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Is the Fed breaking the back of the consumer economy?
The unemployment rate in the Soviet Union was 1% when it collapsed. Everyone had a job. No one could afford to live on their wages.
On Wednesday, the 14th, the Federal Reserve increased the interest rate paid on reserve balances by one-half of a percentage point to 4.4 percent. Their decision was based in large part on their conviction that the economy is overheated, unemployment is too low, wages are growing too fast (see the charts below to appreciate the lunacy of this argument), and that the consumer is “strong” and able to withstand a rate increase that will only result in a mild economic slowdown.
They also made the point of threatening that more rate hikes will follow even though neither the bond market nor the vast majority of financial analysts and economists agrees with that assessment and every major forward-looking economic indicator is flashing a “hard landing" recession warning signs. The last time we aggressively raised interest rates in the face of an imminent economic downturn while having highly restrictive trade policies and conditions was in 1930 when the world was reeling after the crash of 1929. And the Depression that followed was the worst in history. (The rate of the Fed's interest rate hikes is the second fastest in history, only topped by the early 1980s.)
This raises some fundamental questions about how our economic system is “working.”
There is something very wrong with a system that chooses an inflation-fighting policy based on punishing average working people, who have nothing to do with the causes of the inflation we've been experiencing, putting more and more people out of work, and adding extreme hardship at a time when those same working people have already endured multiple years of hardship and decades of loss of economic wealth. There is something profoundly misguided about believing our entire economy can be successfully and equitably steered by something as simplistic as interest rates. And the fact that none of our local, state, and federal elected officials have even let out a peep to question all this speaks to the profound ignorance and incompetence of all of them.
It is equally astounding that when prices of goods and services rise rapidly (which by the way, they are no longer doing), due to one-time factors that are out of our control (pandemic, war, lock-downs, and production and supply-chain constraints) we appear to have no economic tools or policies in place to address that, head-on, instead of trying to micro-manage our economy with an interest rate sledgehammer.
The truth is that it is simply impossible to run a stable economy by jiggering with interest rates and the consequences of this misguided thinking will be profound. So, why hasn't the Fed been using their bully pulpit to demand that Congress put policy measures in place to help calm inflation spikes in a more effective and equitable way?
This week, Jeffrey Gundlach, the noted CEO, and chief investment officer of DoubleLine Capital, compared the Fed and its policy-making to Mr. Magoo; the bumbling, near-sighted, old, cartoon character who groped and crashed his way through the world mistaking everything around him for something it was not. His description is apt.
As just one example, when it became obvious early this year that oil companies were enjoying one of their most profitable years ever, wouldn’t it have made sense to temporarily cap the price of gasoline--the biggest driver of inflation of the prices of all things that need to be transported (energy, food, vehicles, you name it)--instead of rapidly raising interest rates and cratering the entire stock market and real estate market--which every insurance company, college endowment, pension fund, and person with a retirement account or who owns a home is heavily invested in?
(As a footnote, while the Fed and the media continue to shriek about the worst inflation in 40 years, the price of gas at the pump, today, is pretty much in the same range it was in the years before the pandemic began, even though supply remains restricted, essentially proving that the whole "supply/demand" argument was an excuse to price gouge consumers.)
Undoubtedly, the lack of economic policies to address rapid fluctuations in the prices of basic goods and services will hurt the poor and working middle class the most. Yet, our Federal Reserve is cluelessly doing this as much as possible.
This brings us back to the most fundamental assumption the Fed is making: that the financial health of the consumer is rock solid and that consumption needs to be suppressed to stop inflation. (Note that more than 70% of our economy is based on consumption.)
Someone is wrong
Government officials and big-shot central bankers continue to tout how “resilient” the American consumer is and how much they have benefited from the government's handouts during the Covid pandemic. But if the data doesn’t back it up, the Fed’s interest rate policies are going to make things a lot worse for a lot longer than they are expecting.
Let’s do a fact-check. Rex Nutting, writing for MarketWatch, recently noted,
“The loss in real wealth from January through September [of 2022] was about twice as large as the nominal loss — $13.5 trillion in current dollars—after accounting for the rapid inflation experienced this year. Inflation makes both debts and liabilities worth less in terms of purchasing power.
“This 8.6% drop in real wealth over three quarters is the second-fastest decline on record (the data series begins in 1959). The only greater drop was following the financial crisis of 2008-09. (The wealth lost during the Great Depression of the 1930s would likely hold the record if we had the data.)
“Consumers are taking on debt or dipping into their savings to maintain their living standards. By one measure highlighted in this Fed report, the personal savings rate has fallen to 3.7% of disposable income, after averaging more than 10% for the past 10 years.”
At the same time, Reuters reports,
“U.S. consumers will fall behind on their personal loan and credit card payments next year at the highest rates since 2010, according to forecasts from TransUnion, a major consumer credit rating agency. Surging loan delinquencies will follow a year in which consumers loaded up on credit, TransUnion said in a study Wednesday. Americans took out a record 87.5 million in new credit cards and 22.1 million in personal loans in 2022, the report showed.”
This doesn’t sound like a healthy consumer to me. But what about all that government largess during the pandemic? Surely, consumers must have that money to fall back on, right?
Below is a chart of “excess savings” (savings from the pandemic subsidies, above the average historical savings levels; shown in different color bars based on which economic groups have the most to the least excess savings) and how quickly the consumers are spending it down to zero.
As you can see, even the “top quartile” of the population (the wealthy) is very close to completely running out of excess savings. (This might explain why no one is buying all those vacant luxury condos in San Francisco.) This would be a bad indicator of future consumption by itself if it wasn’t for the fact that historical savings for average Americans are already in really bad shape.
Based on data from the Federal Reserve’s Board Survey of Consumer Finances, the median savings balance (cash on hand in readily available checking, savings, and brokerage accounts – not including retirement accounts) is $3,240 for ages 35-44, $5,620 for ages 45-54, and $6,400 for ages 55-64. Worse than that, according to Bankrate, as of January 2022, 56% of Americans are unable to cover an unexpected $1,000 bill with savings.
Not very comforting facts, particularly if we head into a long and drawn-out recession in the coming years.
How are people making ends meet?
Sources of income for many are tenuous at best. Among retirees, Social Security is the primary source of income; 37% of men and 42% of women get 50% or more of their income from Social Security. And for the working middle class, over the past 40 years or more no matter how fast they run they are still falling behind.
Consider the following charts showing “real” earnings (inflation-adjusted) for the average American, middle-class worker.
This chart shows us that in real terms the hourly wage has only risen by .70 cents since the early 1970s. That’s only about 2 ½ percent in more than 50 years! How does that compare with the cost of everything else?
Let’s compare this wage growth with the real cost of housing.
The green line on this chart shows us that the inflation-adjusted, real cost of housing has increased 100% during the same time period as the wages chart that showed an increase of 2.5%.
As I’ve noted in past articles and what the comparison of this chart to the previous chart on wages makes exceedingly clear is we don’t have a housing crisis, we have an overwhelming, societal “unaffordability” crisis.
Now, let’s look at the recent impacts of the Covid pandemic on real weekly earnings for the typical middle-class worker.
This clearly shows that real earnings fell for all of 2020 and 2021—to “real” levels not seen in 40 years, and they are just beginning to make a comeback.
So, if we combine all this data with the imminent exhaustion of personal savings, we might want to ask Fed Chairman Powell, is the consumer and consequently our economy really “strong” and capable of facing even a mild recession without a more equitable, coordinated government economic policy approach?
If the past three years has taught me anything, it's that I shouldn't even try to predict the future. But considering the facts, it might be best to err on the side of caution for awhile.
Bob Silvestri is a Marin County resident, the Editor of the Marin Post, and the founder and president of Community Venture Partners, a 501(c)(3) nonprofit community organization funded by individuals and nonprofit donors. Please consider DONATING TO THE MARIN POST AND CVP to enable us to continue to work on behalf of California residents.