Debt vs. Income:At the Point of No Return

[junker]

complete article. Got permission to post with attribution of both listing URL and address/contact for author...pretty accurate view of the larger picture.

********************************article follows**********

http://www.321gold.com/editorials/b...nson021304.html

Benson's Economic & Market Trends

Debt vs. Income:
At the Point of No Return

Richard Benson
February 13, 2004

At the beginning of 2003, the level of debt that American's owed
as an absolute amount, and as a ratio of income, was already approaching levels never seen before. Debt can be handled in a number of ways:

1) earn enough money to pay it off;
2) default;
3) borrow even more; or,
4) pray for inflation so you can earn more dollars (but really pay back less).

Where are we now?

Last year, personal income increased about 2%. Individual debt increased about 10%. Personal debt for autos, credit cards, etc., topped $2 Trillion - up about $120 Billion despite massive debt consolidation and mortgage refinancing. Mortgage debt rose about $800 Billion, and total individual debt rose over $925 Billion, while wages and salaries rose only $190 Billion. Retirees and savers saw their interest income shrink, as interest paid on savings dropped by $30 Billion. Indeed, given the Fed's low interest rate policies, it doesn't pay to save.

In December, the savings rate dropped to a new low of 1.5% and in the 3rd quarter of 2003, the only reason financial assets were acquired is because they were bought with borrowed money. The low savings rate is even more astounding when you consider the increase in Disposable Personal Income of around $200 Billion from the tax cut. The economy needs $500 Billion in government stimulus from tax cuts and increased spending just to keep employment from falling and to help consumers roll over their credit cards for another month.

The savings rate is actually materially overstated. Personal Income, according to the Bureau of Economic Analysis, includes a few hundred billion dollars in "imputed income" for owning your own home and receiving value for other "non-cash services." Imputed income is significantly greater than the 1.5% savings rate! Unfortunately, debt can only be repaid with actual cash flow. In January, Personal Income rose at about a 2% annual rate and very few jobs were created. Consumers are spending every last penny to live, and many are "tapped out."

What is perfectly clear from simple arithmetic is that without a sudden increase in the number of jobs and the wages they pay, individual debt can not be serviced by personal income. Worse yet, not only are people not saving, but their financial reserves are not in real cash. The only thing keeping the "national ponzi scheme" going is the illusion of wealth created by the Federal Reserve's low interest rates and liquidity that has allowed stock market valuations and housing prices to artificially inflate.
The market value of homes in 2003 rose about $1 Trillion and stock market values rose about $1.5 Trillion. The rising asset prices look like they balance rising debt on household balance sheets. Tragically, the increase in asset prices will vanish the day that interest rates rise, but the debts will still remain. Indeed, not only will the debt remain, but the cost of servicing it will go up dramatically. As interest rates rise, wages and salaries must increase or massive debt defaults will follow.

Income and job growth are so low that we have certainly passed "The Point of No Return." There cannot be an easy resolution to the debt bubble and resolution will only come when a crisis forces change. Perhaps, for this election year, crisis can be postponed by continuing to facilitate an increase in borrowing so that debts can be rolled over, but increased. By 2005, the ultimate outcome to resolve the debt problem looks like it will be a combination of inflation, rising interest rates and debt default.
The reason we do not believe that job and income growth will save the day for the American worker is we have never before seen in history such increases in government spending, tax cuts, federal budget deficits, consumer spending and borrowing, with so little job growth. The massive fiscal and monetary stimulus has mostly been spent. There will be some nice tax refunds this spring, and that's it! The peak of mortgage refinancing is already past. Construction spending is at a peak and the percentage of people who own their homes is at a record 69%. Mortgage underwriting shows that 5% of homebuyers in 2003 really couldn't afford to buy a home, and another 5% could lose their home if one spouse becomes unemployed.

While the industrial sector is recovering, employment in the manufacturing sector has not increased since the start of the recession - there has been job loss in manufacturing for the past 42 months in a row. The United States has been in an economic recovery for over a year and a half and continues to lose manufacturing jobs every month! This is unprecedented!
Capacity utilization in the US remains about 76%, while massive new investments in production capacity are being made in Asia. The drop in the dollar has primarily affected trade with Europe, and Europe isn't stealing our jobs. As long as Asia buys our dollar debt and continues to hold their currencies down against the dollar, job growth will happen there, but not here. Even when China and the rest of Asia "finally float" their currencies, few jobs will come back to America.

In the United States, we only produce 45% of the manufactured goods we consume and much of that production is in electricity, petroleum refining, chemicals etc., that are capital intensive, with few workers required. Critically, many of the workers listed as employed in manufacturing are not engaged in manufacturing at all but in design, marketing, and distribution. Even if the Chinese currency doubled in value, the labor cost for a worker in China would still only be a fraction of the cost for an American in America. The sad fact remains that Personal Income growth will not happen because of job growth. Personal Income remains under pressure as higher "valued added" manufacturing jobs are exchanged for lower paying part-time and service jobs. America is losing manufacturing jobs paying $45,000 - $60,000 a year so it needs three new service jobs paying $15,000 - $20,000 a year just to replace the one manufacturing job that was lost.

So, where are Americans and their mountain of debt headed?
If the days of borrowing more - courtesy of both the Federal Reserve and Asia's Central Banks - are winding down later this year when Asia revalues its currency, it looks like there will only be two ways out: increased inflation and debt default. Both are likely. When those Chinese goods at Wal-Mart go up 30% in price, Americans will see inflation. The Fed will accommodate most of the inflation, but there will be a rise in interest rates. Inflation, if allowed and encouraged, will save the wage earner so he can continue to service his consumer debts. Rising interest rates will smash into housing prices like a tornado in Kansas. Homeowners who have a 30-year fixed rate mortgage will come out in the end, if they don't have to sell their home for at least 10 years. Anyone who wants to sell their home will see some "asset deflation," and financial institutions will experience substantial "debt default." The Federal Reserve will "print money like crazy" to fight asset deflation and encourage inflation. Sometime before or after the Presidential election, the financial markets will be interesting, but painful to many.

Richard Benson
February 12, 2004

President
Specialty Finance Group, LLC
Member NASD/SIPC
2505 S. Ocean Boulevard - Suite 212
Palm Beach, Florida 33480
1 800-860-2907
eMail: [e-mail]

[xchrom]

1. thanks for the article

though i'm the wrong person to clearly explain my thoughts on this -- it seems to me that part of this over all problem lies in americas over reliance on mega corporations for it's economic health.
bigger in this case is not better. lack of diversity in the economy must strain the seams as well.

[beyurslf]

2. I work in the mortgage industry and I see this problem all the time

People are maxed out. CA is one of the best examples (or worst, depending on your perspective). As home prices have soared everywhere, they have skyrocketed there. Many customers will refinance their mortgage for 200,000 and find their home valued at 500,000. They take out equity lines maxing that additional value. if they don'd spend wisely and overuse the equity line, they coudl find themselves 500.000 in debt.

[54anickel]

3. Yes, I just love the way many of them hand you a "credit card" that

is tied into your equity. We got one of these a fews year back when we borrowed for an addition. They gave us the money for the addition along with a credit card for the rest of the equity, without us even asking. When we tried to turn it down, the loan officer said, "Take it anyway, it's already here and approved. You never know when you might need it." We wanted the credit account closed, he wouldn't do it. So we took the card and cut it up, but I did not want that damned thing on our credit report.

[dace]

6. Open cards with zero balances help

When you have extra credit that is not being used, i.e. cards with zero balances, it actually increases your credit score so having it, and not using it is good. The credit agencies view it as "excess capacity" and will qualify you for lower rates on the things you do buy like cars, appliances, etc. I have 48000 in "excess capacity" spread across five cards with zero balances. My credit score "776". Just my two cents.

9. But Japan has funded this and it will run out

There is only six months or so left for mortgages.

Do the math yourself.

[54anickel]

10. I would have to dig to find a link, but it's my understanding that China

is heavily invested in Ginnie & Fannie mortgage securities. That's where they have been recycling most of the "Wal-mart" booty.

13. China has less reserves

But it is also not clear when they report a number, how much is ALREADY in US-currency.

That is to say, a 500b "reserve" number might already include some US treasury holdings.

Note some countries report two separate numbers--one of native reserves, and another of foreign currency holdings.

[54anickel]

15. Found one of them

http://www.jsonline.com/bym/news/dec03/195898.asp

Beijing's central bank, the People's Bank of China, buys mortgage-backed bonds from both U.S. home-lending agencies, Freddie Mac and Fannie Mae, to the tune of $48.6 million on average every workday. In that way, the central bank lends its vast dollar reserves, a byproduct of China's trade surplus with the United States, to Main Street homeowners. Those funds in turn help sustain the U.S. housing boom and put money into the pockets of American consumers.

"China, in other words, not only provides U.S. consumers with cheap, high-quality goods," said Joseph Quinlan, chief market strategist in New York at Banc of America Capital Management, it also lends Americans the money to buy the goods.

China's financial relationship with the United States goes well beyond consumer loans.

China maintains an even higher credit limit with the federal government. China's reserve bank buys some $187 million in U.S. Treasury securities every business day, helping fuel the nation's record federal deficit - which in turn pays for its military expansion, its welfare programs and the economic recovery.

18. But the China numbers are tiny compared to the Japan numbers

The China numbers are actually "tiny"

The point being, Japan has been outspending China by a factor of ten. And Japan is eating away at fixed reserves in order to do this.

China:
48.6mil * 30 days = 1.458bil
187mil * 30 days = 5.61bil

vs.

Japan
65 billion in December

==That's about ten times greater for Japan vs. China==

So I don't think you can say China has much effect compared to Japan, for the last few months.

[xchrom]

4. kick

5. Debt growth without job growth has never happened like this, no?

This is more of a question still in my mind...whether that point has been reached.

Without job and income growth which "rockets", the best outcome from this appears to be stagflation, followed at some point by deflation again.

To wit, if they cannot raise interest rates--like you say, I have not analyzed your story in detail--and they are relying on currency hedging to offset inflation temporarily (see Greenspan testimony, and my follow-up), it seems like they are "caught."

There was just a story on the wire, by the way, on how China and Japan are going to buy up US debt "forever", which I find hard to believe, because all resources on this earth are finite.

Is there any estimate on how long these guys can keep up at a rate of 100 billion a month or so (my guess going forward)?

CASTING A WIDER NET
Last month the Bank of Japan purchased $65 billion in U.S.
dollars, a pace that, if continued, could surpass its purchases
of $188 billion for all of last year.

http://biz.yahoo.com/rf/040213/financial_ginniemae_2.html

[junker]

7. There is another issue on funding your life on debt, as a country or a

person, at some point ALL disposable income goes to debt service....
that point has been past..

now in 2006 at current rates of debt growth, ALL federal tax income will be required for debt service. Further in the next year, ALL income from ALL sources for the govt will have to go to debt service...leaving nothing...called bankruptcy...

8. I just did the calculation

Debt growth cannot go past midyear. Based on the most recent rates of purchase by Japan, and their remaining reserves, their is only about six months left.

So based on simple math, you can see that debts could start having problems in a few months.

Check out my info on my website, or on DU.

[54anickel]

11. Japan is not only using their reserves. They too, are expanding

their money supply - printing yen - going into debt. They have jumped on the bandwagon. Another reason for the US pressure on the EU and why Snow gave Japan that little pat on the head at the G7. The EU is fighting against the monetarism ideology.

I would have to dig thru posts in the SMW thread to find the links.

12. Sure, they could issue on their side

They could issue bonds or some other instrument, but not at that velocity--it would cause an impact of its own. That velocity is HIGHER than the US deficit.

65bil*12=770bil/yr >> US 2004 deficit (500-odd? bil)

No matter what, there is a crunch coming at the current draw, which seems to be related to dollar/yen at the most recent level.

The US will be forced to raise interest rates, in the best scenario. All this stuff about 'waiting until 2005' is baloney. If they try that, it will end in disaster before then.

[54anickel]

14. They already have and it is sitting on the sidelines to use in

currency intervention to stem the rise of the Yen. They are not trying to hold the yen at a precise amount, but they do not want to see it rise to quickly. How fast they burn thru their reserves and the "new money" depends on what happens in the currency markets.

There is no doubt the US will have to raise interest rates, the question is when. Once foreigners stop buying our debt, we will probably (for a while anyway) buy our own debt. That is the last trick in the bag that Greenspin hasn't had to use YET because of the currency interventions. They will continue to try and hold off, at least until November.

16. But it won't last until Nov

Based on the simple math, it won't last until then.

Yes, they have "it"--the amount I cited. At the current rate of draw and dollar/yen, Japan's reserves will be exhausted at mid-year.

This is real bad if their target was to "get GB re-elected." It seems to not be working. The math doesnt work out. The whole thing backfired. Like the war.

Let's say Japan were to continue this until November, they would have to borrow heavily, which would cause draw on the world bond market, which would cause an interest rate spike.

Lose-lose.

I am telling you--there is no way the current state can continue for much longer, let alone until November. Rates can't be low until then.

[54anickel]

17. There's no disagreement here on the fact that rates cannot stay low

forever, much less until November. I think that somehow we got crossed over in this thread. There is a lot going on right now in the currency "wars".

Start with the Snow job about the "strong dollar" and how a declining dollar value is GOOD for the economy. Sure it is, because it's overvalued. Right now thanks to our huge deficit and trade imbalance the greenback is barely worth the paper it's printed on. It's like when someone effs up really bad and says, "I meant to do that". So they hand us the line that a lower dollar will decrease out trade deficit. But what came out in the last report? It INCREASED. Why, because we shifted too much, too fast from domestic goods to imported goods. Thanks to all that off-shoring and out-sourcing.

They've managed to eff things up so badly we are stuck between a rock and a hard place. Increase interest rates and the whole economy based on debt suffers a world of hurt. They don't have to do that as long as foreigners continue to buy our debt. That will come to an end very soon. Right now China and Japan are so awashed with our worthless greenback that they'll use them in the currency markets to keep their currency from increasing. For the time being, that's better than using them as fish wrapping. But they are rapidly getting less bang for the buck. It used to be an intervention by Japan would settle the market for at least a week, now it's a matter of a few hours.

Japan has said they would begin to look to diversifying their portfolio to other options besides dollars in the next month or so. China has been building up their oil and gold reserves with a lot of their bucks for the last few months.

The only way to get foreign banks to continue to buy our debt is to raise the rate of return - interest rates. So yes they are closely related, I just don't see the "direct" relation between foreign investment and consumer debt that your statement of "do the math" alludes to.

Perhaps I am misunderstanding what you're trying to state.

19. Yes we both understand the same, I am trying to estimate and quantify

What I am trying to understand is where the limit is on the current state of easy credit. Many people are apparently guessing and saying "oh, it has to be after the election."

Not good enough.

In doing this, I look at the Japan expenditures vs. reserves.

And by that measure, there isn't enough money for it to last past mid-year.

See my calculations above based on China--showing the amount is tiny compared to Japan. And by the way, China could pull money home due to the bird flu outbreak.

But I guess it is a sound prediction to say interest rates will go up, and/or the dollar will crash by midyear. That's only a few months away. The math is actually easy to prove that, no?

[54anickel]

20. Ahhh. OK. You look at expenditures vs reserves, I look at expenditures

vs sanity and geopolitical pressures. Either view comes up with the same prognosis - they cannot and will not keep this up forever.

You are assuming it will stop when they run out of reserves. I am assuming it will stop when either they regain sanity or they are more confident in their own economies.

Japan is regaining confidence rapidly now. Their uncertainty is based upon the extremely long period of deflation - once bitten, twice shy.

China has a bit of housekeeping left to do for their central banks, bad debt write-offs and getting a handle on what could otherwise be excess capacity. Too much duplication of efforts in certain sectors of their economy due to lack of over-sight on the rapid expansion.

I think once they each get control of their issues, they will allow their currency to rise, slowly and controlled in the beginning.

This is the scary part actually, as the Fed wants a drop in the dollar, but how to keep it orderly will be another matter if the Asian tiger decides to dine on the greenback rather than nurture it.

[54anickel]

21. Hey Junker, question for you......

Do you have any good links/references on the Kondratieff Long Wave Theory? It seems to be a very interesting topic and I've notice you've referenced the K-winter a few times.

Perhaps you would be willing to share your own views on it?

I've just started reading about it. I've read this link:
http://www.ldusa.com/roger/kond_overview.htm

I was hoping to get a bit of guidance on researching the topic. There is an awful lot of info out on the net to sift thru.

Edit to add the link I referred to (Doh!)

[54anickel]

22. A kick, looking for Junker......

[junker]

23. Sorry no links. I have a couple of works by Kondratieff in rusky...

but no e-links. I will see what I can dig up for you.

[54anickel]

24. Thanks, don't go to too much trouble. Just thought you'd have

some thoughts or decent references to share.

[54anickel]

26. I came across this piece by Ian Gordon. Thought it was pretty good.

Does this seem to be an accurate interpretation to you? This is a very interesting subject.

http://www.ldusa.com/roger/ian_gordon_jan2003.pdf

The best introduction to the theory I've been able to find so far is this one. The chart of the current cycles looks legitimate, history was not my best subject. :shrug:

http://www.ldusa.com/roger/kond_overview.htm

25. Are the 100b in"orphan" US Treasury Bonds a Sign?

You guys ask if it is the "point of no return."

Have we found a sign? How does Japan bouncing 100b in US Treasury bonds a month grab you?

What about next month, and the month after? What if they have to issue Japanese bonds to pay for US currency and bonds?

[TheWhitneyBrown]

28. I have a topic I really want to say, but I can't post it.

I don't know why, all I get is a page saying I can't post because I already opened a page to post on. I can't figure it out.

[54anickel]

29. That error is usually if you had a second DU page up in a browser...

I get this one a lot. I'll close the other DU page, get the error the first time I hit post, but it will usually take on the second (or third)time I try. Use the back button if you want to retry posting after getting the error.

Hope this helps. :hi:

[TheWhitneyBrown]

27. So most of the asset deflation will come out of housing?

I hope that's all.
I think it will also come in either higher taxes, or more likely because of politics, much less services for the same taxes.