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Today's Commentary: 05.12.04
The Weight of Debt
I wanted to take a moment to say a few words about the passing of my biggest reader. This man has been following my work for over seven years, cheering me on and challenging me regularly during our weekly phone calls. He won't be here when my first book hits the shelves in the fall and that is a great sadness. He would have loved how it reflected what I had learned. Between its covers were all of things he had taught me through the years. I'm going to miss you Dad.
Today and in the next couple of columns I will discuss why the weight of debt, which at once time seemed so beneficial to the rebirth of the economy has become like obesity. Will the solution - essentially the removal of super sized quantities of readily available credit from the menu - be able to keep the pace of growth going as the stock markets drift into year-to-date negativity, the bond market sells off in this country and most of the free world and mortgage rates step-up instead of down cutting off the free flow of equity based spending?
The stock markets are starting to worry more with each passing day. Granted, there are numerous things that are affecting the equity markets, some more grievous and maybe on any other occasion, might even usurp the nation's debt in terms of newsworthiness. But that debt, even in a higher interest rate environment, is still manageable to a point That point has been reached. Businesses however are unwilling to wrap themselves around that risk the same way the average Dick and Jane continue to do.
The uptick in unemployment numbers did little to satiate the markets and they have been trading steadily south of those jobs numbers ever since their release last Friday. I have mentioned in this column that there are negative ramifications if unemployment diminishes in such a low interest rate environment. Businesses have been posting big profits by operating without all of those expensive bodies cluttering up the factory floor. This made comparisons of year over year profits to last year seem downright stellar. Investors were nonplussed.
So when job numbers improve, although the lion's share of those jobs is still going to part time workers and a growing percentage of that number are teens grabbing short term summer employment. Weekly wages fell as a result. So this has become a major component in making March's 308k gain as well as the past month's numbers looked good.
Wall Street also factors in any real increase in jobs as a negative to profits and cash-fat balance sheets. The costs of increased production when commodity prices are higher are passed on to consumers but the initial price is borne by the balance sheet in the current quarter. As the year progresses, the numbers from last year will improve making profits, by comparison look more and more anemic. Most of the talking heads are right however, in suggesting for the short term things will look good profit-wise, even as the share price takes the brunt of the adjustment.
Everyone knows that there are three things that make folks feel financially good about the way things are going. The first is the increase in jobs. This is mostly a human trait that doesn't lend itself to any concrete process and certainly defies the logic that the Street applies to those figures. Jobs are not always the most important cog in the confidence wheel, but we like the idea that our fellow American is enduring the grueling work week like we are.
The second feel-good is the promise of tax refunds or tax cuts. When the president talked it up last year about the economic springboard his tax cuts would provide, he was hoping that Americans would spend them as fast as they got them. Although they were smaller on average that what was promised, they were dutifully spent.
And nothing makes us feel better about ourselves than an increase in net worth. Even when this is often the most highly volatile piece in the equation, Americans like to know that their investments and they erroneously include the worth of their least liquid asset in the equation, their home, they have gotten used to feeling pretty good. Easy money means that consumerism can go on unabated until someone pulls the plug.
Those three items however are going to crumble under the weight of debt, taking equities with them. Even as the illusion of job creation and the deficit wrenching tax refunds have played themselves out, the net worth of the average investor will begin to decline as interest rates rise. Home ownership will become more expensive reigning in those highfalutin' borrowers who not only borrowed 80% of the cost of their homes but added the down payment in as a second mortgage for good measure. Many with rates that will adjust upward with every uptick in rates.
This has created a new class of investor, a product of a cracked-up boom. This investor is not worried about their financial future in the same way we worried about ours when we were younger. These people are looking to a future full of ups and down, rich and broke as part of a normal cycle of short term goal setting. Banks are willing to accommodate these people even as rates begin to rise. But the cracked-up boom, an term used by economist to suggest that with the right convergence of low rates and accommodative money coupled with spend-happy consumers actually does more damage than good over the long run, creating multiple bubbles to be crushed under the weight of debt and "measured" responses to the problem.
And when rates do rise, the only question left to ask is how high can they go. I believe that at the suggested pace of the rate increases orchestrated by "what, me worry" Fed Chairman Alfred E. Greenspan could go to as high as three percent.
There is some speculation that the drive to buy goods as prices increase is based on the belief that things will never be this cheap again. They will be right but the savings will be passed on as the cost of a ever-increasing service to the debt they are carrying. By that time though, consumers will have finally awakened to the fact that inflation will not be going away either.
That is only the first part of the problem in determining the weight of debt.
