Sunday, December 8, 2013

A thought for Sunday: Why stagnant wages and trends in interest rates make me a longer-term Doomer

 - by New Deal democrat

A commenter to a post I wrote this past week asked if there were anything I am "Doomerish" about.  As it happens, yes there are several such things.  I guess that makes me a "closet Doomer."

By nature, I am pessimistic.  I am always expecting Pandora's box to be opened and for all kinds of horrors to come flying out. But I am also a math nerd, and that means I view Pandora's box like a safe with a combination.  Doom can't come flying out until all of the tumblers have fallen into place.  Until the proper combination has been found, and the safe unlocked, Doom is at bay.  In fact, my first post ever at Daily Kos, in October 2005, was entitled "Not Doomed Yet".

Let me explain in detail the source of my longer-term pessimism, by referencing two posts I wrote in 2007 and 2008.

By 2007, all of the tumblers appeared to have triggered, and in August 2007 I wrote what I still think is one of my best posts ever, "Are Hard Times near? The Great Decline in interest rates is ending". My overall view of the economy now is really the same as it was then.  The "Great Moderation" so beloved of Alan Greenspan was actually a chimera of declining interest rates.  Here's what I said then:
   ... [T]he "Big Picture" from 1981 - present  is that [t]he American consumer has had largely stagnant wages since 1974.  While from 1980 through 2006, the median income of an American household has risen only from $39,700 to $48,200 in real terms, house prices for example have shot up form nearly $125,000 to $246,500.  Consumers have responded generally by taking on more and more debt.  Total household debt service has risen from 16% in 1980 to 19.4% in 2006. 
    Fortunately for consumers, there has been a generation-long decline in interest rates since they peaked at 15.21% for the 30 year US Treasury bond in October 1981.  This has allowed consumers to refinance their debts at ever lower rates every few years.  They have also been assisted by a bull market in stocks that took the S & P 500 from 102 in 1982 to 1553 in 2000, and the subsequent housing boom/bubble. 
   There are signs that this "Great Disinflation" of declining interest rates is coming to an end.  Only twice in the last 27 years has the consumer been unable to refinance debt or tap into his or her stock or house ATM. ... [T]he 3rd and final time is almost certainly near.
....   [Given wage stagnation], the only way American consumers have been able to significantly improve their lifestyles is either to take on debt, using assets which have appreciated in value as collateral [stocks from 1982-2000 and housing thereafter], or to refinance their debt at lower interest rates.  If consumers are unable to tap the value of assets, or to refinance, then without improvements in wages, they will pull back and cause a consumer-led recession.... 
.... The Longer-Term:  are Hard Times coming? Interest rates are no longer declining
    Beyond the possibility of a recession in the very near term, a first-order danger signal for the long term future is that long term interest rates seem unlikely to move lower than 4% anytime soon....  These problems suggest that the 27 year decline in interest rates is ending.  From here we may well see fluctuating interest rates that begin to rise in sustained fashion again at some point in the next 3-8 years.  A rising interest rate environment would be deadly for consumers and for other debtors like the US Treasury. 
    If long term interest rates do decline again, consumers may yet have one more chance to refinance their spending for the next few years.  But any increase in interest rate yields for 30 year US Treasury bonds above 5.5% would likely mean that the Great Disinflation of interest rates is over, and Hard Times -- when individual and Sovereign debtors alike must "pay the piper" -- are upon us
While the thesis obviously wasn't perfect, Hard Times did come to pass just as expected, as overextended consumers (and banks!) had to pay down debt.  In January 2008, which we now know was only one month into the "Great Recession," I wrote "The Slow Motion Bust unfolds in earnest," saying:
    Whoever inherits the White House on January 20, 2009 is likely to confront serious and urgent economic conditions unlike any we have seen in our lifetimes.  For the mortgage crisis is only part of a bigger insolvency crisis that has already taken longer to unfold than most economic downturns in our history.
    Below the fold I'll describe past "panics" or economic busts from the 19th century, to show you how quickly they unfolded....
    Consider this, not a set of predictions for 2008, but rather a look at the Big Economic Issue that will dominate this year and the entire next Presidency.
.... By a "slow motion bust", I mean to suggest that the current situation is like the 19th-early 20th century "panics" described above, except that instead of unfolding quickly, the situation is unfolding at a snail's pace.  Like an ageing behemoth of a warrior, the economy may need to sustain 1000 blows before it goes down, but that onslaught of blows is ever so gradually accumulating.
 As it turned out, the bankruptcy of Lehman Brothers was the blow that slay the beast, and also there was one more chance to refinance, as Ben Bernanke and the Fed engaged in Quantitative Easing, and long term interest rates sank as low as 1.52% in July 2012.

So what am I Doomerish about?

Now at the end of 2013, we still have the same long term problem that I wrote about in 2007.  Over the long term, wages are still stagnant, and below their 2010 peak.  Interest rates are more than 1% above where they were 17 months ago. HELOCs are a thing of the past.  We have just had a new peak in stock market prices, however, and the "wealth effect" should lead to some increased spending by the top 10%-20% of households.

I have long thought that the secular Bear which began in 2000 was not going to end until about 2020, and that there would probably be 3 stair-steps down.  The first 2 have already happened, but if there is a 3rd, at the end the situation will probably be worse than it was in late 2009. With nominal wages only increasing by 1.8% a year for the last 4 years, even 2% inflation causes households to lose ground.  This can't go on indefinitely.  Either real wages must meaningfully improve, or that 3rd recession is going to happen sometime soon (but not now, and almost certainly not in the next 9 months).  It may well start from a position of incomplete recovery from the 2008-09 recession, and if so that next recession is likely to feature actual wage deflation.

With the oxygen of refinancing shut off in the era of sideways and then rising interest rates, a era which I believe began in July of 2012 and will last at least a generation,  economic expansion can only take place once real wages start to rise again and/or sustained asset price inflation persists.

Doomerish enough for you?