I’ve been concerned about the state of the U.S. economy for several years, but only recently has mainstream America started waking up to the severity of the crisis. Even the depths of the Dow bear market in 2003 didn’t engender this much pessimism. At the time, most people still believed that stocks would go up in the long run, and it was time to scoop up the bargains.
The bargain hunters looked right when the markets rallied strongly for the next four years. Although last October the Dow breached 14,100, it’s been a bumpy ride down since then. The U.S. suffered it’s worst June stock market slump since 1930. In only a month the Dow plunged 10.19%, the Nasdaq dropped 9.10%, and the S&P lost 8.6%.
Unlike the previous bear market, investors don’t have dramatic home price appreciation to fall back on. Most urban and suburban areas were enjoying annual double digit increases from 2002 through 2005 according to the S&P/Case-Shiller Home Price Indices. Now the top twenty metropolitan regions are down an average of 15.8% since last spring. Real estate speculators can no longer count on home equity loans to generate extra cash when needed.
Now I sense the level of fear is elevated, even among the middle class. Americans don’t believe this downturn will be over quickly. Even the managed press has dropped much of its optimistic facade, and some are mentioning the “d word” - depression. Reporters are openly mocking the fantasy economic indicators released by the government. John McCain’s campaign advisor Phil Gramm called the financial distress in the U.S. a “mental recession” and was roundly criticized.
Once you investigate the real economic condition of the United States, you realize how vulnerable the middle class is. One researcher who has been shining the light on bankruptcy and financial stress in this group since the 1980s is Elizabeth Warren, a professor at Harvard Law School. One of her presentations filmed in 2007 (based on her research in 2005) is available on YouTube here (https://www.youtube.com/watch?v=akVL7QY0S8A). I highly recommend you watch it and pass it on to friends and family.
In the video, Warren asserts that most families need both parents to work to enjoy the trappings of a middle class lifestyle - an average size house in a safe neighborhood, adequate health care, a college fund for the children, and a couple of late-model cars. This is a stark change in only a generation. Warren points out that in the early 1970s, most families only had one employed parent, usually the father. Thirty years ago, a mother with a six year old was less likely to hold a job that the mother of a six month old infant today.
If families are pulling in two incomes in this decade but are still struggling, where is the money going? Warren originally expected that the middle class was blowing their budget on designer clothes, gourmet food, and fancy appliances. However, data from the Commerce Department told another story. The family of 2005 spent 32% less on clothes, 18% less on food, and 52% less on appliances than the equivalent 1970 family. Electronic gadgets only account for an increase of $300 per year adjusted for inflation. In short, discretionary spending as a percentage of income was down.
Fixed expenses however, are sharply up. While today’s families are spending less per car, most households need two vehicles to commute to work. Child care and preschool are common expenses for many parents that were rare in 1970. A two income family also means a 25% increase in taxes. While the median house grew slightly by about one room in the past three decades - McMansion developments notwithstanding - mortgage payments rose by
76%. Employer sponsored health insurance costs 74% more than in 1970, and may not cover many of the expenses. Not coincidentally, today’s families are spending three-quarters of their income on basic needs, compared to only 50% of wages in the 1970s.
Despite these realities, the media portrays people who file bankruptcy as irresponsible spendthrifts. In contrast, 90% of bankruptcies are caused by family breakup from death or divorce, job loss, or health problems, not conspicuous consumption. Some 20% of broke families suffer all three catastrophes which cause them to plunge into a lower economic class. Children are more likely to experience a bankruptcy in their family than a divorce. Unlike divorce, bankruptcy is often hidden from everyone due to the social stigma.
Children are a major risk factor for middle class financial calamity. In 2001, 7.4 out of 1000 childless married couples filed for bankruptcy. The number more than doubled for parents.
Warren’s research found that two income families are surprisingly more vulnerable to becoming poor than one income families. In the past, if the father was laid off, there was generally a worker in reserve who could step in. Even if the mother did not have an equal earning potential, at least the family could gain a small income plus an unemployment check.
Today families depend on two incomes to pay their expenses, so the chance of financial disaster has doubled. They require all 104 paychecks per year. The average savings rate has dropped from 11% of income in 1970 to net negative. These families are living so close to the edge - barely able to pay their fixed costs like their mortgage and utilities - that any misfortune can push them over the edge to bankruptcy. Too often these families fall out of the middle class and never regain their previous standard of living. Warren sees the U.S. in a disturbing trend of stratification into two classes - a large lower class and a small group of rich people.
If anyone in the family gets sick, income will likely crash. Warren found that women with critically ill children stay at the hospital until they get fired. Even if the child or spouse is discharged from the hospital, someone has to stay home to care for their medical needs. Patients are sent home “quicker and sicker” than a generation ago, and families must take up the slack. I know a woman who recently quit her job to care for her father-in-law, as this was more economical than trying to purchase nursing care for him.
With the dire situation facing the U.S. middle class, I wondered what Warren’s solutions would be. I searched for some of her other writing and read through excerpts from her book, The Two Income Trap. I agree with her admonition to cut large fixed expenses now before a personal crisis hits. It’s essential to live within your means. It doesn’t make sense to cut out restaurant meals when your real problem is an unaffordable mortgage. If your budget is strained, you will eventually run out of discretionary items to cut. This is doubly true as the annual U.S. real inflation rate is firmly into double digits, and the price of most necessities is rising at a frightening rate.
I also like Warren’s recommendation to save six months of living expenses in case of an emergency. If you don’t have six months’ worth of expenses saved, get as close as you can. Work on decreasing major outlays so you can save more. Due to the fragile nature of the U.S. banking system, I would spread this savings out between different banks, while keeping some money in cash and highly liquid forms of precious metals hidden in safe but accessible places.
Warren’s idea to get the shortest loan term possible has merit. During the housing bubble, borrowers became overloaded with debt because the monthly payments seemed manageable at first, and they didn’t worry about the mortgage reset. I appreciate that she doesn’t criticize all debt as bad, like I’ve seen some writers do. In a high inflation environment, it makes sense to borrow at an interest rate that’s much lower than M3, especially if you can pay off higher rate debts.
I also concur with Warren that bringing back usury laws would be a excellent way to protect the consumer from predatory lenders. These lenders take advantage of vulnerable borrowers and loopholes in the law to raise rates to unfair levels like 911% per year - reminiscent of loan sharks.
Other solutions offered by Warren are more socialist, and don’t make sense from the Austrian Economic perspective I ascribe to. Noting that homes in “good” school districts cost more than those with “bad” schools, Warren proposes public school vouchers. Unfortunately, this is the educational equivalent of giving aspirin to a cancer patient. Over the past few decades, public schools have received rapidly increasing money and government attention, while turning out increasingly less knowledgeable students. The system is irreparably broken. I would prefer allowing families to be able to opt out of public schools entirely without having to pay the taxes for services they don’t use.
Warren also believes that a college education is necessary to join the middle class, so she wants a tuition freeze for state universities. She complains that tuition is increasing at about three times the CPI rate. Since CPI is admittedly massaged lower by government statisticians, I don’t think it’s valid to use it as a yardstick.
In addition, all the education grants and subsidized, government-guaranteed loans are the cause of the high cost of university. If college students had to prove to loan officers that they deserved the money, or had to pay up front for classes, demand for college courses would drop precipitously. With very few students willing to attend at that price, tuition would drop until campuses were full again. Teenagers can’t get their parents to give them $100,000 to start a business, but many can get that financial commitment to enter college without a career plan or a marketable major.
Continuing the education theme, Warren would like public education to start a year or two earlier with universal preschool. She believes this will help all families. As far as I can tell, universal means mandatory, and I bristle at the thought of adding a new bureaucracy to enforce this policy.
This will also cost more taxpayer funds to expand a system that’s already failing, and unfairly increase the burden on people with grown children or no kids at all. As states like California are already making it more difficult to meet requirements for homeschooling, universal preschool would increase the burdens on these parents.
As a mother herself, Warren is concerned about the struggles of parents. She proposes subsidized child care for working mothers as this is a large budget item. However, she doesn’t want stay-at-home moms to miss out on this largesse, so she believes that these families should also get a government check. Again this policy is unfair to childless people and older parents. Government funds would also cause the cost of child care to rise, just like college subsidies raised the price of tuition.
Warren’s ideas totally collapse when you scrutinize the state of the U.S. federal budget. The government will not be able to deliver on their current promises, much less increase social assistance. As Richard Fisher, President of the Dallas branch of the Federal Reserve stated in a recent speech, the unfunded liabilities of Medicare and Social Security are USD $99.2 trillion.That’s the total if America funded all its obligations now with today’s dollars. The money deducted from your paychecks has long been spent and then some. An increasingly smaller workforce will not be able to support the Baby Boomers through their senior years, and a similar dynamic is occurring in aging societies like Japan.
No matter what you think about the social “safety net,” it’s already starting to erode. Retirees are struggling as their Social Security cost of living adjustments are tied to an artificially low CPI. John Williams estimates that SSI payments would be twice as much if the government used statistics properly. Many large companies have critically underfunded pension plans, and the Pension Protection Act of 2006 requires that benefits be frozen or recalculated in order to make these plans more solvent. Unfortunately, that makes your monthly check a lot smaller. Workers who are counting on a comfortable retirement may find themselves living in poverty if they don’t have a backup plan.
I never like to leave my articles on a hopeless note. I believe there is a partial solution for the coming stratification of the U.S. into two classes, upper and lower. While I can’t save everyone from poverty, I can help my readers get into and stay in the upper class. It is possible to become self-sufficient and fund your own retirement, as long as you don’t follow the talking heads on TV. The majority will not get rich, so you can’t follow the crowd no matter how reassuring this is.
Break from the herd and put the bulk of your savings in bullion. The older you are, the more conservative you should be, which means a larger percentage of metal in your portfolio. Then add to your precious metal position with investments in quality resource, energy, and infrastructure companies like the ones I profile in my newsletter. Reduce your fixed expenses and you will have more money to buy hard assets as well as a cushion in case unexpected events occur.
Copyright © 2008 Jennifer Barry
