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October 22, 2009

A 28% Plunge In Our Standard Of Living
by Daniel Amerman

Crisis & Globalization I

For the average person, what is the immediate danger from the financial crisis? Not just the financial crisis itself, but the government and Federal Reserve's response to the financial crisis, which is essentially to create trillions of dollars out of thin air? For you and me, what's the immediate, tangible danger of this limitless bailout of the most politically powerful special interest group in America, the bankers of Wall Street?

Some people would say a high rate of inflation, others would say a depression - or both. For the average person, let me suggest that there is something we don't usually think about -- a third danger -- something that could drastically transform the day to day lives of 300 million Americans within a space of weeks or months, because the fastest collapse occurs with what wasn't real in the first place.

In this article we're going to discuss why about 10% to 30% of your day to day standard of living hasn't been "real" for a number of years now. Because this standard of living we take for granted is actually based on our running a massive trade deficit, meaning that the United States consumes much more than we produce.

If we were suddenly forced to consume no more than we produce -- which is exactly what the financial crisis risks -- there would be catastrophic consequences for the American consumer, potentially almost immediately. It's not too late for the US as a nation, for us as individuals, but time is running out fast, and if we are to find effective personal and societal solutions, then we need to clearly understand the extraordinarily dangerous combination of a nation in the midst of a severe financial crisis even while it has been running a huge trade deficit for many years.

Personalizing The Trade Deficit

What the trade deficit represents is the difference between what the United States produces as a nation and what the United States consumes as a nation. For instance, in 2008, the US exported about $1.8 trillion, and imported about $2.5 trillion. The difference between what we sold and what we bought was a shortfall of $700 billion: the trade deficit. Huge number, but what does it really mean?

Let's make it personal. There are 111 million households in the United States. If we take $700 billion and we divide it by 111 million households, we come up with a trade deficit per average American family of about $6,300 a year. The median income per American household is about $50,000 per year. So when we put the deficit into personal terms, it means that about 12% of the standard of living of the average American family consists of goods we consume from other nations, for which we don't produce enough with our own goods to pay.

What does that mean for your family in practical terms? For an answer, go to any Wal-Mart or other big-box retail store, or massive retail mall, and walk the aisles. You will see row after row of goods, ranging from baby clothes, to shoes, to DVD players, and what they all have in common is that they are made in other countries and that we actually can't pay for them.

This may sound theoretical, perhaps even crazy, but there is nothing more real and tangible than the trade deficit when it comes to the day to day standard of living of the average American family. We're not talking about paper wealth, or stocks, bonds or options. Goods and services that are consumed daily are the ultimate reality. A $700 billion annual national trade deficit represents $6,300 worth of goods and services per household, per year, that we can't pay for. Instead of esoteric theory, let me suggest that every time you bring something home from the store, you are relying upon our national trade deficit to pay for part of what's in the bag.

28% Of Discretionary Income

So if other nations stopped letting us have what we can't pay for, we suddenly have many less goods available and they would cost much more. Unfortunately, this doesn't translate to going down from a 50 inch flatscreen TV set to a 44 inch TV in order to cut 12% from cost. Because the key measure here is what's referred to as discretionary income.

Do you get to decide how to spend your entire paycheck every month? Of course not. We have to pay the mortgage or rent, which is about 37% of income for the median household, and we have to pay income taxes and social security and medicare as well. For the average family -- the median family -- housing and taxes take over half their income.

Meaning we've only got about $22,500 left per household, after housing and taxes. And when we compare our $6,300 per household share of the national trade deficit to what's left after housing and taxes, then we just lost about 28% of our income.

Twenty-eight percent of our income. In every household in America. We're no longer talking about new TVs, we're talking about putting gas in the tank, because over half of of our oil is imported. We're not talking about steak dinners but about whether we can go to McDonald's. And instead of the latest fashion, we may be rediscovering a quaint historical artifact known as a sewing machine. Except that we buy those from overseas too, so I'm not sure that will work.

How Did This Happen?

Depending on your perspective - this is either a pretty horrible situation, or a pretty neat trick. How have we been getting away with this? How did we end up in Lotus Land these last few years?

Basically, other nations and -- we'll use China as the biggest example -- produce all sorts of goods for much cheaper than we can produce them ourselves, with the biggest difference being that its laborers work longer hours for less money. With globalization, we dropped our trade barriers, and let these less expensive goods effectively destroy our own domestic industries, that used to produce everything from cameras to clothing tissues to consumer electronics. We have hollowed out our own economy, effectively moving our industrial strength as a nation overseas.

Now from an ivory tower theory perspective, we pay for these goods using our supposedly superior intellectual resources. But in reality, the rest of the world doesn't value America's so-called intellectually superior knowledge nearly as much as we would like them to. The proof? Look at the size of our trade deficit in the real world. Because we don't have the goods to sell to them, they buy US treasury bonds instead, and effectively use the US trade deficit to fund the US budget deficit. Neat trick eh?

An Unstable Relationship

So how real are the chances of our having a precipitous drop in our national standard of living because other nations will no longer provide goods that we can't pay for?

Well, relationships like this are always unstable when we look back over world history, but this is one that exists for a reason. China doesn't buy our treasury bonds because they like us -- they buy them to prop up the value of the dollar, keeping the dollar artificially high, so their goods stay artificially cheap, and their industrial base can grow while ours shrinks. In other words, through currency manipulation, they hollow out our real economy, build their real economy and we get a temporary, artificially high standard of living. If they cut us off too abruptly, the dollar plunges in value, we can no longer afford the goods they sell, and then their own economy also likely goes straight into depression.

So they've got their reasons to maintain the relationships, but this is still quite unstable. Let me suggest that the chances of this unstable relationship falling apart -- potentially quite abruptly -- are far higher than they were in the past.

One reason is that we didn't used to have this huge imbalance, this inability to pay for our own standard of living. And the greater the imbalance, the stronger the forces pushing a correction, finding a natural balance. Pushing us towards where we would be without massive currency manipulations.

The True Risk From The Bailout

The other reason is the financial crisis. Trillions of dollars are being created out of thin air. The Federal Reserve and Congress are doing fantastically dangerous things to the value of the dollar, in the interest of effectively bailing out the most powerful special interest group in America, Wall Street and the bankers. The idea that the US government is trying to preserve the value of the dollar is becoming increasingly difficult to believe.

In fact, it's becoming an insult to your intelligence, as I cover in my article "Bailout Big Lies Threaten Your Savings."

This is profoundly disrespectful to our creditors. The problem with relying on other nations to provide your standard of living, is that you've just given up control over your standard of living, and you'd better be very respectful of the people who are providing it. We are not being respectful. With each round of government spending that the government can't actually afford, as it sells out the average citizen for the benefit of Wall Street, it ratchets up the chances of a precipitous, entirely real drop in our national standard of living. Straight down to living only off of what we can produce.

And now on a personal level, I do believe that we need to go there. We need to get to the place where our national standard of living is based on what our national economy actually produces; our national security depends on it, as does the rebirth of American jobs. That doesn't mean we don't buy goods from overseas, but that does mean that we produce enough in exchange pay for them. However the key is how fast we go there. Because if it happens too quickly, we risk national economic catastrophe.

What if that happens? What if we push our luck too far, what happens to the US dollar and the US economy?

That will be the subject of the next article / video in this series, "Inflation Supply Shock & A Plunging Dollar".

Taking Personal Action In An Unfair World

Politically, what is happening with the bailout of Wall Street is unconscionable. The day to day standard of living for 300 million people in the United States is at stake - yet, the billions in personal bonuses continue to go out to Wall Street bankers, with no substantive regulatory changes. The average person knows this is an outrage. Yet, nothing seems to be happening politically to change this. If you want to help politically, then please send this article around to those you know, so the full stakes will be known to more people.

If politics fails us all, then it isincumbent upon us to take personal action to protect ourselves and our families. There are actions we can take as individuals, but you won't read about them in the mainstream financial media. Following the conventional financial strategies will likely do no more than continue to set you up for victim status, in an insider's game that is rigged against you. Instead, you need entirely different strategies than the failed strategies that have been devastating all of our savings.

The good news is that you have more tools than you may think, some of which may surprise you. Tools which can give you the opportunity to turn financial disaster into personal net worth. But, if you want this to happen - then education is the essential first step. You are going to have to not just understand, but to master some of the financial forces and methods in play here. With Turning Inflation Into Wealth being the first key step. Good luck to you in these perilous times.

Would you like to find practical solutions to the issues raised in this article? Do you know how to Turn Inflation Into Wealth? To position yourself so that inflation will redistribute real wealth to you, and the higher the rate of inflation - the more your after-inflation net worth grows? Do you know how to achieve these gains on a long-term and tax-advantaged basis? These are among the many topics covered in the free "Turning Inflation Into Wealth" Mini-Course. Starting simple, this course delivers a series of 10-15 minute readings, with each reading building on the knowledge and information contained in previous readings. More information on the course is available at DanielAmerman.com or InflationIntoWealth.com.

Daniel R. Amerman, CFA
The-Great-Retirement-Experiment.com

Daniel R. Amerman is a financial futurist, author, speaker, and consultant with over 20 years of financial industry experience. He is a Chartered Financial Analyst (CFA), and holds MBA and BSBA degrees in Finance from the University of Missouri. He has spent seven years developing a large, unique and intertwined body of work, that is devoted to using the foundation principles of economics and finance to try to understand the retirement of the Baby Boom from the perspective of the people who will be paying for it.

Since 1990, Mr. Amerman has provided specialized quantitative consulting services to financial institutions, with a particular emphasis on structured finance. Previously, Mr. Amerman was vice president of an institutional investment bank, with responsibilities including research, synthetic securities, and capital market originations.

Two of Mr. Amerman's previous books on finance were published by major business publishers. "COLLATERALIZED MORTGAGE OBLIGATIONS, Unlock The Secrets Of Mortgage Derivatives", was published by McGraw-Hill in 1995. Mr. Amerman is also the author of "MORTGAGE SECURITIES: The High-Yield Alternative To CDs, The Low-Risk Alternative To Stocks", which was published by Probus Publishing (now a McGraw-Hill subsidiary) in 1993. Advertised by the publisher as a professional "bestseller" for four quarters, an Asian edition was sold as well.

Mr. Amerman has spoken at numerous professional seminars and conferences nationwide, for a variety of sponsors including New York University, the Institute for International Research, and many others. After the publication of his prior books, he acted as keynote speaker at a number of banking related conferences over the next several years.

This article contains the ideas and opinions of the author. It is a conceptual exploration of general economic principles, and how people may - or may not - interact in the future. As with any discussion of the future, there cannot be any absolute certainty. What this article does not contain is specific investment, legal or any other form of professional advice. If specific advice is needed, it should be sought from an appropriate professional. Any liability, responsibility or warranty for the results of the application of principles contained in the website, pamphlets, videos, books and other products, either directly or indirectly, are expressly disclaimed by the author.

Copyright © 2006-2009 Daniel R. Amerman, CFA

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