An important story in Reuters (hat tip Scott) described how the current expansion, in a break with the past two decades, depends on the spending of lower-income households, and that spending in turn is heavily dependent on rising debt levels. The bottom line is that the last two years of growth were brought to you by subprime borrowing.
The Reuters piece, by Jonathan Spicer, also argues that the sell-by date of this unsustainable subprime-debt-fuelled growth may have been postponed by the Trump tax cuts. If anything, the picture may be even worse than that view suggests, since some experts, as well as our own readers, have said in some, perhaps many cases, the cuts in income tax withholding looked high relative to the taxes that would be due for 2018. In other words, more taxpayers than in the past may find themselves hit with unexpected tax bills come April.
Independent of whether bigger debt millstones around the necks of subprime borrowers are a harbinger of a slowdown, high levels of personal debt are a negative for growth. Personal borrowings are almost never productive. Even the often-hyped examples of borrowing for education or borrowing to start a business are overhyped. With higher eduction overpriced and the punishment for missing a payment draconian, the merits are at best debatable, and that’s before you factor in the risk of graduating during a recession or crisis. Similarly, since 90% of new businesses fail in three years, pray tell why is borrowing to start one a sound idea?
Two months ago, Wolf Richter provided some aggregate data on household debt levels:
So the ratio of non-housing consumer debt to disposable income – the burden these consumers carry on the backs in relationship to their incomes – is higher than ever, and only historically low interest rates have kept it manageable.
But interest rates are now rising, and many of these consumer debts have variable rates.
This explains a phenomenon that is already appearing: How this toxic mix – rising interest rates and record high consumer debt in relationship to disposable income – has now started to bite the most vulnerable consumers once again. And for them, debt service is getting very difficult.
In Q1, the delinquency rate on credit card debt at banks other than the largest 100 – so at the 4,788 smaller banks – spiked to 5.9%, higher than at the peak during the Financial Crisis, and the credit-card charge-off rate spiked to 8%. These smaller banks marketed to the most vulnerable consumers that had been rejected by the biggest banks.
Key section of the Reuters story, which I urge you to read in full:
A Reuters analysis of U.S. household data shows that the bottom 60 percent of income-earners have accounted for most of the rise in spending over the past two years even as the their finances worsened – a break with a decades-old trend where the top 40 percent had primarily fueled consumption growth….the rise in median expenditures has outpaced before-tax income for the lower 40 percent of earners in the five years to mid-2017 while the upper half has increased its financial cushion, deepening income disparities. (Graphic: tmsnrt.rs/2LdUMBa )…
As a result, over the past year signs of financial fragility have been multiplying, with credit card and auto loan delinquencies on the rise and savings plumbing their lowest since 2005…
In the past, rising incomes of the upper 40 percent of earners have driven most of the consumption growth, but since 2016 consumer spending has been primarily fueled by a run-down in savings, mainly by the bottom 60 percent of earners, according to Oxford Economics….
With inflation factored in, average hourly earnings dropped by a penny in May from a year ago for 80 percent of the country’s private sector workers, including those in the vast healthcare, fast food and manufacturing industries, Bureau of Labor Statistics figures show.
This anecdote gives an idea of what that bottom 40% looks like:
Myna Whitney, 27, a certified medical assistant at Drexel University’s gastroenterology unit in Philadelphia, experienced that firsthand.
Three years ago, confident that a steady full-time job offered enough financial security, she took out loans to buy a Honda Odyssey and a $119,000 house, where she lives with her mother and aunt.
Since then she has learned that making $16.47 an hour – more than about 40 percent of U.S. workers – was not enough.
“I was dipping into my savings account every month to just make all of the payments.” Whitney says. With her savings now down to $900 from $10,000 she budgets down to toilet paper and electricity. Cable TV and the occasional $5 Groupon movie outings are her indulgences, she says, but laughs off a question whether she dines out.
“God forbid I get a ticket, or something breaks on the car. Then it’s just more to recover from.”
The foundations of this “recovery” have looked shaky, and this data confirms these concerns. But when and how fast things unwind is anyone’s guess, particularly with wild cards like trade wars, emerging market crises, China deleveraging and Brexit collateral damage in the mix.