Saturday, July 31, 2010

Optimism Dims as GDP Slows, Trade Gap Widens and Consumer Confidence Falls

The U.S. economy lost momentum in the second quarter, as GDP slowed to a 2.4% annualized rate. The average over the previous two quarters was 4.4%.

However, first quarter GDP was revised upward to 3.7%, from the prior estimate of a 2.7%. Yet that just made second quarter growth appear even worse.

Consumer sentiment also fell to 67.8 in July, from 76 in June. This is a critical development since consumer spending accounts for 70% of GDP.

Though disposable income rose 4.4% in the second quarter, cautious consumers were hanging on to their hard-earned money.

Personal savings were estimated at 6.2% of disposable income last quarter, significantly higher than the 4% that had been estimated earlier.

As a result, consumer spending slowed to an increase of 1.6% after growing at a 1.9% annual pace in the previous two quarters.

As consumers continue to cut debt and save, it will result in even slower economic growth and fewer jobs in the future.

The Conference Board's chief economist predicts a 1.6% annualized rate for the second half of the year. That raises fears of a stagnating economy, and may even signal coming deflation.

The nation's trade balance continued to worsen, reaching $426 billion in the second quarter.

Imports grew at a much faster pace the exports, which rose at a 10.3% rate. However, imports soared at a 28.2% clip, the most in 34 years.

The problem with the trade deficit is that it creates a drag on GDP and jobs. Buying goods from abroad means they are not being made here at home.

Net exports subtracted 2.8 percentage points from growth. Imports had a record negative contribution to quarterly GDP.

There is no reason to suspect that the trade gap will improve any time soon, and it will continue to weigh on GDP growth.

Even as consumer spending slows, government spending is increasing, driven by extended unemployment benefits, emergency aid to struggling states, and growth in the food stamp program. A stunning one-in-eight Americans are now using food stamps, the Supplemental Nutrition Assistance Program.

Government spending rose at a 4.4% annual pace after a 1.6% drop in the first quarter. Spending by state and local governments rose 1.3%. Federal spending rose 9.2%. Government spending added 0.9% to growth.

For most Americans, none of this can be taken as a sign of progress or recovery.

The slowing GDP reading was also due, in part, to dwindling federal stimulus money. And its full exhaustion will further hinder growth in coming quarters. Coupled with weakened consumer sentiment and spending, the US economy will be hard pressed to recover.

Yet, we now know that the economy wasn't nearly as robust or healthy as we had thought, even preceding the recession.

The government also released revised data for the last three years on Friday, which revealed that the economy was on shaky legs as far back as 2006.

According to the Bureau of Economic Analysis, for 2006-2009, real GDP decreased at an average annual rate of 0.2 percent. GDP was revised down 0.2 percent for 2007, 0.4 percent for 2008, and 0.2 percent for 2009.

The US faces a series of structural issues that will be very difficult to overcome: an over-reliance on foreign oil that negatively impacts the trade balance; a dismantled manufacturing base that will be difficult to resurrect in a highly competitive and unbalanced global economy; a retiring Baby Boom population that will receive costly entitlements; the fastest growing demographic is people over 85, which is an unproductive populous; massive public and private debts that need to be paid down; and the combination of stalling GDP / shrinking tax base that will worsen the debt-to-GDP ratio.

In the current environment, it is very difficult to find a ray of sunshine.

Growth would need to equal 5% for all of 2010 just to lower the average jobless rate for the year by one percentage point. Clearly, that is not going to happen.

Advanced economies are mature economies, and are therefore harder to grow. The sad reality is that growth has been rather slow for a number of years.

Since the second quarter of 2006, there has only been one quarter in which GDP was at least 4%. And the 5.6% growth in the fourth quarter of 2009 was largely the result of government stimulus spending.

Aside from the 16 million unemployed Americans in need of work, the economy needs to add about 150,000 jobs a month just to absorb the annual increase in population and the entrance of new people into the workforce, such as college grads.

We are years from what was once considered normal, and may have in fact entered a new normal.

Optimism is indeed scare.

Friday, July 30, 2010

California Facing $500 billion in Unfunded Pension Debt

According to a study done by Stanford University's public policy program, California's real unfunded pension debt amounts to more than $500 billion, nearly eight times greater than officially reported.

Studies by Northwestern University and the University of Chicago reached similar conclusions.

These pension burdens are weighing heavily on the Golden State's budget.

This year, $5.5 billion was diverted from higher education, transit, parks and other programs in order to pay a fraction of current unfunded pension and healthcare promises.

Without reform, that figure is set to triple within 10 years. As it is, California's pension costs already rose 2,000% from 1999 to 2009.

Obviously, this is simply unsustainable. Other programs for the majority of Californians are already becoming unaffordable. Education, in particular, has taken a severe hit.

Existing pension costs are a ticking time bomb for the state because they amount to contractual promises that must be met.

Retirement and healthcare costs will weigh heavily on California for many years, even if future pensions are soon reformed. New employees may not receive the same rich guarantees as their predecessors, but the old obligations will remain crushing.

However, enacting necessary reforms will require taking on the powerful public employees' unions, who will wage war to protect their generous benefits.

Saving the state from these bloated pension costs will be an epic battle; the state's public employees have collective bargaining rights.

But legislators will have to engage that fight soon, otherwise the Golden State will be renamed the Red State due to all of its budgetary red ink.

Thursday, July 29, 2010

Grim Milestone: Bank Failures Reach 100 for Second Consecutive Year

On Friday, seven more US banks failed, brining the total to 103 this year. It marked the second consecutive year that bank failures exceed 100.

Since the creation of the FDIC in 1933, there have been only 12 years in which 100 banks have failed in a single year.

And we've just experienced two of them in a row.

The pace of bank failures this year is well ahead of last year, when 140 banks were shuttered. That marked the highest number of closures since 1992, during the height of the savings and loan crisis.

It seems that there are still many more failures to come; by the end of the first quarter, the number of lenders on the FDIC's "problem" banks list had climbed to 775, the highest since 1992.

The banks on that list are most likely to fail, yet their names are never made public out of a fear of creating a run on those banks.

Bank failures over the past two years pushed the number of FDIC institutions to below 8,000 for the first time in the agency's 76-year history. Two decades ago, the FDIC insured more than 16,000 institutions nationwide.

The FDIC has been desperately trying to raise capital from the banks to deal with the flood of failures. The problem is that many of these banks are already under-capitalized, hence the reason they are failing.

The government changed accounting rules for banks during the financial crisis so that they no longer have to mark the properties they've foreclosed on to market values. Banks have been allowed to "extend and pretend," as they await the housing market to recover. That could take many years.

If they had to mark these "assets" — which at this point could be more accurately described as liabilities — to current market values, even more institutions would be revealed as bankrupt.

As the commercial real market continues to falter, and more loans go bad, the losses at banks will become overwhelming. And there is a good chance that US taxpayers will end up footing the bill for these failures, as well as the bad loans that are causing them.

Saturday, July 24, 2010

Housing Bubble Continues To Lose Air

If you've been holding your breath waiting for the housing market to rebound, you should exhale. The air continues to go out of the market as well.

After a 15% drop in May, housing starts fell another 5% in June, according to the Commerce Department. Housing starts are now at their lowest level in eight months and 76% below their 2006 peak.

Despite record-low mortgage rates, demand for housing remains low. For months, the housing market had been on government life support, buoyed by the federal tax credit. Now that the credit has expired, the market has fallen.

With an abundance of inventory available due to foreclosures and short sales, it's no surprise that housing starts are declining. Builders are putting on the breaks. Inventories of unsold new homes stand at 40-year lows.

That's because we are mired in the worst housing downturn since World War II.

However, the market simply isn't going to bounce back to its previous highs. Unemployment is too high to support a renewed demand for housing, and consumer credit has been decimated. A whopping 35% of Americans have credit scores too low to even qualify for a loan.

Home builders are fully aware of this ugly reality and they are very discouraged. The builder sentiment index fell back to a 15-month low in July on the heels of a large drop in June.

In the past decade, housing demand was artificially inflated due to a massive increase in the monetary base — which increased bank lending — and an equally massive cut in the federal funds rate to the lowest level in more than 40 years. Both of these schemes were initiated by the Federal Reserve.

This combination created a false prosperity, which ultimately fueled a false demand.

The deflation of the housing bubble is an ongoing process, and the air will continue flowing out of that bubble for the foreseeable future.

Wednesday, July 21, 2010

Trade Imbalance Sucking Money, Jobs Out of US

The US trade deficit widened to $115 billion in the first quarter, or 3% of US GDP, according to the Bureau of Economic Analysis. That amounted to over a billion dollars a day.

It was the third consecutive quarterly increase. And yet this negative trend continued in May, as the trade deficit reached an 18-month high.

Typically the trade gap is blamed on oil imports. However, oil imports sank 9.1 percent to $27.6 billion as both the price and the volume of oil shipments declined.

The trade deficit continues to widen even though exports rose 17% in the first quarter. The problem is that imports continue outpace exports. This means an awful lot of money is flowing out of the United States.

The concurrent flow of imports into the US is displacing American jobs. We're buying all these foreign goods instead of making them here at home.

The trade gap creates a drag on GDP. If we could export more, we would increase GDP.

When the economy tanked in 2009, both imports and exports declined, yet the trade imbalance was more than halved. The trade deficit hadn't been that small in a decade. Now, as exports are significantly trailing imports once again, the trade imbalance has re-expanded.

Such an imbalance is simply unsustainable.

In June, Treasury Secretary Tim Geithner warned that other countries can’t rely on US consumers to propel the global economy. Given the state of US unemployment, plus consumer spending and confidence levels, that seems like a reasonable conclusion.

The reason our economy melted down in the first place was because it was built on a bubble of debt. American consumers simply cannot continue taking on ever more debt while serving as the world's primary consumer.

Our unemployment problem will lead to further imbalance.

America needs to produce more, export more, and save more. For more than a quarter-century, we did exactly the opposite. And that's exactly what we need China to do now; import more and spend more.

Our trade gap with the China is the largest of any individual country, reaching $22.3 billion in May.

Although China, Germany, Japan and the US — like all other countries — would love to be net exporters with trade surpluses, not every nation can fit that profile. Someone has to buy.

For a long, long time, that has been the US. The problem for the US is that we don't export nearly enough to continue paying for all those foreign goods.

Exports represent nearly half of Germany's GDP, 30% of Great Britain's, 28% of China's and just over 10% of US's, according to Fred Hochberg, president of the Export-Import Bank of the United States.

That's not just bad for the US; it's bad for all those nations who want — rather need — us to buy their goods. Without US exports, where will the money for all this commerce come from?

As noted, the current situation is simply unsustainable.

Tuesday, July 20, 2010

Bad Credit Scores Affecting More Than 1/3 of Americans

New figures show that 25.5 percent of consumers — nearly 43.4 million people — have a credit score of 599 or below, marking them as high risks for lenders.

According to John Ulzheimer, the President of Credit Education at, even in the loose credit years of the previous decade — when almost anyone was extended credit — a 600 credit score was still considered sub-prime.

The key dividing line between prime and sub-prime is a score of 650. When the number of people whose credit score is below 650 are added up, they total 70 million people, or 35 percent of consumers. These are the people considered to be at an elevated credit risk.

Normally, just 15 percent, or 25 million people, fall into this high risk / sub-prime, category. But credit scores have worsened considerably for a much larger percentage of the population. Ulzheimer says this is the biggest shift in FICO score distribution he's ever seen since the score became widely available in 1989.

This bottom 35 percent of consumers are either denied credit outright, or they are charged exorbitant interest rates. This applies even to credit cards.

The FICO score ranges from 300 to 850, though the highest score is exceptionally rare. Scores in excess of 750 are also rare, and individuals with these scores can pretty easily attain credit and are often courted, if not aggressively pursued.

These worsening credit scores mean that more than a third of Americans won't qualify to buy a house or a car. That lessened demand will have far-reaching effects across the economy, limiting GDP growth.

It will also affect those 70 million people in the most direct sort of way.

Most Americans have gotten used to mitigating the effects of low or stagnant wages though the use of credit. And the unemployed may be entirely dependent on it.

For many of them, those days are now over.

Saturday, July 17, 2010

Decreased Lending Shrinks Money Supply

Deficit Reduction Will Shrink It Further

The size of our continuing deficits and bloated debt have politicians concerned and citizens scared. The fiscal path we are on has been repeatedly characterized as "unsustainable" by economists, members of Congress, and the Federal Reserve.

The IMF warns that US gross public debt will reach 97% of GDP next year, and 110% by 2015.

Willingly, or unwillingly, change is on the horizon. The federal budget will be cut.

If the US were to cut its projected 2010 deficit in half by 2013 — as agreed to at the G-20 summit — that would be a cut of $780 billion. There is no easy way out of this. It will cause a lot of pain to a lot of people.

As the government begins paying down its debt, standards of living will decline.

With a national debt exceeding $13 trillion and other debts and obligations — such as Social Security, Medicare/Medicaid and veterans payments — reaching $99 trillion (according to the Dallas Federal Reserve), the only hope the US has to repay these debts is by inflating its currency to the point that it loses value. Fixed debts can then be paid back with devalued money.

However, events seem to have gone beyond the reach of the government and the Federal Reserve. Despite their best efforts to stimulate the economy and create at least a little inflation, the threat of deflation now seems more likely.

An unintended consequence of shrinking government spending will be shrinking the money supply, since virtually all “money” today originates as loans or debt.

However, the money supply has already been shrinking at an alarming rate.

In a May 26 article in The Financial Times titled “US Money Supply Plunges at 1930s Pace as Obama Eyes Fresh Stimulus,” Ambrose Evans-Pritchard writes:

“The stock of money fell from $14.2 trillion to $13.9 trillion in the three months to April, amounting to an annual rate of contraction of 9.6pc. The assets of institutional money market funds fell at a 37pc rate, the sharpest drop ever."

As Professor Tim Congdon from International Monetary Research notes, "It’s frightening. The plunge in M3 [money supply] has no precedent since the Great Depression."

This is not good for the banking system since the vast majority of the money supply is created by banks as loans (or credit). And since bank loans are now virtually the only source of new money in the economy, the interest can only come from additional debt.

Just this week, the earnings results of the three biggest US banks were announced, and they weren't encouraging.

Bank of America, the largest U.S. bank by assets, said Friday that second-quarter net interest income was $13.2 billion, down 10% from $14.7 billion in the same period last year.

J.P. Morgan Chase, the second-largest U.S. bank by assets, said net interest income was $12.8 billion in the period, down 13% from a year earlier, largely driven by lower loan balances.

And Citigroup, the No. 3 U.S. bank, reported a 13% drop in quarterly revenue. Average loans in the company's Regional Consumer Banking business fell 2% to $218 billion, partly driven by declining balances in North America.

Consumers and businesses simply aren't taking out new loans. Instead, they're still focused on reducing the massive debts they racked up during the boom of the previous decade.

In this environment, bank revenues will likely remain flat or continue to shrink. When you combine decreased borrowing in both the private and public sectors, the money supply will continue to shrink.

Unfortunately, the economy will continue to shrink along with it.

The pace of events is outstripping the efforts of the Treasury and the Federal Reserve. It seems that neither is able to control the shrinking money supply and, therefore, they cannot control the outcome.

Thursday, July 15, 2010

Fed Downgrades Economic Forecast; Dilemma at Hand

The Federal Reserve has downgraded its forecast for economic growth in the second half of the year and into 2011.

In fact, Fed officials believe it could take five to six years before the US economy is fully recovered from the Great Recession of 2008.

The Fed foresees more years of high unemployment, very low interest rates, continued deleveraging, and the persistent threat of deflation.

With the economy showing signs of faltering, Fed officials are considering a range of options to stimulate growth. But the reality is that, in this battle, the Fed may have finally run out of bullets.

After spending the beginning of this year talking about how to exit from its extremely loose monetary policies that injected trillions into the banking system and housing market, the Fed is now wondering what more it can do to increase demand and stimulate growth.

However, there's a disagreement at the Fed Board about exactly what is happening, and what they should do about it. There are those at the Fed who fear inflation, while others worry about deflation.

The ones who worry about deflation are starting to think the Fed should be doing more. But with interest rates already near zero, you have to wonder, what more can they do? Mortgage rates are already near all-time lows.

Last year, the Fed bought $1.7 trillion worth of mortgage bonds and Treasury debt. Perhaps they could try more of that, but how much further can they expand the Fed's balance sheet? Massive infusions of cash into the economy would have the same effect on the Fed's books. And there are disagreements among Fed officials about how effective that would be anyway.

If the Fed were to launch a new asset-purchase program, that may cause global investors to lose faith that the Fed will be able or willing to pull money out of the economy in time to prevent inflation. That would lead the investors to demand higher interest rates on long-term loans.

Investors could also come to fear that the Fed was "monetizing the debt," or printing money to fund budget deficits.

And, of course, both of these possibilities would be counterproductive.

Central banks utilize monetary policy, or the manipulation of the money supply, to control inflation. An inflated money supply in relation to the amount of goods and services in the economy eventually results in price inflation throughout the economy.

The Fed, like all central banks, prefers inflation to deflation. Yet despite all its best efforts, deflation still appears to be a threat.

Despite massive monetary stimulus, including $1 trillion in excess bank reserves, the Fed expects consumer prices to rise only about 1% this year and less than 2% per year over the next two years.

If deflation does indeed take hold, the Fed will pull out all the stops and take the most dramatic measures to thwart it. Deflation, a dangerous cycle of falling prices, could actually spur the Fed to undertake another round of massive asset purchases, despite the risks that it would entail.

The reality is that there are no good options. Every move will have undesired consequences.

Without a doubt, the next couple of quarters, and years, will be fascinating, to say the least.

Wednesday, July 14, 2010

Latest Indicators Spell Trouble for US Economy

The US trade deficit widened to an 18-month high in May, catching many economists by surprise. The amount of money flowing out of the United States indicates that economic growth may be slowing. That's a bad sign for an already weak US economy.

According to the Commerce Department, the overall US trade gap for goods and services rose nearly five percent to $42.3 billion in May, from $40.3 billion in April.

Notably, the deficit cannot be blamed on oil imports, which sank 9.1 percent to $27.6 billion as both the price and the volume of oil shipments declined. Consequently, sales at gas stations also fell, down 2% as pump prices also declined.

Of greatest concern, perhaps, the trade deficit with China — the largest with any individual country — widened to $22.3 billion in May, from $19.3 billion in April. It was the biggest gap since last October.

However the trade data was mixed.

Imports climbed nearly three percent to a 19-month high of $194.5 billion in May, while exports also rose 2.4 percent to a 20-month high of $152.3 billion. So the good news is that exports are climbing, but they are being outpaced by imports.

Exports add to GDP, while imports reduce it. That's why it's critical for the US to increase exports and decrease its reliance on cheap consumer imports. Simply put, a trade deficit creates a drag on the economy.

In fact, the trade deficit may result in a 1-2 point reduction in economic growth for the second quarter. The US economy grew by 2.7 percent in the first quarter, but various indicators show the expansion may slow in the second half of the year.

China has undervalued the yuan in relation to the dollar to keep its products artificially inexpensive in the US while discouraging US exports into China, There are now concerns that the growing trade gap could create a wider rift between the two nations.

This controversial currency policy, which the Chinese central bank vowed to loosen just weeks ago, is contributing to high unemployment in the US. And it undermines President Obama's goal of doubling exports within five years to increase both jobs and growth.

But China is not the only obstacle to that goal.

The European debt crisis has slowed growth in Europe and raised the value of the dollar 14 percent this year versus the euro. As with China, a stronger dollar against the euro makes US goods costlier and less competitive in Europe.

The deficit with the European Union rose 7.5 percent to $6.2 billion as imports rose 3.2 percent, outpacing a 1.9 percent rise in U.S. exports to that region.

The upside to the rise in imports is that it indicates US consumers are spending once again. But given the state of unemployment, housing, consumer debt, and the state of the overall economy in general, this is a confounding development.

Consumer spending increased in four of the first five months this year (April was flat, but not declining). In fact, consumer spending rose at a 3 percent pace in the first quarter.

However, the data is contradictory.

Retail sales fell 1.1 percent from April to May, marking the first decline since September 2009. But, on a year-over-year basis, core retail sales were up 4.5 percent from May 2009.

And now we find that retail sales decreased 0.5% in June, further indication that the economy is slowing. Retail sales are a critical indicator because they account for about half of total consumer spending.

Two consecutive months of declines don't paint a portrait of confident, free-spending consumers.

In fact, the consumer confidence index plummeted to 52.9 in June — the lowest level since March — from a downwardly revised 62.7 in May. That's a huge drop. A reading above 90 indicates the economy is on solid footing; above 100 signals strong growth. By this measure, we are a long way from recovery.

And, rather suddenly, consumers are saving again. Cautious Americans saved more in May than at any time since September. According to the Commerce Department, the personal savings rate in May -- the part of every paycheck that goes unspent -- rose to 4 percent, the highest amount in nearly a year.

In this environment, it is not possible for US consumers to increase both savings and spending.

So the data is quite contradictory. No matter, American consumers simply won't rescue the US economy by purchasing foreign goods.

Given the challenges facing US consumers, it's hard to envision domestic consumption — which accounts for 70 percent of GDP — leading the US into economic recovery.

And given the expanding trade gap, it's also difficult to imagine exports leading the recovery either.

So what will? Your guess is as good as mine. But the numbers don't look good.

Sunday, July 11, 2010

Prepare For Tax Hikes & Budget Cuts

The world economy is reaching a point of stagnation, and perhaps contraction will follow. Consumption has dwindled. However, we live in a perpetual growth system that cannot handle this sort of pullback.

So governments around the world have jumped into the breach with absolutely massive stimulus programs designed to rekindle growth. Under the current economic model, if you're not growing, you're dying.

However, all of this government spending has led to a run-up in government debts. As we've seen in Europe, this spooks markets and can lead to a credit crisis. That can make it difficult, if not impossible, for nations to borrow money. And even if they can, the costs are prohibitive.

As a result, the G-20 nations have pledged to cut their deficits in half by 2013, and to "stabilize or reduce" their debt-to-GDP ratios by 2016.

The debt-to-GDP ratios of some of the world's largest economies — including the U.S. and U.K. — are stunning and potentially dangerous.

The U.K., the world's seventh largest economy at $2.1 trillion, is facing a massive debt burden and a depressed currency. The U.K. faces a deficit that is 12.5% of GDP (similar to Greece), and a national debt equaling 72% of GDP. But when private debt is added, things get a lot worse.

A study by the McKinsey Global Institute found that the U.K. has the world’s worst private and public debt in comparison to GDP, with a ratio of 470%. Yet, due to artificially low interest rates, the problem stands to get a lot worse as those rates inevitably rise.

In an effort to address its fiscal shortfall, the U.K. government outlined a budget intended to eliminate its structural current deficit through a combination of spending cuts, a two-year public sector pay freeze, a bank levy, and tax increases.

U.K. Chancellor of the Exchequer George Osborne announced an immediate increase in the capital-gains tax paid by higher earners from the current 18% to 28%, and the value-added tax will increase from 17.5% to 20% in January, 2011.

This is what the U.S. has to look forward to; tax hikes and budget cuts.

The U.S. is currently facing a current budget deficit that is 10% of GDP, and the 2011 deficit is projected to rise to 11% of GDP. Meanwhile, the national debt recently topped $13 trillion. The long-run projections of the Congressional Budget Office suggest that the U.S. will never again run a balanced budget. Imagine that.

If the U.S. were to cut its projected 2010 deficit in half by 2013 — as agreed to at the G-20 summit — that would be a cut of $780 billion. This will result in a lot of pain for a lot of people. There is no easy way out. It's going to hurt a lot.

However, the Obama administration recently said it will work to reduce the U.S. fiscal deficit to 3% of GDP by 2015. That would amount to a $994 million budget cut.

While these reductions are desperately needed, they will severely impact the lives of tens of millions of Americans.

Since two-thirds of the federal budget is comprised of Social Security, Medicare, payments to veterans, and interest on the national debt, cuts to these items will range from painful to impossible. The U.S. cannot — will not — default on its debt payments, so the cuts will come from the aforementioned entitlement programs.

The government will not be able to significantly reduce the debt it has recklessly run-up unless it does it on the backs of the American people. Many of them will be the most vulnerable; the elderly, the disabled, the poor and the unemployed.

The effects of budget cutting will be brutal and lasting. And it seems that day of reckoning will soon be at hand.

Undoubtedly, the bloated military budget should be — needs to be — significantly reduced. But that's a story for a future article.

To be continued....

Thursday, July 08, 2010

Personal Savings Rebound Is Both Blessing & Curse

Consumer spending increased in four of the first five months this year (April was flat, but not declining), which, given the state of employment and wages, was a rather strange development. In fact, consumer spending rose at a 3 percent pace in the first quarter.

But upon further inspection, it was revealed that Americans were tapping into their savings to fuel the spending upticks.

What Americans haven't been able to afford outright, they've bought with credit.

Total household debt is now nine times what it was in 1981 — rising twice as fast as disposable income in the same period. Though it's been dropping for the last two years, household debt is still $13.5 trillion, exceeding disposable income by $2.5 trillion.

Deficit spending indicates a lack of savings. Simply put, Americans have been spending money they don't have for quite some time.

In the 1970s and 1980s savings as a percentage of GDP were in the 5 - 7% range. In the decades since, personal savings have declined to the 1 - 3% range.

In 2005, the savings rate actually turned negative for the first time since the Great Depression, and it stayed that way for about two years. The lack of savings has some far-reaching effects. Millions of Americans are unprepared for a financial emergency, or for retirement.

The percentage of workers who said they had less than $10,000 savings grew to 43 percent in 2010, from 39 percent in 2009, according to the Employee Benefit Research Institute's annual Retirement Confidence Survey. That excludes the value of primary homes and defined-benefit pension plans.

Workers who said they had less than $1,000 jumped to 27 percent, from 20 percent in 2009.

As interest rates have decreased, so, too, has the American savings rate. In search of better investments, some Americans have shifted out of savings accounts because of declining rates of return. Other Americans simply had nothing left to save; wages have been stagnant since the 1970s.

In early 2009, savings in aggregate as a percentage of GDP went negative for the first time since 1952, and has continued its downward trend. This includes consumer savings, corporate savings, and government savings/surpluses.

The lack of savings creates an inability to domestically fund the huge deficits being run up by the federal government. That forces the nation to continue relying on foreigners to finance our debt.

But, rather suddenly, consumers are saving again. Cautious Americans saved more in May than at any time since September. According to the Commerce Department, the personal savings rate in May -- the part of every paycheck that goes unspent -- rose to 4 percent, the highest amount in nearly a year.

While this has its virtues, it will also present some challenges.

Consumers have begun saving at a time when the U.S. economy needs their dollars the most. Any hope for a recovery rests on consumer spending, which comprises 70 percent of our nation's GDP.

Unfortunately, Americans weren't saving during the salad days of the last decade. Instead, they were consuming and creating debt. And now, when they are needed to spend the economy out of its doldrums, there is very little to tap into.

American consumers are rightly worried about the economy and about their own personal finances. So they are paying off debt. And recent reports indicate they are putting off large purchases, like homes and the durable goods that fill them.

An increase in the personal savings rate, while usually a welcome sign, is just exactly what the US economy doesn't need right now. On the other hand, all the debt creation of the last decade is what got us into this mess in the first place.

At the moment, it is both a blessing and a curse. But given the state of the economy and wages, a savings increase is probably just a temporary phenomena. Most Americans will likely end up spending all of their income on essentials anyway.

Whether that will be enough to jump start the economy seems unlikely.

Wednesday, July 07, 2010

Our Deficit & Debt Problems Are Guaranteed To Worsen

And They are the Fault of Both Political Parties

The financial position of the US doesn't look good right now. That's because for the better part of four decades, our government has consistently spent more than it has taken in. Since 1970, the Federal Government has run deficits for all but four years (1998–2001).

Politicians, regardless of their political stripes, love to show voters in their districts that they can deliver, that they can bring home the bacon. This results in an array of "earmarks" for public works projects, like roads, bridges and public transportation infrastructure, plus more dubious expenditures.

But these earmarks are not the real drivers of federal budget deficits. Congress is on pace to spend $11 billion on disclosed earmarks in fiscal year 2010, according to Taxpayers for Common Sense.

While that is indeed a lot of money, in relative terms it's a pittance. The federal budget for fiscal 2010 totals a whopping $3.55 trillion. That amounts to more than 35,000 billion dollars. What this means is that earmarks account for just .032% of the total budget.

Americans are rightfully concerned — even angry — about the size of our annual budget deficits and their effect on our swelling national debt, which has now surpassed $13 trillion.

Much of this anger is currently directed toward President Obama.

As a lifelong Independent, I approach this criticism in a purely non-partisan manner. That said, I think it is important to make the facts clear.

Fully two-thirds of the federal budget is made up of mandatory spending. These are the items for which Congress lacks the discretion for spending, such as Social Security, Medicare/Medicaid, payments to veterans, and interest payments on the debt.

Even if there were no more deficit spending — in other words, if the government spent only what it collects in revenues — there would still be an enormous debt. And there also would be billions of dollars in interest payments still owed on that debt.

Ceasing deficit spending will not erase the debt. It won't even begin to address it. To begin paying off the debt would require the government to spend less than it collects in taxes for many years, a near unimaginable proposition. And it would require the politically combustible combination of tax hikes and budget cuts.

The government's fiscal year runs from October 1 to September 30.

During fiscal year (FY) 2008, the national debt increased by over $1 trillion. That was before Obama even took the oath of office.

In July 2008, the budget deficit for the fiscal year ending in September 2009 was projected to reach $482 billion — the highest number ever recorded.

Yet, the Congressional Budget Office later projected that the deficit for FY2009 would total $1.2 trillion, or 8.3 percent of GDP. However, supplemental appropriations for the Iraq and Afghanistan wars, and earmarks, eventually pushed the figure even higher.

During FY 2009, the federal government collected approximately $2.1 trillion in tax revenue. However, the government spent nearly $3.52 trillion — up 18% from FY2008. That resulted in a budget deficit of $1.42 trillion, significantly higher than the $482 billion originally projected. And the former projection would have been a record.

It should be noted that the fiscal 2009 budget was also enacted before Obama became president. The point is, we've been on a collision course with a hard reality for decades, and the impact date was rapidly accelerated during the last one in particular.

During the past decade, Congress passed two separate rounds of major tax cuts. Meanwhile, the military has been fighting two separate and very lengthy wars. From the beginning, this was a recipe for fiscal disaster.

As noted, approximately two-thirds of the Federal Budget is comprised by Social Security, Medicare & Medicaid, payments to veterans, and interest on the debt. Cuts to these budget items will range from brutal to impossible.

Meanwhile, federal revenues have been falling due to high unemployment and lower incomes. For example, during FY2009, the U.S. government collected about $400 billion less in tax revenues than in FY2008. At 15% of GDP, the 2009 tax collections were at the lowest level of the past 50 years.

Budget shortfalls are not some new phenomena. From FY 2003-2007, the national debt increased approximately $550 billion per year on average. In relative terms, from 2003-2007 the government spent roughly $1.20 for each $1.00 it collected in taxes. This increased to $1.40 in FY2008 and $1.90 in FY2009.

George W. Bush was president during all of these fiscal years. This is not to put the blame squarely on his shoulders, but it is worth remembering that deficit spending has long been a way of life in Washington. This problem goes back 40 years. Each party has contributed to the problem. Whether it's lower taxes or higher spending, the result has been continual deficits and a burgeoning debt.

All politicians promise the citizens exactly what they love to hear; you can have all the government services you want, without paying for them.

Two concurrent wars and falling tax revenues are currently driving our annual budget deficits. Perhaps Obama can be blamed for not halting two unending and unwinnable wars. The rising national debt will eventually force the US to offer higher interest rates to buyers of that debt.

Paying higher interest rates will slow economic growth. And aside from the higher costs to service the debt, the government fears slower growth because it would make the debt-to-GDP ratio even worse.

Much of the anger towards President Obama centers around the stimulus program enacted shortly after he entered the White House. How the money was spent is certainly up for debate, but since it was government spending, there was surely graft and waste.

While the stimulus was widely described as a $787 billion spending bill, $300 billion of that was directed toward tax cuts for 95% of Americans. So it was, in actuality, a $487 billion spending bill. One thing almost all economists recognize is that as bad as this recession has been, without all of that government stimulus upholding the economy and stepping in for reluctant consumers, things would have been even worse.

But while all that deficit spending lessened the problems associated with a stagnant or shrinking economy, it created an even worse debt problem. And the associated tax cuts also reduced Treasury revenues and added to the deficit.

The government was able to undertake its massive Keynesian spending practices (aka, stimulus, or deficit spending) during the Great Depression because it didn't enter that period with the massive debt levels it has today. That is now our Achilles Heel.

The U.S. was already running massive deficits even before tax receipts plummeted, which is making matters worse. As a result of consumer retrenchment (due to unemployment and the housing collapse), government spending is the only thing presently under-girding the economy, even as it increases the deficit.

However, if the government reduces spending, that will have a negative effect on GDP. In past recoveries the growth of the private sector has overcome that negative effect. But the private sector isn't truly recovering, and it cannot recover unless consumers recover. It's all a big, vicious cycle.

The deficit certainly needs to be cut. But cutting the deficit too fast could also throw the country into an even deeper recession. Deficit reduction will also reduce GDP. That means the government collects less taxes, which makes the deficits worse, which means it has to make more cuts than planned, which means lower tax receipts, and so on and so on.

The important thing is for Americans to fully understand the problem, and to not blame the president or any one particular party. They are all to blame. Our "leadership" hasn't led. Our politicians have been shortsighted, reckless, dishonest, and irresponsible. Both parties have failed us.

As I said, we've entered a big, vicious cycle. And life is going to become even more painful for most Americans.

In short, it's going to get ugly. Count on it.

Tuesday, July 06, 2010

Strategic Defaults Pose Huge Risks to Banking Industry

At the halfway point of 2010, 86 US banks have gone under. That is well ahead of last year's pace, when 140 banks were closed.

There have been only 11 years since the creation of the FDIC in 1933 that 100 banks have failed in a single year. We are now on track to surpass that number for the second consecutive year, and we may do it before the summer ends.

To provide some perspective, just three US banks failed in 2007, and 25 US banks were closed in 2008, which was more than in the previous five years combined.

However, this year the FDIC is bracing for a wave of bank failures due to foreclosures and commercial real estate failures. That will cost the agency billions of dollars at a time when it is already facing financial trouble. The agency is expecting an additional $20 billion in losses over the next three years.

At the end of 2009, the federal deposit insurance fund carried a negative balance of $20.9 billion. To manage the crisis, the agency raised $5.6 billion in a special assessment and $46 billion in prepaid quarterly assessments last fall. For accounting purposes, the agency will add that gradually over 13 quarters.

What this means is that the FDIC has $30.7 billion ostensibly insuring $4.83 trillion in deposits.

In the fourth quarter of 2009, the FDIC said there were 702 lenders on its "problem" banks list, the most since 1993. Yet, by the end of the first quarter, the list had climbed to 775, the highest since 1992.

The banks on this list are most likely to fail, yet their names are never made public out of a fear of creating a run on these banks.

Bank failures over the past two years pushed the number of FDIC institutions to below 8,000 for the first time in the agency's 76-year history. Two decades ago, the FDIC insured more than 16,000 institutions nationwide.

Lenders are facing additional stress since many mortgage borrowers are deliberately choosing to default when their mortgage exceeds the value of their property. These "strategic defaults" have become a heavy burden for the banking industry.

A Federal Reserve study showed that when equity falls below 50%, half of defaults are strategic.

According to CoreLogic, more than 11 million homeowners across the country are underwater. It's estimated that number could double in the next year, which means nearly half of all American mortgage holders will owe more on their homes than those homes are currently worth.

That would spell disaster for the banking system. And the FDIC would be quite challenged to cover all the losses.

Friday, July 02, 2010

Housing Declines Reach New Records

New Housing Data Will Spur Calls for Extension of Tax Credit, but the Program Was Plagued With Fraud

The pending home sales index, a leading indicator for sales of existing homes, plunged 30% in May. According to the National Association of Realtors (NAR), the decline is a new record low.

The index, which measures signed sales contracts on previously owned homes, was down 15.9% compared with the same month a year ago. And it had risen 23% between January and April.

The sharp drop in pending home sales mirrors the 33% drop in sales of new homes in May, which are also recorded at the time of the sales contract. That was the slowest pace in the 47 years records have been kept.

This is terrible news not only for the housing industry, but for the national economy in general.

The expiration of the first-time home-buyer's tax credit was largely faulted for the declines.

The program, which expired in April, gave qualified homebuyers up to $8,000 in the form of a refundable tax credit. They got the cash even if they owed no taxes.

However, homebuyers did get a little more time to close on their homes and receive the tax credit. This week, Congress voted to extend the June 30 closing deadline until the end of September. But that only affects those who met the April deadline to sign sales contracts.

The tax credit has helped more than 2.5 million people buy homes, and the program has distributed $18 billion in tax credits.

With that kind of money available, there were bound to be unscrupulous individuals taking advantage of the program and taxpayers. In fact, the IRS says it has blocked almost 400,000 questionable claims, stopping about a billion dollars from going out improperly.

However a new report from the IRS's chief watchdog discovered tens of millions of dollars in fraud.

Though the tax credit applied only to a primary residence, an estimated 1,300 inmates fraudulently collected the tax credit from behind bars. In fact, there were more than 200 people serving life sentences who cashed in.

The Treasury inspector general for tax administration says his team found more than $17 million in credits for homes purchased before the start of the program — including some bought 10 years ago. And some 10,000 taxpayers collected credits on homes that had already been claimed by someone else. In one case, 67 people all used the same address.

So while there will be calls to extend the program further to reinvigorate the housing market, it was very expensive to all taxpayers and was fraught with abuse.

Thursday, July 01, 2010

Peak Oil Is Upon Us. Gulf Drilling Is Proof

Evidence of Peak Oil is all around us.

Have you heard of Peak OIl? Do you know what it is?

Peak Oil is the point in time when the maximum rate of global petroleum extraction is reached, after which the rate of production enters terminal decline.

According to numerous experts in the field, that time has arrived. Global oil supplies have peaked even as global demand continues to grow.

No less an authority than the Energy Information Administration (the statistical and analytical agency within the U.S. Department of Energy) says that Peak Oil is all but upon us.

At present, global usage is outstripping new discoveries. For every four barrels of oil we consume, we discover only one.

The desperate need to find new oil sources is driving BP and other oil companies to go to great extremes — such as extracting oil from deep beneath the sea.

In 1979, Shell Oil set a record by drilling in over a thousand feet of water in the Gulf of Mexico. By 2003, ChevronTexaco was drilling 10,000 feet down in ultradeep water. Think about that; that's nearly two-miles below the surface.

The reason oil companies are going to such extremes is that land-based oil is getting harder and harder to find. Nearly every major find of the past decade has been a deep water find. This, it seems, is where much of the remaining extractable oil is to be found.

Even as onshore oil production is declining around the world, the demand for petroleum is increasing around the globe. So, oil companies are drilling in deeper, and riskier, waters. By the end of this decade, up to 40 percent of our oil could be produced offshore.

According to Interior Department estimates, there could be as much as a three-year supply of recoverable oil in the Gulf, and more than two years’ worth of natural gas, at current rates of consumption. But those estimates are based on seismic data that is, in some cases, more than 30 years old.

The eastern Gulf of Mexico (where BP was drilling when disaster struck) is believed to contain as much as 3.5 billion barrels of oil. However, the U.S. alone uses 7.66 billion barrels per year. That amounts to just 5 1/2 months of oil at current usage.

Perhaps this give you an idea of the kind of pickle we're in. It's crunch time, as in "oil crunch." The Deep Water Horizon wasn't just in nearly a mile of water; it was also drilling three miles into the ocean floor. These are truly desperate moves.

Tad Patzek, a top petroleum engineer and professor at the University of Texas, calls drilling in deep waters an "extremely difficult, harsh environment" and says that the technology that works there "can only be compared in its complexity to technology that we use in space."

Does anybody doubt that if oil were discovered on the moon the oil companies would find a way to get there and bring it back?

Desperate times call for desperate measures. And the people who follow supply and demand issues are worried.

Dr Richard Ward, the Chief Executive Officer of insurance giant Lloyd's of London, is warning that the world is facing a “period of deep uncertainty” over the decline of fossil fuels – and may soon be coping with $200-a-barrel oil.

Dr. Ward recently issued a stark report in which he warns business managers to be ready for “dramatic changes” as oil, gas and coal supplies will soon be “less reliable and more expensive.”

The world “has entered a period of deep uncertainty in how we will source energy for power, heat and mobility, and how much we will pay for it,” Ward states.

The reason we should heed his warning is that insurance companies are in the business of assessing risk. They make large financial calculations based on likely outcomes.

The entire U.S. economy — in fact, the entire global economy — is completely reliant on oil. Without it, everything comes to a halt. And without new sources to feed a growing population and developing economies, there will no economic growth — only stagnation and then contraction.

The U.S. consumes 21 million of the 86 million barrels of oil used around the world each day. U.S. consumption is higher than any other nation and equals the combined consumption of the next five largest national consumers (China, Japan, Russia, India and Germany).

The ability to meet this tremendous demand has allowed the U.S. economy to expand vigorously, outpacing the rest of the world for a century.

But the availability of oil can change quickly.

In 1970, the U.S. was still the world’s oil largest producer, yet its crude production peaked at a level never since exceeded. What may be surprising to most people is that the U.S. is currently the world's third-biggest oil producer, following Saudi Arabia and Russia.

However, our seemingly unquenchable appetite for oil also makes us the world's largest oil importer by far. The U.S. imports almost two barrels of crude for every one it extracts.

In the U.S., we love the automobile and it is still our primary means of transportation. About two-thirds of our oil consumption is for transportation.

In every way, conservation will have to begin in earnest.

Oil, and the access to it, has allowed the U.S. to assume its preeminence in the world. The arrival of Peak Oil could eventually level that playing field, perhaps quite considerably.

Peak Oil is upon us.