With rising inflation and debt payments, the household budgets of all of us are being squeezed. The picture does not look pretty.
Let's first look at inflation. Signs of rising prices - the way in which we are most influenced by inflation - are everywhere. Regular gas now costs over $3 a gallon, insurance and property tax bills are escalating, and staggering home heating costs will definitely keep Santa from coming down the chimney this Christmas. Natural gas prices are particularly worrisome as they push up the price of electricity, anything plastic, and the general cost of manufacturing. For 2006, the big effect of hurricanes Katrina and Rita will be the needed excuse to raise the cost of insuring a home by 10 to 30 percent (depending on where the lucky homeowner lives). Rising diesel prices push up the cost of goods on every store shelf because they have to be trucked in. The CPI data for September, scheduled for release shortly, is likely to show an annual rate of increase, over September 2004, of at least 4 percent.
So, how bad is inflation? In the past year, the wages and salaries of American workers have not kept up with inflation. If the CPI (currently at 4 percent) was honest and included rising housing prices and did not over-indulge in hedonic price adjustment, 5.5 to 6 percent would be the actual reported number. Bottom line: Americans are being squeezed by prices rising faster than income. As the winter heating bills pile up and rising manufacturing and shipping costs make their way to store shelves, our loss of purchasing power will only get worse.
Second, let's look at rising debt payments. Americans owe about $11 trillion dollars - $2 trillion for consumer debt and $9 trillion for mortgage debt. As much as one-third of the loans given today are adjustable rate (this includes credit cards, ARM mortgages and home equity loans). Americans owe over $800 million in home equity loans ("HELOC") which are mostly tied to the prime rate, with an average interest rate of 8 percent. Just a few short years ago, when the Fed Funds rate was 1 percent, these HELOC loans seemed almost "free" at 5 percent. Well, money is no longer free. Americans also owe over $800 billion of credit card debt with an average interest rate of 13 percent. Credit card debt is tied to the prime rate and like ARMs and HELOC loans, interest rates have been moving up at a steady pace.
The Federal Reserve has raised interest rates 11 times since they first started tightening and several more increases are scheduled that should take the Fed Funds rate to 4.5 percent by the end of January, 2006. Short-term interest rates have been rising 2 percent a year. Every time consumers are forced to pay another 2 percent on average for their $11 trillion of debt, they will have no choice but to raid the cookie jar for an extra $200 billion. The only problem is that most Americans haven't been saving so, unfortunately, their cookie jars are empty.
Worse yet, for consumers making credit card payments, the US Treasury has new regulations that will come as a real shock this fall. The Treasury has the authority to set minimum principal payments on credit cards and is increasing the minimum from 2 to 4 percent per month. For the average American with a $10,000 credit card balance, that increases the minimum monthly payment from $200 to $400. For the big spender with $50,000 in credit card debt, the monthly payments would pop from $1,000 to $2,000! Needless to say, a large number of people are used to paying the minimum every month, and millions of card holders are maxed out on numerous cards and barely meeting monthly payments. So, even if prices weren't rising, the American debtor will be getting hung out to dry by a noose of credit cards around their neck.
Between rising prices and debt costs, how bad is it really for the average American? Our guess is that most of us will experience an increase in monthly costs of no less than $300, and many will see their monthly costs rise over $700. Also, "The Bankruptcy Abuse Prevention & Consumer Protection Act of 2005" will require debtors to pass a strict Means Test to determine whether they can have their debts liquidated through Chapter 7 or whether they must enter a repayment plan through Chapter 13. This Act goes into effect on October 17 and is designed to make working Americans wage slaves to the bank for life so we'll not only get squeezed, we'll get crushed! The Means Test is just plain mean. With this new law, the bank not only comes first but a creditor may get to pay them forever!
Credit card delinquencies, as measured at the end of the second quarter of 2005, have been heading up towards 5 percent. When the minimum payment increases every month along with your heating bills this winter, I am confident consumer loan defaults will keep the bankruptcy courts busy.
Even before this big squeeze of rising costs, most of us couldn't afford to save. The question now is, "can the consumer afford to spend?" The latest government figures from August show consumption was down by 1 percent, and earnings before inflation were also down. Auto sales figures just released by GM and Ford for September show the sales of Sport Utility Vehicles collapsing by 50 percent.
Borrowing against the house, which has fueled increased consumption over the last decade, must now be used to pay higher bills for buying less. If we can no longer afford to save or borrow, it's likely we will no longer be able to spend. If the consumer cuts back, it means recession.
Before the war and hurricanes, the budget deficit was about $400 billion, and the trade deficit was $700 billion. Now, our country gets to pay for an extra couple hundred billion for energy; several hundred billion more for consumer, mortgage and Federal debt service; a hundred or two billion for the hurricanes; and another couple hundred billion for the endless war. Pretty soon this will add up to real money!
I, for one, wonder how long the United States can get foreigners to pay for it all so I don't have to foot the bill. Meanwhile, I am only considering stocks that look like good shorts. Gold and silver remain great investments, especially when bought on dips in their market price. Stay tuned and when in doubt, stay in cash!
