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Even before a budget cuts, US households looking vulnerable

From Andy Lees this morning:

Economists at the Northeastern University in Boston recently found that corporate profits captured 88% of the entire US economy’s income growth between the second quarter of 2009 and the fourth quarter of 2010, with workers taking just 1% of the increase. Recent Department of Labour data showed unit labour costs edged up 0.7% in the year to March though not enough to make up for a 2.9% fall in the previous 12 months. Northeastern economics professor Andrew Sum says the mismatch is “historically unprecedented” and bodes ill for future growth, especially given many companies are sitting on their cash rather than investing it. “Workers have no money, no purchasing power, so that’s why consumption is not moving”. By sitting on their profits firms are acting like earners “who take their money and stuff it in the mattress. That’s happening across the economy”. This means that US growth is either financed by debt (mainly Federal debt) as household income is not keeping pace with GDP growth, or secondly by exports which makes H2 potentially vulnerable to a slowdown as the international markets start to slow.

Andy notes the earnings miss by Caterpillar and slow US revenue growth at GE and Ingersoll Rand as data points showing softer earnings growth from US domestic sources. The debt ceiling debate has stalled and the possibility of default is no longer an outlier. Even so, budget cuts from a deficit deal would weaken consumer demand in the US, already slowed by unemployment. My expectation is that by next month the first spate of earnings warnings will trickle in and S&P earnings growth for the rest of the year will start to be cut.

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.

6 Comments

  1. David Lazarus says:

    I actually think that the GOP and Tea Party have no idea of what will be the result and so will be shocked when the downgrading’s come. Though I suspect that they will not put it down to their own incompetence. Longer term until the US households have more disposable income the US will struggle to recover. With corporations now getting nearly all the gains of the last few years and the super rich probably getting all that is left it means that banks will have a dire few decades as consumers either pay down debt or default. I also think that people will be much less inclined to spend in future, and there could be a return to a more cash driven economy as small community banks are risky and not given adequate support from the regulators.

    • Many in the Tea Party Caucus have such an intense distrust of Obama that they do believe he is putting on a show for political effect and that the situation is not nearly as dire as he has painted it. It is that undercurrent – and the “let the chips fall where they may” attitude – which makes the default possibility real.

      The President, if forced to deal with this will have to do what California did when it couldn’t pay its bills and issue IOUs or selectively default. My sense is that the bonds themselves will have to be paid first. Other government expenditures will not get paid and that means a hardship for those who expect the money, whether companies doing business with the US government or people receiving services and benefits.

      • David Lazarus says:

        I do agree that the they can get by for a while but they have already been raiding pensions to get them through to this position. The politicians need to lose pay and benefits for the remainder of the year if they are in breach of the debt ceiling. Also work arounds are the same dodgy practices that got Enron into trouble. They need to just stop paying everyone including bond holders and let the Tea Party see the outcome. Maybe recalls of all the GOP and Teaparty members for the mess that they created might help. The problem with IOU’s is that they might not be accepted. Though the solution that California took to put everyone on its payroll on minimum wage would make the electorate happy. If they got more than their representative or congressman then they might like that.

    • Geneva Ayte says:

      The downgrades will come whether or not we default. Question: Do YOU know what the outcome will be should the US default? Do you believe that a drunk can spend himself sober? Right. So then why is the Tea Party incompetent in demanding that no more debt be incurred? “Longer term until the US households have more disposable income the US will struggle to recover.” … And just how is issuing more government debt conducive to increasing disposable income? Public debt is at $14.3 tril with a deficit of $1.5 tril. And we can barely scrounge up 1.8% growth. Because this kind of massive debt is a growth crimper. I would love to know how your thought process flows. But am afraid to inquire.

      • David Lazarus says:

        Quite frankly these rating agencies are the same ones that missed the financial crisis in its entirety. They rated junk mortgage bonds as AAA so that they could be fraudulently sold to third parties.

        The analogies make no sense because without debt the economy will suffer incredibly. It will get substantially worse if the debt ceiling is not raised. The problem with the economy is that the majority of individuals are stuffed with debts that they can barely pay back. Big corporations have plenty of money but are hoarding it. Without governments spending the economy implodes. Just look at Ireland which had a budget surplus immediately before the crisis and is now on the verge of bankruptcy. They have cut spending and the economy has gone into a negative tail spin. The comparisons with Greece are only appropriate if you go into austerity.

        There are two solutions to this crisis. First is to have an austerity budget. That will mean a substantial cut in government spending. This could be education, so expect much bigger classes unless you are rich enough to send your kids to private school. Then there will be cuts to law enforcement, this will lead to a surge in crime, which will hit your insurance rates on home and car insurance. The economy will collapse as much as 10% if not a lot more. WIth the debts still the same the debt burden climbs, and because average incomes will fall substantially the pain is worse. Imagine if your finances are set up for $100 000 pa with a $300 000 mortgage. Then your boss says he is giving you a 20% pay cut. So now your income is only $80 0000 but the mortgage is still $300 000. So you now have to pay this same debt on a much smaller salary. You might be able to make big cutback but not enough. Do this again and cut your salary to $60 000 because the economy is bad and you have a $60 000 income and $300 000 mortgage if not more, then remember your home will not be worth as much as you paid for it. Do you go bankrupt now or wait another year?. This is a deflationary debt spiral that is devastating Greece and Ireland right now. Eventually you have to go bankrupt.

        The alternative is to keep the economy growing by borrowing, keeping everything stable in terms of employment and pay rates. That will allow people to pay down their debts. That way when they have cleared their debts they can spend. Their incomes would not have fallen. This could take many years, just look at Japan. If they had not kept spending they would have had a depression. That is the stark choice America faces now.

        The problem is that without the government incurring debt on your behalf to keep the country going everyone else’s ability to pay down their debt is much tougher. The end result will be a surge in bankruptcies. Then with foreclosures increasing, even if you have no debts it will drag down the value of your assets. House prices will fall another 20% as a result of a government default or of a hard cap to spending. So that is why voting for collapse is incompetent.

        There have been many mistakes since this crisis began and will continue to be mistakes but deliberately picking the worst option will top any made before or since.

        Also much of this debt was incurred under George W Bush, in starting two wars and putting the tab on the credit card. Now those same people object to that credit card limit being increased to fund their wars or even allowing the cutting of military spending. Much of this deficit is really the Bush deficit because the economy has not recovered back to normal.

        There are ways that cuts can be made to the deficit which would ease the problems but I doubt that they will be undertaken. First raise retirement age to a level that will mean that the social security funds will remain positive. End caps on contributions and taxes so that high earners pay in more. Though even if you scraped all discretionary spending you would still be no where near balancing the books. So defence spending will need to be cut or big tax rises needed.

        Also longer term reforms are needed to stop the private debts building up so much. Though I doubt that will ever happen since Wall Street has bought the government it wants to stop such reforms ever happening. So I expect another major financial crisis before long.