building of so many homes. Retail sales growth had gone flat but was probably just a pause in the normal course of the business and credit cycle. Not to worry.

Then a funny thing happened to the economic engine of the country, something that had never happened before in post-WW2 America. The ratio spiked upward, registering nosebleed readings.

M2DebtCLIRatio2006-2008

The preference for present money continued upward but the change in debt, the bottom number in the ratio, plunged downward and this drove the ratio higher. The Federal Reserve began buying some of this debt until it held about $2 trillion.

Debt2008-2010

As the change in debt turned negative, the ratio turned negative, a post Depression first. Month after month, old debts soured.  People and businesses shunned new debt. People who were saving more of today’s money were being offset by those who had to tap their savings accounts to make up for lost income. Toward the end of 2008, the economy lost as many jobs each month as it lost in total for the first six months of 2008. Retail sales dropped a few percent each month.

M2DebtCLIRatio2008-2011

Like a car whose brakes have failed, the ratio continued its downward slide. In a program called Quantitative Easing (QE_, the Federal Reserve began buying more debt in an effort to get this ratio into the positive zone.

By the middle of 2012, the ratio broke into the positive zone as debt stopped contracting. The preference for liquidity was strikingly high, going up above 8, more than three times higher than the 2.5 level of the 1980s recession.

M2DebtCLIRatio2012-2014

The Federal Reserve continued to buy debt as the economy staggered to its feet.  In 2013, the stock market finally surpassed its inflation adjusted value at the start of the recession.  In the early part of 2014, the ratio of liquidity to debt, of present money to future money, finally fell below 2. At mid-2014, the Fed had accumulated $4.5 trillion in debt, $3.7 trillion of which had been added during the financial crisis. After 6-1/2 years, the number of people employed finally rose above its pre-recession level.  The Fed ended its debt buying program.

So where do we stand today? The stock market and house prices continue to make new highs but the current reading of this ratio show that people continue to prefer today’s money over tomorrow’s money.

M2DebtCLIRatio2014-2017

In short, the economy is still healing. During the expanding economy of the 1960s, the ratio was a bit over 1 for half the decade.  People who had grown up during the Depression were understandably a bit cautious. However, both present and future money grew at a steady rate during the 1960s. Today’s households and businesses have been scarred by the financial crisis and are cautious.  Into this cautious confidence, the Fed has a lot of debt to unload.  It must maintain a balance between money preferences as it feeds the debt it bought during the crisis back into the economy.

Debt Equity Ratio

June 28, 2015

Ding, ding, ding!  I was surprised to see that this is my 500th blog article!

As I noted last week, the stock market has traded in a fairly tight range for the past six months.  Some market seers see this as a topping pattern before either a crash or a serious correction.

Money not spent on current consumption can be invested in past spending – debt – or tomorrow’s spending – equity.  Stocks rise when more people shift money toward tomorrow’s spending in the hopes of better corporate profits.

Last week I estimated the equity market at about $25 trillion.  The latest Federal Reserve Flow of Funds report puts the value of corporate equities at $22.5 trillion at the end of March.  A time series graph of the Fed’s valuation of non-financial corporate equity might give an investor some pause as it is 50% above the worst case scenario base trend line.

Using a middle of the road trend line, we see a market valuation that is 20% above trend.

On the chart above, I have outlined the long term bear market from 1968 – 1982.  That 14 year period of negativity might be a poor starting point for a trend line for the following thirty years.  Let’s take government debt out of the picture for a minute and look at the ratio of household and non-financial business debt to corporate equity valuations.  As the graph below shows, climbing stock prices (the divisor in the ratio) lower the ratio of debt to equity and signal a growing confidence in the future- or does it signal an overheated market?

 Let’s add in government credit market debt, which will shift the ratio of debt to equity up.

We can see the stock market peaks in 1968 and 2000 when the market entered a long term decline called a secular bear market.  Notice that the ratio at the start of the financial crisis in 2008 is about the same as today but that neither was at a peak or trough level.  Now let’s add in the credit market debt of the financial sector.

This again raises the percentage of debt to equity and subtly changes the pattern of the ratio.  We see the go-go years of the 1960s as a decade of confidence, perhaps too much confidence fed by an upsurge in defense spending.  Rising inflation, debt and the slog of war began to erode that confidence and lead into the secular bear market that started in 1968.

In the late 1990s we can see the ratio approach the same levels as in the late 1960s.   It is in this chart that we see a revealing characteristic that marked the period before the financial crisis.  Although stock market prices were rising, housing market debt was rising as well so that the ratio of debt to equity stopped falling after the recession of 2001 and the start of the Iraq war.  That halt in the debt-equity ratio signaled an uncertainty in future profits, tugging new investment dollars toward the past.

This trend of accumulated debt attracting new investment dollars is clearer if we reverse the ratio, showing the equity/debt ratio.  In the 1990s, equities climbed and the equity/debt ratio climbed as well.  In the mid-2000s, equities again rallied but the equity/debt ratio stayed relatively flat, indicating that investors were putting dollars into debt instruments as well as the stock market.  Since the financial crisis, equities have climbed far above the market levels of 2007 but the debt/equity ratio has recovered at a much slower rate.  Despite historically low interest rates, high government debt and finance debt continues to attract investors’ money.

Current stock market valuations are moving the ratio toward the future but investment in the spending of the past continues – until the 30+ year bull market in bonds reverses and investors abandon a falling bond market for the equity market.

GDP and Education

June 29, 2014

This week I’ll review some of this week’s headlines in GDP, personal income, spending and debt, housing and unemployment.  Then I’ll take a look at some trends in education, including state and local spending.

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Gross Domestic Product First Quarter 2014

The headline this week was the third and final estimate of GDP growth in the first quarter, revised downward from -1% to -2.9%.  This headline number is the quarterly growth rate, or the growth rate over the preceding quarter.  A year over year comparison, matching 2014 first quarter GDP with 2013 first quarter GDP, shows an annual real growth rate of 1.5%, below the 2.5 to 3.0% growth of the past fifty years.  The largest contributor to the sluggish GDP growth was an almost 5% drop in defense spending.  Simon Kuznets, the economist who developed the GDP concept, did not include defense spending in the GDP calculation.

Contributing to the quarterly drop was the 1.7% decline in inventories.  Businesses had built up inventories a bit much in the latter half of 2013 in anticipation of sales growth only to see those expectations dashed by the severe winter weather.  Final Sales of Domestic Product is a way of calculating current GDP growth and does not include changes in inventory.  Let’s look at a graph of the annual growth in Real (Inflation-Adjusted) GDP and Real Final Sales of Domestic Product to see the differences in the two series.

Note that Real GDP growth (dark red line) leads Final Sales (blue line) as businesses build and reduce their inventory levels in anticipation of future demand and in reaction to current and past demand.
  
The Big Pic: if we look at these two series since WW2, we see that ALL recessions, except one, are marked by a year over year percent decline in real GDP.  The 2001 recession was the exception.

Secondly, note that in half of the recessions, y-o-y growth in Final Sales, the blue line in the graph, does not dip below zero.  We can identify two trends to recession: 1) businesses are too optimistic and overbuild inventories in anticipation of demand, then correct to the downside, causing a reduction in employment and a lagging reduction in consumer spending; 2) consumers are too optimistic and take on too much debt – selling an inventory of future earnings to creditors, so to speak – then correct to the downside and reduce their consumption, causing businesses to cut back their growth plans.  In case #1, a decrease in consumer spending follows the cutbacks by businesses.  In case #2, businesses cut back following a downturn in consumer spending.

In this past quarter, employment was rising as businesses cut back inventory growth, indicating more of a rebalancing of resources by businesses rather than a correction.  Consumer spending may have weakened during the first quarter but, importantly, did not decline.  We have two hunting dogs and neither is pointing at a downturn.

For a succinct description of the various components of GDP, check out this article written for about.com by Kimberly Amadeo.  Probably written in the first quarter of 2014, her concerns about the inventory buildup in 2013 were proved accurate.

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Income and Spending

Personal Income rose almost 5% on an annualized basis in May but consumer spending rose at only half that pace,  2.4%.  The spending growth is only slightly more than the 1.8% inflation rate calculated by the Bureau of Economic Analysis, revealing that consumers are still cautious.

I heard recently a good example of how data can be presented out of context, leading a listener or reader to come to a wrong conclusion.  Data point: the dollar value of consumer loans outstanding has risen 45% since the start of the recession in late 2007. Consumer loans do not include mortgages or most student loan debt. If I were selling a book, physical gold, or a variable annuity with a minimum return guarantee, I could say:

My friends, this shows that many consumers have not learned any lessons from the recession.  They are living beyond their means, running up debts that they will not be able to pay. Soon, very soon, people will start defaulting on their debts and the economy will collapse.  This country will suffer a depression that will make the 1930s depression look tame.  Now is the time to protect yourself and your loved ones before the coming crash.

Data is little more than an opportunity to spread one’s political message.  Data should never lead us to reconsider our message, our point of view.  If I were penning a politically liberal message, I could write:

The families in our country are desperate.  Without enough income to satisfy their basic needs, they are forced to borrow, falling ever deeper into debt while the 1% get richer.  We need policies that will help families, not the financial fat cats on Wall Street.  We need a tax structure that will ensure that the 1% pay their fair share and not have the burden fall on the shoulders of most of the working Americans in this country.


Selling a political persuasion and selling a car brand often employ similar techniques.  Data should never lead us to question our loyalty to the brand.  If I were crafting a conservative message, I could write:


The misuse of credit indicates an immaturity fostered by cradle to grave social programs, which are eroding the very character of the American people, who come to rely less on their own resources and more on some agency in Washington to help them out.  People steadily lose their sense of personal responsibility, becoming more like children than self-reliant adults.

However, the facts behind the data point lead us to a different story. In the spring of 2010, consumer loans spiked, rising $382 billion in just two months.

That surge represents more than a $1000 in additional debt per person. Consumers did not suddenly go crazy.  Banks did not open their bank vaults in a spirit of generosity. Instead, banks implemented accounting rules FAS 166 and 167 that required them to show certain assets and liabilities on their books. $322 billion of the $382 billion increase in consumer loans during those two months in 2010 was the accounting change. If we subtract that accounting change from the current total, we find that real consumer loan debt increased only 5.5% in 6-1/2 years.  And that is the real story.  Never in the history of this series since WW2 have consumers restrained their borrowing habits as much as we have since December 2007.  We had to.  In the eight years before the financial crisis in 2008, real consumer debt rose 33%, an unsustainable pace.

About two years ago, loan balances stopped declining and since then consumers have added $80 billion, much of it to finance car purchases. $25 billion of that $80 billion increase has come only since the beginning of this year.  On a per capita, inflation adjusted basis, consumer loan balances are still rather flat.

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Housing

New home sales in May were up almost 20% over April’s total, and over 6% on an annual basis.  Existing homes rose 5% above April’s pace but are down 5% on an annual basis.  Each year we hope that housing will finally contribute something to economic growth.  Like Cubs fans, we can hope that maybe this year….

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Unemployment Claims

New unemployment claims continue to drift downward and the 4 week moving average is just below 315,000.  Our attention spans are rather short so it is important to keep in mind that the current level of claims is the same as what is was last September.

It has taken this economy six months to recover from the upward spike in claims last October.  The patient is recovering but still not healthy.

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Minimum Wage

The number of workers directly affected by changes in the minimum wage are small.  We sympathize with those minimum wage workers who try to support a family.  The Good Samaritan impulse in many of us prompts us to say hey, come on, give these people a break and raise the minimum wage.  What we may forget are the implications of any minimum wage increase.  Older readers, stretch your imagination and remember those years gone by when you were younger. Workers in their early working years often see the minimum as a benchmark for comparison.  The much larger pool of younger workers who make above minimum wage may push for higher wages in response to increases in the minimum wage.

Fifty years ago, Congress could have made the minimum wage rise with inflation, ensuring that workers in low paid jobs would get at least a subsistence wage and that increases would be incremental.  Of course, there are some good arguments against any nationally set minimum wage.  $10 in Los Angeles buys far less than $10 in Grand Junction, Colorado.  Ikea recently announced that they will begin paying a minimum wage that is based on the livable wage in each area using the MIT living wage calculator .  Several cities have enacted minimum wage increases that will be phased in over several years but none that I know of are indexed to inflation as the MIT model does.

Congress could enact legislation that respects the differences in living costs across the nation.  For too long, Congress has chosen to use the minimum wage as a political football.  Social Security payments are indexed to inflation because older people put pressure on politicians to stop the nonsense.  There are not enough minimum wage workers to exert a similar amount of coordinated pressure on the folks in Washington so workers must rely on the fairness instinct of the larger pool of voters if any national legislation will be passed.

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Education

Demos, a liberal think tank, recently published a report recounting the impact of rising tuition costs on students and families.  Student debt has almost quadrupled from 2004 – 2012.  Wow, I thought.  State spending per student has declined 27%.  More wows.  How much has enrollment increased, I wondered?  Hmmm, not mentioned in the report.  Why not?

The National Center for Education Statistics, a division of the Dept. of Education, reports that full time college enrollment increased a whopping 38% in the decade from 2001-2011.  Part-time enrollment increased 23% during that time.  Together, they average a 32% increase in enrollment. Again, wow!  Ok, I thought, the states have been overwhelmed with the increase in enrollment, declining revenues because of the recession, etc.  Well, that’s part of the story.  Spending on education, including K-12, is at the same levels as it was a decade ago.

From 2002-2012, states have increased their spending on higher ed by 42%.  Some argue that the Federal government should step up and contribute more.  In 2010, total Federal spending on education at all levels was less than 1% ($8.5B out of $879B).  Others argue that the heavily subsidized educational system is bloated and inefficient.  As much cultural as they are educational institutions, colleges and universities have never been examples of efficiency.  Old buildings on college campuses that are expensive to heat and cool are largely empty at 4 P.M.  Legacy pension agreements, generously agreed to in earlier decades, further strain state budgets.  We may need to rethink how we can deliver a quality education but these are particularly thorny issues which ignite passions in state and local budget negotations.

Although state and local governments have increased spending on higher ed by 42% in the decade from 2002-2012, the base year used to calculate that percentage increase was particularly low, coming after 9-11 and the implosion of the dot-com boom.  Nor does it reflect the economic realities that students must get more education to compete for many jobs at the median level and above.

Let’s then go back to what was presumably a good year, 2000, the height of the dot-com boom.  State coffers were full.  In 2000, state and local governments spent 5.14% of GDP (Source).  By 2010, that share had grown to 5.82% of GDP (Source). That represents a 13% gain in resources devoted to education.  But that is barely above population growth, without accounting for the rush of enrollment in higher education during the decade.

Let’s take a broader view of educational spending, comparing the total of all spending on education, including K-12, to all the revenue that Federal, state and local governments bring in.  This includes social security taxes, property taxes, sales taxes, etc.  As a percent of all receipts, spending on education has declined from 30% to under 18%.

Many on the political left paint conservatives as being either against education or not supportive of education.  Census data shows that Republican dominated state legislatures, in general, devote more of their budget to education than Democratic legislatures.  W. Virginia, Mississippi, Michigan, S. Carolina, Alabama and Arkansas devote more than 7% of GDP to education, according to U.S. Census data compiled by U.S.GovernmentSpending.com.  Only two states with predominantly Democrat legislatures, Vermont and New Mexico, join the plus-7% club (Wikipedia Party Strength for party control of state legislatures).

In the early part of the twentieth century, a high school education was higher education.  In the early part of this century, college may be the new high school, a minimum requirement for a job applicant seeking a mid level career.  What are our priorities?  In any discussion of priorities, the subject of taxes arises like Godzilla out of the watery depths.  People scramble in terror as Taxzilla devours the city. Older people on fixed incomes and wealthy house owners resist property tax increases.  Just about everyone resists sales tax increases.  Proposals to raise income taxes are difficult to incorporate in a campaign strategy for state and local politicians running for election.

Let’s disregard for a moment the ideological argument over Federal funding or control of education.  Let’s ask ourselves one question:  does this declining level of total revenues reflect our priorities or acknowledge the geopolitical realities of today’s economy?

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Takeaways

Reductions in defense spending, inventory reductions and a severe winter that curtailed consumer spending accounts for much of the sluggishness in first quarter GDP growth.

A surge in new home sales is a sign of both rising incomes and greater confidence in the future.

Consumer spending growth is about half of healthy income gains.

Spending on education has grown a bit more than population growth and is not keeping up with surging enrollment in higher education.

Follow The Money

June 14th, 2014

This week I’ll take a look at some near-term trends in small business, labor, oil and housing and a few long-term trends in income and debt.

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Small Business

Huzzah, huzzah!  The monthly survey of small business owners by the National Federation of Independent Businesses (NFIB) broke through the 96 level after cracking the 95 level last month.  Sentiment has not been this good since mid-2007.  Hiring plans have been on the rise for the past several months and owners are reporting rising sales.

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JOLTS (Job Openings and Labor Turnover Survey)

The Job Openings report from the Bureau of Labor Statistics (BLS) has a one month delay so the data released this past week was for April.  The number of job openings was 40,000 higher than expected, coming in close to 4.5 million.  As a percent of the workforce, job openings are approaching pre-recession highs.

The decline in construction job openings is a disappointment.  We are near the same level as 2003, a weak year of economic growth.  We should expect to see an uptick in job openings in next month’s report, confirming that projects put on hold during the severe winter in the eastern part of the country are again on track.  Further declines would indicate a spreading malaise.

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Gross Domestic Income

On a quarterly basis Gross Domestic Income, GDI, and Gross Domestic Product, GDP, differ somewhat but over the long run closely track each other.  Following up on two previous posts on Thomas Piketty’s book Capital in the 21st Century, I wondered what percent of GDI goes to pay employee compensation.  As we can see in the chart below, total compensation for human labor has been dwindling to post WW2 levels.

This is total compensation, including benefits.  Wage and salary income as a percent of total national income has declined steadily.

As a percent of total income, employee benefits have more than tripled since the end of World War 2 and now comprise more than 10% of the country’s income.

Demographic shifts have contributed to the decline of labor income.  The post war boomer generation, 80 million strong and 25% of the population, contributes to the trend as they save for retirement. As capital gains, interest and dividend income increase, this reduces the share of wage and salary income.

Economic changes have been a major factor in the decline of labor income.  Capital investments in technology, both in hardware and software, have reduced the need for labor for a given level of production.  Capital investment demands income to pay back the investment. For most of the 20th Century, machines replaced human muscle in farming, manufacturing and construction.  In the past two decades, machines are increasingly replacing mental muscle.

How we count labor income has changed.  Tax law changes in 1986 and 1993 reduced the amounts that are included as compensation but the overall effect of these changes is relatively minor.

If we divide the country’s total employee compensation by the number of employees, we might ask “What recession?”  Average annual compensation has climbed from $38-54K in a dozen years.  That’s almost a 50% raise for every employee!

Of course, everyone has not had a 50% increase in income over the past 12 years.  Human capital, the educational and technical training that an employee has to offer, has earned an increasing premium in the past three decades. Those with more of this capital have captured more benefit from the dwindling pool of labor needed for the nation’s production.

Average disposable income tells a more accurate story of the majority of people in this country.  Disposable income is what’s left over after taxes.  The trend is downward.

How do we cope with flat income growth?  Charge it!  It’s the Amurikin way! Per capita Household Debt has increased 75% in the past 13 years.  After a decline from the rather high levels before the recession began in late 2007, per capita debt has leveled off in the past two years.

Rising house prices and stock market values have increased net worth.  As a percent of net worth, household debt has declined to the more sustainable levels of the 1990s.

The percentage of disposable income needed to service that debt is at thirty year lows, meaning that there is room for growth.

In response to the hostilities in Iraq, oil prices have been on the rise.  Historically, a rise in oil prices leads to a rise in prices at the pump which takes an extra bite out of disposable income and puts a damper on consumer spending growth.

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Oil Prices

A blog by Greg McIsaac at the Washington Monthly in May 2012 presents an interesting historical summary of oil prices and production.  The American love of simplicity leads many to credit one man, the President, for the rise and fall in gasoline prices, although the President has little, if any, influence on oil pricing. McIsaac notes The combination of lower energy prices and increased energy efficiency in the 1980s reduced US expenditures on energy by nearly 6 percent of GDP.  Deregulation of energy prices begun under the Carter Administration were largely credited to the Reagan administration.   He writes “crediting Reagan with falling energy prices of the 1980s exaggerates the roles of both Reagan and deregulation and obscures the larger influence of conservation and increased production outside the US.”  Production actually fell for several years after regulatory controls were lifted.

Further increases in oil prices will no doubt be blamed on this President.  The one thing that each outgoing President bequeaths to the newcomer before the inauguration is the Presidential donkey suit.

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Housing

Redfin Research Center reports a sharp decline in the number of houses sold through May. After a 7.6% year-over-year decline in April, home sales slid 10% from May 2013 levels.  Real estate agents are reporting a shift from a seller’s market to a buyer’s market.

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Takeaways

Small business accounts for approximately 60% of new jobs and optimistic sentiment among small business owners is growing.  The labor market continues to show continuing strength in the number of job openings and a decline in new unemployment claims.  Disposable income growth is flat but the portion of income needed to service debt is very low.  Rising oil prices and a slowing housing market will crimp economic growth.
Next week I’ll look at a complex topic – is the stock market fairly valued?  

Labor and Money Flows

September 1st, 2013

On this Labor Day weekend, I’ll review some things that caught my attention this past week.

The employment picture has shown steady but slow improvement.  The weekly survey of new unemployment claims continues to show downward movement.  In a survey that is about 13 years old, called the JOLTS, the BLS gathers data on Job Openings, Layoffs and Turnovers.  A component of this survey includes the number of employees who have quit their jobs, referred to as the “JOLTS quit rate.” In the aggregate, it indicates a hive intelligence, the estimation of millions of people about the prospects of getting another job.  Decades ago, researchers asked a number of people to estimate the number of jelly beans in a jar.  Each estimate has very small chances of getting close to the actual number, but the average of all estimates was found to be almost exactly the number of jelly beans in the jar.  I don’t know whether this experiment has been replicated but it is interesting.

After recent months of surging new orders for durable goods, July’s report, released Monday, showed signs of caution and a “return to the mean” of a positive upswing this year.

Although this past month’s data was negative, industrial production shows a clear uptrend.

In an analysis released a few months ago, the Federal Reserve examined data from the 2010 triennial (every 3 years) survey of households and estimated that inflation adjusted net worth per household (green line in the graph) has just climbed back to the level it was almost ten years ago.

 

On the positive side, average net worth is not less than it was ten years ago.  On the negative side for those nearing retirement, it is not more that it was ten years ago.

On Friday, the Personal Consumption and Expenditures (PCE) report showed a 1.4% year over year percent gain, indicating the tepid growth in household spending.  Below I’ve charted the percent gain in PCE vs the percent gain in GDP for the past thirty years.

We are still below the low points of the 1980s, 1990s and early 2000s.  The Federal Reserve is projecting GDP growth of 3 – 3.5% in 2014 but this may be another in a string of rosy forecasts by the Fed, who have repeatedly revised earlier rosy forecasts.  If the Fed were a contractor, it would be out of business due to poor estimating.  A $16 trillion economy is not a kitchen remodel by any means, but it does illustrate how difficult it is for the best minds to make even short term predictions of the economy from the vast amounts of sometimes conflicting data.  Consider then the folly of the Government Accountability Office (GAO), the economic watchdog created by Congress and mandated by Congress to come up with ten year estimates of economic growth and the consequences of existing and proposed legislation.  Those in Congress continue to trot out these fantasy numbers to support or criticize policy and legislation.

Washington continues to vacuum in money and talent from the rest of the country.  Of the richest counties in per capita income in the U.S., the Washington metro area has two of the top three.  The other county in the top three is a stone’s throw from the metro area.  As Washington politicians convince the rest of us that they have the solutions, lobbyists and graduates flock to the concentration of power, jobs, money and influence.
 
Bond yields have increased more than 1% since the spring, meaning that the prices of the bonds themselves have fallen dramatically.  Most of this change has been a reaction to forecasts for stronger growth and a tapering of the Fed’s stimulus program called Quantitative Easing.  Washington is sure to get in the way of stronger growth for the economy as a whole.  Policy out of Washington is designed to promote strong economic growth for Washington.

The market research firm Trim Tabs regularly monitors money flows into and out of the stock and bond markets.  They  reported today that outflows from the stock market in August were half of the record inflows in July.

The blood spilled this year has been in the bond market.  Trim Tabs reports that outflows from bond funds and ETFs have totalled more than $123 billion in the past three months.  Flows into bond funds and ETFs were about $750 billion in 2012, almost a doubling from the $400 billion invested in 2011. (Fed Flow of Funds tables F.120, F.121)

While the prospect of higher rates may have been the trigger that caused a reversal of bond inflows, the underlying current is also an overdue correction of the surge of investment in bonds in 2012.

Households continue to shed debt in one form or another so that total liabilities continue to decline. However, every man, woman and child in this country is carrying, on an inflation adjusted basis, 2-1/2 times the amount of debt they carried thirty years ago.  This level of household liability will continue to put downward pressure on growth.

This next week will kick off with the ISM manufacturing report on Tuesday and finish the week with the monthly employment report.  Year over year percent gains in employment have been steady and guesstimates are for maybe 200,000 net job gains.  150,000 net jobs are needed to keep up with population growth.

The Fed meeting is coming up in mid-September so this employment report will be watched closely to guess the next steps the Fed will take. 

Blossoms and Blight

March 24th, 2013

The Blossoms

There have been a number of encouraging reports these past several months, helping to fuel new highs in the popular SP500 stock index.  After falling off dramatically five years ago, real (inflation adjusted) retail sales finally surpassed 2007 levels.

Housing prices around the country are on the mend.  Although the purchase only home price index is still below the vaulted levels of the bubble years, it is exactly where it would have been if there had been no bubble and housing prices had grown at their customary 3 – 4% per year.

In recent months, the manufacturing sector of the economy has surged upward, rebounding from weakness in the latter part of 2012.  For the past year, the Eurozone has been in or near recession, yet some are hopeful that increased demand in this country and some emerging markets are helping to balance the contractionary influence of decreased demand in the Eurozone.  Let’s hope that this surge in the first part of the year does not fade as it did in 2012.

New claims for unemployment continue to decline. 

The Blight

But a 7.7% unemployment rate and a record 14 million disabled (SSA Source) show that the labor market is still sick.  The percent of working age people who are working, or the participation rate, continues to drift downward.

While the steadily improving retail sales indicate growing consumer confidence, per capita purchases are about where they were in the late 1990s, 15 years ago.

While consumers have been shedding debt, state and local governments continue to hold large levels of debt which does not include promised pension and health care benefits to retirees.

Federal Spending continues to outpace receipts, adding to the debt at a rate of more than 4% per year. At that rate the debt will double in about 18 years, reaching $30 trillion in 2030.  As a percent of the entire economy of the country, the deficit or annual shortfall between spending and revenues is still about 7%.
 

As housing prices recover and households either pay down or shed debt in foreclosure or bankruptcy, household balance sheets are looking better. What has happened in the past five years is a massive shift of household debt to the balance sheets of local, state and federal governments.

The blossoms catch our eye, inspiring hope, causing some to not notice the blight.  But the stock market, the barometer of millions of watching eyes, tells a more complete story.  While the stock market has shown renewed optimism in the past several months, its inflation adjusted value indicates a more tempered enthusiasm for the long term future of the economy and corporate profits.

Economic Overview

The U.S. Treasury web site has a good slideshow of various components of the economy.  The first couple of slides detail the net budget impact of TARP, Federal Reserve and other government programs.  Subsequent charts illustrate the depth of the recession, the decades long accumulation of household debt, the headline and long term unemployment rates, and auto and home sales.