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Where is the 'Negative Wealth Effect?'

US Savings Rate

Ever since the U.S. stock market started to swoon, economists have been waiting for the "negative wealth effect" to slow the over-consumption spree. Much to the disappointment of more than a few economists, consumers have maintained their spending binge as if nothing has happened. Maybe nothing has happened, yet. A recent study published by the Federal Reserve Bank of New York reveals an interesting aspect of the financial condition of the American household. For the overwhelming majority of Americans their house is truly their castle. For the middle class real estate accounts for a substantial portion of household assets. Real estate accounts for almost 70% of assets for those in the 40th wealth percentile and slowly declines to 50% for those at the 80th percentile. Equities account for less than 10% of assets; it is only the top quintile of wage earners where equities make up more than 10% of household assets. Only households in the top 5% have more stocks than real estate.

Another study found that wealthier Americans decreased their savings the most. In fact, the top 20% of wage earners reduced their savings rate dramatically from 8.5% to a minus 2.1% over the past eight years. The second quintile also decreased its savings rate to a minus 2.15 from 4.7%. Interestingly, the bottom 40% increased their savings rate from 4% to 7.3%. This gives a lot of credence to wealth effect theory. The study did indicate that there is a lag in the wealth up to several quarters. That would indicate that the "negative wealth effect" has been at work for the upper income group and will likely get more pronounced into the second half of the year. However, for the majority of Americans their total assets rose more from housing appreciation rather than equities. And thus far housing values have remained intact.

This savings deficit has put the typical American worker on the brink of financial distress. Almost half of Americans do not have enough savings to last more than three months should something happen to their jobs. And half of those could not even make it one month. Another found that the typical family has net financial assets totaling less than $10,000. This includes retirement funds. The study also found total assets for a typical family amount to $70,000 with the vast majority attributed to their house.

Saving for retirement has also been neglected. A report by the Employee Benefit Research Institute and the American Savings Education Council found that 71% have saved enough for retirement, down from 75% last year. The survey also revealed that only 63% of workers feel confident that they will be able to maintain a comfortable retirement, down from 72% last year. It seems workers have a negative attitude about saving for the future. A recent study found that 30% of job-hoppers cash-out of their 401(k)s instead of rolling the money into an IRA. The AARP conducted a study with disturbing findings:

  • 40% of older Americans will face poverty at some point in their "retirement" years.
  • Lower income Americans ages 51-60 have a median net worth of $6,500. This included home equity, and 401(k)s.

The AARP was so concerned that it is changing its advice for a secure retirement. "Earnings" will now join Social Security, pension, and savings as sources of income.

Almost every statistic that measures consumer health is horrible and getting worse. Consumer bankruptcies jumped 17.8% in the first quarter compared to last year. This is while the economy is still growing! The percent of disposal income required to service debt payments rose to 14.3%, continuing its steady rise since 1993. Not to mention the record amount of consumer debt outstanding.

While it seems pretty elementary that households are stretched thin, several economists insist that everything is just fine. This camp of economists sees the household balance sheet full of appreciated assets, namely real estate, so consumers are not over-leveraged. However, it must be pointed out that this statistic is only beneficial in bankruptcy court. I doubt Capital One will accept a handful of shingles and a kitchen sink for payment. Additionally, how valid is a ratio when an increase in one component encourages growth in the other. In this case, rising asset prices led to over-consumption though borrowing against the inflated assets. Moreover, assets values are highly volatile while debt levels are constant. We have already seen the start of the correction in inflated equities and hints of a similar correction in real estates values are apparent.

"We weren’t only living in a stock market bubble. It was also a lifestyle bubble," summarizes Brian Nottage, economist with Economy.com. This "lifestyle bubble" has left the economy with a tremendous double-edged sword. It is painfully clear that it is in the best interest of the individual to retrench and start building up savings once again, however, if all consumers put the breaks on consumption the economy would definitely be thrown into recession.

The latest non-manufacturing survey out of NAPM indicates that a recession might not wait for consumers to start retrenching. The survey posted its second consecutive reading below 50. Readings below 50 indicate contraction. This is especially ominous since it has been the service sector that has kept the economy from slipping into recession. Even more troubling is that almost every single indicator is declining, except the prices paid component. Here is the table that was included with the press release from the National Association of Purchasing Managers.

Series May April Change Direction and Rate of Change
Business Activity 46.6 47.1 -.5 Decreasing Faster
New Orders 48.6 45.9 +2.7 Decreasing Slower
Backlog of Orders 46.5 44.0 +2.5 Decreasing Slower
New Export Orders 48.5 55.5 -7.0 Decreasing from Increasing
Inventory Change 47.5 45.5 +2.0 Decreasing Slower
Inventory Sentiment 63.5 64.0 -.5 Decreased Feeling of "too high"
Imports 48.5 49.3 -.8 Decreasing Faster
Prices 59.5 59.5 0 Increasing at Same Rate
Employment 46.6 46.7 -.1 Decreasing Faster
Supplier Deliveries 52.0 51.0 +1.0 Slowing Faster

The direction of the individual components does not bode well for the near future. Rather than a recovery beginning in the third quarter, it looks more like the economy is starting down a slippery slope.

Another blow to "new economy" economists was the downward revision of first quarter productivity. First quarter productivity declined 1.2%, the biggest drop since the first quarter of 1993. This in turn pushed unit labor cost up 6.3%, which is the largest increase since the fourth quarter of 1990. It is likely that this trend will continue. During recessions companies are not able to cut labor cost as fast as revenue declines.

There is glimmer of hope for the beleaguered steel industry. President Bush is likely to impose some sort of intervention to reduce the onslaught of foreign steel. As the manufacturing sector continues to languish, a meaningful recovery for the steel industry does not look eminent. However, prices did creep up for the industry’s primary product, hot-rolled steel, by $10 per ton in May to $230 per ton. Prices are still down over 30% from just three years ago, and remain near a twenty-year low. The ongoing woes in the manufacturing sector do not bode well for any swift recovery, if any. There have been a total of 19 steel companies that have filed Chapter 11 since December 1997. One notable statistic is that these companies have a combined $13.3 billion in debt, which is not much more than the $12 billion raised by Worldcom just last month. The immediate future looks tough as World Steel Dynamics is projecting global demand to decline 1.4% to 832 million tons.

Greenspan continues to view inflation as a non-threat since "cost increases are not being followed through with significant pressure on prices." I guess we know greenspan@aol.com is not the Chairman’s email address nor must he use AT&T for long distance. AT&T recently announced it's increasing residential rates up to 11%. If this increase works, it should be concerning since AT&T is raising rates because it is losing revenue as customers are leaving for carriers with lower prices. So now lower demand equals higher prices. Other price increases include more hotels adding sur-charges around the country.

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