The Illusion of the Bush Economy's Growth is Revealed

Ever since I have been writing about the economy (about 4 years) I have focused on the mammoth increase in US debt during this expansion. It has led me to question the underlying vitality of this expansion as a whole. Events of the last six months indicate the markets are also asking the same question right now, although in a somewhat different way.

In effect, the economic dominoes are starting to fall. Ultra-low interest rates which inflated asset prices and allowed an explosion of debt are starting to seriously bite as a financial system is burdened with too much bad debt on its books. In addition, the market is starting to realize that asset prices -- namely housing -- were ephemeral and will have to drop. In effect, the entire economy is going through a process of reevaluating "the greatest story never told" and are discovering it wasn't that good a deal to begin with.

Let's start with a few basic charts.

Above is a chart from of total household debt. Notice the curve is almost parabolic over the last few years -- and especially this expansion.

Above is a 10 year chart of household debt. Notice it has increased from about $8 trillion to a little under $14 trillion, which is a really big increase.

As a result of this increase in total household debt outstanding, the householed debt payment ratio has increased to the highest level in 25 years.

Let's place the household debt level in perspective. Here is a chart tabulated every 5 years of total household debt outstanding and its percentage of GDP and total disposable income. The GDP and disposable income numbers are from the Bureau of Economic Analysis and the household debt numbers are from the Federal Reserve's Flow of Funds Report. The figures for 2007 are for the third quarter.

Notice that both percentages jumped sharply during this expansion. This is what easy credit will do for you.

Now -- this massive debt orgy has allowed the US to inflate its home prices.

This has allowed Americans to extract home equity loans from their homes to buy more stuff. Because home prices increased so much in value, Americans felt richer, so they felt as though they could spend more.

Now, I'm not alone in questioning this expansion. Business Week has an article titled, How Real Was the Prosperity?" where they ask the same question.

Consumer Spending: The rule for a prudent individual is simple: Don't spend more than you make. For a long time, the U.S. economy obeyed that rule. As far back as the 1960s, personal spending, adjusted for inflation, has basically tracked the overall growth of the economy, as measured by gross domestic product. Sometimes consumers would get ahead of the economy for a few years, and sometimes fall behind, but never for very long.

That pattern changed in the 1990s. As of the third quarter of 2007, the 10-year growth rate for consumption was 3.6%, vs. GDP growth for the same period of 2.9%. This difference represents an enormous gap. If consumer spending had tracked the overall economy over the past decade as it has in the past, Americans today would be spending about $600 billion less a year. The extra spending has amounted to a total of about $3 trillion since 2001.

Consumer Lending. The past 10 years will go down as one of the greatest consumer-lending sprees ever. Adjusted for inflation, consumer debt--including mortgages--rose an average 7.5% per year since 1997, far faster than the 4.2% rate of the previous 10 years. The last time debt rose so fast was the 1960s, as the postwar generation bought homes and autos. If Americans had kept borrowing at their pre-1997 pace, they would have had about $3 trillion less in debt.

Corporate Earnings. Yes, there's been a profit boom in recent years. Corporate earnings, as measured by government statisticians, have averaged 8% of GDP over the past decade, up from a low of 6.5% in the early '90s. That has helped propel stocks upward.

But here's an unfortunate truth--the profit surge has been mainly in one area, financial services. Financial institutions have benefited from the consumer credit boom, the proliferation of new financial instruments, and relatively low rates. By contrast, the earnings of nonfinancial companies over the past decade have averaged about 5.3% of GDP, about the same since the mid-1980s. There are few signs of any acceleration, even after years of restructuring.

Right now we're just starting to deal with the hangover from this debt orgy. The entire financial sector has been wracked by writedowns for the last 6 months. No one has been spared. Estimates are for total writedowns of $300-$500 billion. So far, we've only had $100 billion or so, so we have a ways to go.

We just had the weakest holiday season of the last 5 years, indicating consumers are starting to get tapped out -- they can literally borrow no more. While it is never a good idea to bet against the American consumer who will sell his mother to buy the next thing, high gas and food prices, a tanking housing and stock market and a weakening job market will undoubtedly provide some serious headwinds for the foreseeable future.

Consumer lending is going through the wringer right now as well -- and for good reason. It use to be that all you needed to get a loan was a pulse. Now you actually have to have a credit score.

But the central problem of this expansion is all of that debt has to go somewhere. You can't just slice and dice a pool of debt into many pieces and completely eliminate risk; that just can't be done. But everyone thought you could do it, which is basically how we got into this mess in the first place. Now everyone has the pleasure of choking on a ton of bad loans. And it's not going to stop anytime soon.

To make matters worse, the level of debt in the economy assumes a certain asset value. For example, if a banker makes a $100,000 loan for a $100,000 house and the home starts to decrease in value, the banker will at some time have to writedown the value of the loan. So as home prices decrease anyone who owns mortgage related debt (and that is literally everyone on the planet) will have to writedown the value of their debt. This constrains their ability to make new loans, which hurts an economy like the US which depends on credit creation.

That's the central point to the Business Week article's title. This expansion is based on the inflation of an asset class -- namely, housing. As that asset increased in value, consumers felt wealthier and therefore spent more. They extracted more equity from their homes for more consumer purchases. This was a net positive for consumer spending and the economy as a whole. However, as that asset value decreases -- which is what we are experiencing now -- the exact opposite is also true. Consumers will spend less because they feel less wealthy. And they probably will for some time.

Comments

[bumpersticker]

It reminds me of Annie singing "Tomorrow" - it's always a day away. Easy credit, budget deficits, and financial stimuluants can all be a nasty Daddy Warbucks time-warp that creates the illusion that tomorrow will always be a day away.

This Annie-like illusion is shown in the massive borrowing from other countries, in waging war that is not budgetted, in extending credit based on "Today" never quite happening, and providing stimulants to keep pushing "Tomorrow" past the end of the Bush adminitration.

Credit isn't always bad, but we have lost the sense that we must pay for what we do during our watch - be it a family or a Presidency.

[Patriot323]

None of this matters. Money is air. Money is debt. we could have $1,000,000­,000,000,0­00,000 trillion in debt, but it won't matter. You see, none of this 'money' is real. It's all air. We own the world because of LEVERAGE. We will continue to own the world because of MILITARY POWER. I am not worried. The US will be the power for the next 100 years because of leverage. They have this all under control, it's all fixed. Everything is fixed and they are playing the public like a fiddle. Just sit back, be smart and don't get into debt. That simple.

[retarius]

This is very interesting stuff...bu­t with so much data available about different aspects of the economy, one can make a seemingly plausible argument for pretty much any position..­.see the guy below that uses the charts to show that Bill Clinton caused this mess!

MY own view is that we are looking in the rearview mirror, when we should be looking ahead. In my opinion, lowering interest rates isn't going to do much...we overdosed on cheap credit already...­plus banks don't want to lend to people that may not be credit worthy, and so with the mammoth amount of debt that Americans already carry, what bank is going to lend them more at lower rates to buy consumer goods?

In my opinion, there is a festering sore on the center of American values. Basically solipsism on a national scale.

[dolphy]

Let's start betting now and see where the stocks will bottom out. 9000, anyone?

[Cid]

So, uh.....how much is old mom worth anyway? I just saw this bitchin' flat-screen that I just gotta have! (/sarcasm)

[CAPTAINSKIPPY]

The Bush economy is great and works well - for the robber barons.

[GH]

And continuing:"That's the central point to the Business Week article's title. This expansion is based on the inflation of an asset class -- namely, housing. As that asset increased in value, consumers felt wealthier and therefore spent more."

Don't see any real reason to argure with that, on the surface. So the Question is: Why do we appear to celebrate the expansion of the last expansion, while condemning this one, when (Understanding that the longer lived underlying and longer term dangerous trends simply continue.)

From Baker again (EARLY 2003): :It’s a good story, but the reality is quite different. The Clinton boom was built on three unsustainable bubbles. One of them, the stock bubble, has already burst. The other two bubbles—the dollar bubble and the housing bubble—are still with us. The dollar bubble is starting to deflate, and the housing bubble is perhaps just now reaching its peak. These bubbles created the basis for the 2001 recession and the economy’s continuing period of stagnation.

The basic facts of the economy’s rapid deterioration over the last two years are widely known. After creating an average of more than 3 million jobs a year from 1996 to 2000, the economy has lost more than 2 million jobs since March 2001. This reversal has been associated with a rise in the unemployment rate from an average of 4 percent in 2000 to 6 percent today. The increase among African-Americans has been even larger, rising from 7.6 percent in 2000 to 10.9 percent in April, and larger yet for African-American teens, with the unemployment rate rising from just over 24 percent in 2000 to peaks as high as 35 percent in March. While real wages were growing at close to a 2 percent annual pace in 2000, wage growth has recently fallen to zero for most workers.

The economy’s reversal was associated with a plunge in the stock market.'

[GH]

Ya got the title wrong again, Hale. It should be,"The Illusion of the Clinton and the Bush Economy's Growth is Revealed."

Leftie economist Dean Baker already summed up the Clinton economy, which was in ruins - and creating the massive shift from surplus to deficit, by the time Bush came in as: "The Clinton boom was built on three unsustainable bubbles. One of them, the stock bubble, has already burst. The other two bubbles—the dollar bubble and the housing bubble— are still with us. The dollar bubble is starting to deflate, and the housing bubble is perhaps just now reaching its peak. These bubbles created the basis for the 2001 recession and the economy’s continuing period of stagnation­."

http://www.inthesetimes.com/site/main/article/bursting_bubbles

The rest of the picture is in your graphs: In ever single exhibit, it is clear as a bell that the negative trends, which you (and indeed we should be) were established and accelerating as Bush took his seat in the oval office.

Now with "Total household debt as a % of GDP, the 2005 - 2010 projection is right back to the 1995 - 2000 numbers (about 5%). The huge leap from 2000 to 2005 was caused by the massive historic 2000 collapse of the late 1990's bubble economy.

Exact same pattern for the "Household debt as a % of total disposable income." When millions of hard working Americans lost their jobs and their income and their life savings from the 2000 bubble crash and the thousands of companies that went out of business and downsized, a massive shift occurred in the numbers.

Looking for political smear is the name of this game Hale. Looking to solve the long entrenched problems facing us would serve you and us better.

[Phideaux]

Great insights BONDDAD!
Looks like the new coin-of-the-Realm after the melt down will be ammunition.

Me thinks I'll spend my (borrowed from China) $600 Government refund on as many boxes of shells as it will buy.

[CharlesMac]

There is no reason to believe that the excesses of expansion of one asset class did not spread to other equity valuations. They are not discrete and independent.

My example is my dipstick neighbor (a fine and intelligent individual). At the end of 2006, he had a $3,000 bonus. He invested it in the stock market, by adding to his Best Buy position in Jan 2007. He then bought a $3,000 HDTV (at his favorite store, Best Buy) on a credit card. Which he moved to his Home Equity line of credit, because he is "not stupid" to pay the cc interest rate.

So he bought stock with debt.

There is stock essentially on margin in the Market. It has all worked in a nice little circle. Buy the goods, so the P/Es look good, then buy the stock.

The example is the market's retail sector, but there is no reason to believe it isn't in the entire market.

The graphs show good argument that debt service has become a problem for households, along with commodity prices. The circle is breaking down.

The Administration meme has been "The economy is great. LOOK AT THE STOCK MARKET." Did anybody notice how Repub tapdancing changed? A bunch of soundbites had them mentioning that the stock market isn't a reflection of the economy.

All Bernanke did was give the consumer a bit of breathing room. And averted a triple takedown of the market. He calmed the panic, but there is still a double discount of future earnings and valuations to occur. Spending and the percentage that is an equity bubble.

A debt conversion cycle will suspend the inevitable.

But it is coming.... the debt has to be paid.

[mmckinl]

The Trillion Dollar Swindle

The 100 million stimulus is designed to give the Fed another Trillion to bail out their shareholders, the Money Center Banks. Because our Government will have to borrow this money the debt placed in the Fed will be leveraged 10 to 1 using debt based fractional banking.

And now we find out the Bond Insurers will need 200 Billion to bail them out ! Just yesterday the New York State Insurance Commissioner said it would be 15 Billion !

http://business.timesonline.co.uk/
tol/busine­ss/industr­y_sectors/
banking_an­d_finance/­article324­8731.ece

[Oldtimer]

This is one of the most important posts I have
ever seen on HuffPost. I wish that Arianna
would start a new department, a new feature
that breaks down the economy in graphic terms
like this. Instead we are getting Pollstrology
when what we really need is Ross Perot with
his simple charts and pointer in hand. If Al
Gore can win the Nobel Prize with his charts
and graphs why can't America, with all it's
TV business shows and punditry, produce a
spokesperson who can lay out these eceonomic
facts succinctly? Wall Street and it's TV
personalities are pulling the wool over everyones eyes and they are getting away with
it. As for Bush, our liar-in-chief, expect
all his labor statistics to be as honest as his
state of the union speeches. He is lying about unemplyment figures. This economy is not producing jobs that can pay for jumbo loans.
I'd like to see a chart that shows the percentage of income required for housing in
the 60's, 70's, 80', 90's....
I'd like to see a chart for percentage of
income needed for gas, for healthcare, for
education. Is everything going up and soaking
up the consumer's buying power? Is this not
ADDING FUEL TO THE DEBT FIRE?

[Pdubya]

Don Luskin Named Economic Advisor to the Ron Paul 2008 Presidential Campaign

“Ron Paul’s economic plan is the real thing… not just a band-aid”

ARLINGTON, VIRGINIA – Newly appointed Ron Paul economic advisor, Donald L. Luskin, issued the following statement about Dr. Paul’s proposed comprehensive economic revitalization plan:

“Ron Paul’s economic plan is the real thing – a plan. It’s not just a band-aid designed to ‘stimulate’ the economy in an election year. It’s a fundamental agenda for real and lasting change, making the US economy more vibrant and competitive, and removing barriers to advancement for all Americans.­”
Donald L. Luskin is Chief Investment Officer for Trend Macrolytics LLC and contributing editor to the National Review Online and SmartMoney.com. He is also a frequent guest on CNBC, and the author of two books: Index Options and Futures: The Complete Guide and Portfolio Insurance: A Guide to Dynamic Hedging.

Mr. Luskin is available for interviews regarding Congressman Paul’s economic policies.

Congressman Paul’s comprehensive economic revitalization plan can be found online at: www.RonPaul2008.com/Prosp...

http://www.ronpaul2008.co...

[OutsideLookingIn]

Much the same has been said in more understandable and accessible language in one of the most popular and widely-read magazines in New Zealand, see:

http://www.listener.co.nz/issue/3533/columnists/10388/be_prepared.html;jsess
ionid=F34B­F294E2F5DA­93CF209646­22D1AFDA

Your average New Zealander is better informed about the coming crisis than your average American.

[NicoleAnonymous]

this is kind of off-topic but is this legal?

I'm trying to pay off all my credit cards but I've been good about making my payments on time for more then the minimum. I've never had a late payment except once I was a day late because I forgot to go to the bank but that card is paid off. I was looking at my Washington Mutual balance and couldn't understand why I was paying so much interest. It turns out they raised my APR to 25% although I always pay on time and haven't done anything wrong.

Can credit card companies change our interest rate anytime they want without a reason? Shouldn't it be the same APR that you had when you got the card?