Austerity in America

What will austerity look like in America?

State and local governments are broke. Pension plans are unfunded. Unemployment is as high as ever. Sovereign debt is a problem. The total debt in the world economy is too high. Entire western world has borrowed excessive amounts in the last few decades. This is not just the money owed by governments, but it is the money people and companies borrowed from the banks. Debt has reached an all time high compared to the GDP of the countries involved. Perfect storm is coming. Austerity and spending cuts will be deflationary. Why? Are we still in Kondratieff Winter? Or did it end with the 2008 crash? What will the Kondratieff Wave bring next?

Since the start of the European sovereign debt debacle, the word “austerity” has been bandied about a lot.

It wasn’t an everyday word, and may send some people to the dictionary. Merriam-Webster defines “austerity” this way: enforced or extreme economy.

But even knowing this definition might leave one wondering how “austerity measures” relate to Europe’s debt crisis. The Associated Press (5/13) provided this overview:

Austerity has been the main prescription across Europe for dealing with the continent’s nearly 3-year-old debt crisis, brought on by too much government spending. But what does it mean for the average European? Imagine paying sales tax of 23 percent or more. Or having your wages cut by 15 percent. Austerity comes in many forms: higher taxes, fewer state benefits, more job cuts, working longer until retirement, you name it.

How about America? Will austerity measures be imposed on the world’s largest economy? Well, a Marketwatch columnist says “America’s new Age of Austerity is already here…Yes, America is already in a depression.” (5/29)

We agree. In fact, Robert Prechter said as much in the September 2011 Elliott Wave Theorist:

Bulls say the economy is in recovery, albeit a weak one. Bears are calling for a “double dip” recession, like the back-to-back recessions of 1980 and 1982. But, as is often the case, we disagree with both camps: The economic contraction of 2007-2009 was not a recession; the respite since then is not the start of a new economic expansion; and the economy is not going to have another “dip” into recession. The economy has been sliding into depression.

The signs of an American austerity are becoming widely visible. And nowhere is this belt-tightening more evident than in state and local governments. Recent years have seen a multitude of stories that describe reduced services. And in the overall economy, we’re seeing a de-leveraging of debt. Unemployment remains relatively high. Here’s a CNBC headline from today (5/30):

Sign of the Times: 20,000 Apply for 877 Auto Job Openings

This story about a new automobile plant in Montgomery, Alabama is one of many like it that feature jobless or under-employed individuals standing in line.

Above I showed the September 2011 quote from Robert Prechter. Yet he actually foretold much of what is financially happening today in his 2002 book Conquer the Crash.

That’s right. Ten years ago, he described what this age of austerity would look like. Much of what he described looks just like what is going on today. But how about the rest of what’s described in Conquer the Crash?

Yes, there’s more. You see, Prechter pointed out much more than what unfolded in the 2007-2009 financial crisis. Do yourself the biggest of favors and learn what he has to say. Be one of the few who are prepared vs. the majority who will be caught off-guard.

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  • What to do with your pension plan
  • How to identify a safe haven (a safe place for your family)
  • What should you do if you run a business
  • Calling in loans and paying off debt
  • Should you rely on the government to protect you?
  • Money, Credit and the Federal Reserve Banking System
  • Can the Fed Stop Deflation?
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3 thoughts on “Austerity in America

  1. Pingback: Tony
  2. My WSJ subscription ends this month. I just caleld earlier today to make sure it wasn’t renewed. Not only did they raise the cost, but that two-tiered system where you pay extra for premium content is just stupid. Plus they got rid of the Earnings Digest which I thought was great.

  3. Hi Karl,I agree that many first time buyaders will find they were not actuadally helped by the FHOG at all. To your quesadtion, e2€œwhen and how could this maradket botadtom out and what is the potenadtial for fuutre growth?e2€9d I cane2€™t preaddict when the botadtom will be. In regards to fuutre growth, I think we can work backadwards towards an answer. This is long-winded and awkadward, so bear with me. The quesadtion we need to ask is e2€œhow much debt do we have, how much can we hanaddle now and into the fuutre, and what does this imply for the fuutre of house prices?e2€9dSo how indebted are we? Stevee2€™s monthly newsletadter focuses on the big picadture e2€“ the amount of debt comadpared to GDP on a national level. The housading maradket is smaller, and I believe ite2€™s more inforadmaadtive to look at housading debt and priadvate incomes. THD = total housading debt in Australia.THD is pubadlished monthly by the Reserve Bank (D02 LENDING AND CREDIT AGGREGATES e2€“ Coladumn L, Housading (includading secuadriadtiadsaadtions)). This stands at $826.9 biladlion as of December.TPI = total priadvate income in Australia.There are many ways to estiadmate income. I done2€™t know whether ecoadnomadics proadfesadsionadals have a preadferred meaadsure. Ie2€™ve looked at the ABSe2€™s 5206.0 Final Houseadhold Conadsumpadtion Expenaddiadture, but decided it was prone to disadtoradtions. So I use a crude meaadsure instead, the prodaduct of employadment numadbers (ABS 6202.0 — Labour Force e2€“ Trend Employed Peradsons) and income (ABS 6302.0 — Averadage Weekly Earnadings e2€“ Series A597108W).Novemadber 2006, AWE = 846.7, Employed Peradsons = 10,315,300. Annual income estiadmate = $454.1 billion. While this figadure is far from peradfect, and omits non-wage earnadings such as share divadiaddends and interadest payadments, I think ite2€™s reaadsonadably repadreadsenadtaadtive of the income of peoadple who are likely to be house buyading. Plus ite2€™s replicable. So we owe $827 biladlion and earn $454 biladlion. Our debt-to-income ratio (DIR) is around 180% using this meaadsure. Of course we done2€™t need to repay the whole lot at once, just the interadest payadments. The cost of this debt seradvicading curadrently averadages 7.65% (conadseradvadaadtively), for a total annual bill of $63 biladlion. Our debt-servicing ratio (DSR) is 13.8% of our TPI. Note that TPI is gross income. Debt to post-tax income is higher. Note Ie2€™ve also ignored required payadment towards loan principal.This is where we start to tease out some clues. Using the staadtisadtics above, we have never paid such a large proadporadtion of our incomes to mortadgage interadest. The high interadest rates of the early 90s didne2€™t even come close. Yet 13.8% appears on the whole to be manadageadable. Reposadsesadsion rates, though risading alarmadingly, are at very low levels. If 13.8% is manadageadable, is 15%? 20%?a025?One answer is e2€“ it doesne2€™t matadter! More on that later. The other answer is full of assumpadtions and guessadwork. If we take housading costs above 30% of gross income to cause housading stress (this is genaderadous as often >30% net is used), assume that 33% of peoadple rent and another 33% have repaid an averadage of 50% of their loan prinadciadplee2€a6 See, I told you it was full of assumpadtions! Anyadway, if we do all this we find that 33% of the group are left payading 66% of the interadest. That would be costading them 28% of their gross wage, very close to the 30% limit. It may be even worse, given many would be recent buyaders who bought at the height of the boom but are yet to reach their peak in earningse2€a6Back to e2€œit doesne2€™t matadtere2€9d! Over the long term the DSR will nataduadrally flucadtuadate but canadnot conadtinue to rise indefadiadnitely. If it did, it would first take food from tables and evenadtuadally cost every cent of income earned. The actual numadber at which it stops risading is far less imporadtant than the fact that it must stop risading. Supadposading the DSR stopped at 13.8% foradever. If incomes didne2€™t rise and interadest rates remained conadstant, the debt level wouldne2€™t rise either. In effect, there would be no addiadtional money availadable for new mortadgages. Only repaid money could be re-loaned. In realadity, incomes do rise. To mainadtain the 13.8% DSR, for every new doladlar earned, 13.8c would go towards interadest payadments on a loan. At 7.65% interadest, this 13.8c would supadport $1.80 in new lendading e2€“ in other words, DIR would stay ata0180%. Workading backadwards now e2€“ with TPI at $454 biladlion, if incomes (includading addiadtional employadment) rise by 5% over the year, TPI will rise by $22.7 biladlion. With a 13.8% DSR, that enables an addiadtional $41.3 biladlion in mortadgage debt with no addiadtional presadsure on houseadholds. The probadlem is, we added $103 biladlion in mortadgage debt last year alone! If we accept that at some point the DSR and DIR must staadbilise then we must accept that mortadgage debt accuadmuadlaadtion must fall to below annual income appreciation.What does this imply for prices? We need to now look to another 3 staadtisadtics e2€“ housading turnover, averadage new loan size and loan to puradchase price ratio. Actuadally, that last one is probadaadbly unnecadesadsary. A healthy housading maradket needs an averadage turnover of around 5% of dwellings per year (see RBA Finanadcial Staadbiladity e2€“ March 2006). With around 8.4 miladlion dwellings, that would be 420,000 pera0year. The averadage new loan size was $226,000 in Decemadber (ABS 5609.0 — Housading Finance), and around 500,000 dwellings were bought and sold durading the finanadcial year (5609.0 TABLE 1. HOUSING FINANCE COMMITMENTS e2€“ Coladumn L). Loan size x Turnover is about 13% higher than the growth in mortadgage debt, preadsumadably the result of sales by indebted indiadvidaduadals (new mortadgage replaces old mortgage).To the pointy end. If housading debt growth were to fall this year from $103 biladlion to $41 biladlion, one of the foladlowading would need toa0occur:- New mortadgages fall to an averadage of $90,000– Housading turnover falls to 205,000 or 2.4% of stock– A lesser comadbiadnaadtion of both. Peradhaps turnover falls to 400,000 and the averadage mortadgage to $115,000. Peradhaps turnover falls to 300,000 and the averadage mortadgage falls to $155,000.Lete2€™s say the latadter. A $71,000 drop in the averadage new loan might reaadsonadably transadlate to a $71,000 drop in the averadage house price. This doesne2€™t look so bad, as litadtle as a 20% coradrecadtion, foladlowed by busiadness as usual! Not quite. Rememadber that prices (ignorading the Decemadber REI boost which is hisadtoradiadcally foladlowed by an equal or worse fall in the foladlowading quaradter) are already down 10% in much of Sydadney and Melbourne. This would not be just a short dip, it would need to be a susadtained shift in pricading and turnover levadels, which would only rise gradaduadally in line with incomes. A 5% increase in incomes would supadport a 5% increase ina0debt.Did I take the long road to the answer? Yes. But was it worth it? No. Well does it leave any doubt that this will occur? Yes, just a litadtle? Huh? Oh I givea0up.

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