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30% per Year for Five Years

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January 07, 2008 – Comments (12)

Imagine if you could get a return of 30% per year for 5 years.  With compounding you'd have 271%.  At this rate it wouldn't take long to secure a very nice retirement.

But it isn't investment return that has grown at 30% for 5 years.  Americans have been spending 130% of income for the past 5 years.  It means that on average households have an extra 1.5 times income of debt.  This amount is staggering and that is the only way to describe it.

Consider affordable housing being 3x income, with 25% down that means that an affordable mortgage should not exceed 2.25 times household income.  Essentially, on average, Americans have 2/3rd of a maximum mortgage of extra debt.  Only about 2/3rds actually own a home.

At 8% debt servicing of the interest alone costs 12% of income.  

Thirty percent is close to 1/3rd of income.  It means that households need to reduce spending on average by 25% to live within their means.  

This will not be easily fixed and it means that every industry is going to take a hit.  I can't see how this doesn't take years upon years to fix.  I suppose allowing the dollar to inflate to double reduces the debt burden to 6% of income if you can figure outh how to make sure wages go up proportionately.  But, the interest rates would go up enormously in order to attract money.

Spending 130% of income when the economy is supposedly booming is a complete disaster.  People should be saving when times are supposedly good. 

I don't see how this doesn't result in years of hard times.  

Good economist like Mish have been advising for the past few years how to prepare for the hards times that are coming as a result of this insane behaviour.  The advice has been simple, do not borrow any more money, cut back on spending and reduce debt.

It is probably time to consider what the credit squeeze means to investments as people are forced to start living within their means.

I think everything gets hit.  I guess cheaper substitution products do well, hot dogs for meat and that kind of thing. 

12 Comments – Post Your Own

#1) On January 07, 2008 at 10:08 AM, GS751 (27.40) wrote:

I own QID an investment I am very happy with.

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#2) On January 07, 2008 at 10:47 AM, floridabuilder2 (99.24) wrote:

After the UE numbers came out, I bought QID on the open and I am up really nice... it goes to show you that if you stay in cash and just wait until the 2nd shoe drops you may leave some profits out, but there are still a lot of profits to be made even with the fed lowering rates.. which they will...  the tech heavy nasdaq is going to get killed... the QID has heavy weighting to the big giants like AAPL, RIMM, etc...  these are great stocks, but if the market turns investors will turn on these stocks because of their high p/e

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#3) On January 07, 2008 at 12:14 PM, FoolishChemist (96.87) wrote:

I've often wondered what would happen if everyone started saving like me.  My friends joke with me that if everyone was as cheap as I was, the entire economy would collapse.  There would be no Starbucks, the iPod/iPhone would be a flop, everyone's cell phone would be 5 years old, everyone's car would be 15+ years old...  The economy is barely squeaking by with a few percent growth with us living beyond our means, if everyone cut back by 25%, forget recession, major depression.  Unfortunately we got ourselves to the point where the duct tape is stuck on the hairy arm.  Will it be one big rip or a bunch of little ows?

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#4) On January 07, 2008 at 6:52 PM, dwot (47.53) wrote:

Good going GS and FB.

FoolishChemist, I have been tight with finances as well.  I got a new computer earlier in the year and that was driven by the resource hog web pages out there.  I had my old computer in Vancouver and fool crashed it a few times.  It was about 6-7 years old and I really had no interest in replacing it.  I also have a second-hand laptop I bought, which I also used, and that thing is so slow.  I have decided that I am going to buy myself a high powered, small, laptop, maybe a tablet.  Tablets are great for teachers.

I think that there will be far more people in that position.  I've been able to do some spending, but I'd say my spending is down because the income is no where where I thought it would be, and the costs are so much higher.  Getting ahead just never seemed to be happening.  When I met my husband his car, the one I drive now, was about a year old.  I'd say for the last 9 years I've been looking at the car saying, I hope we get another 3-5 years out of this car.  If the car is still running in 3 years and not killing me with maintenance then I will still be driving it.

I wonder how much the losses are write-off will reduce house hold expenses.  Part of the foreclosures will reset that level of household spending downwards as people find cheaper accommodations.

I am thinking it will be a depression.  If you look at the last depression the debt didn't go away, it just never got repaid.  I read that the banks did manage to pay 88c on the dollar on their deposit. 

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#5) On January 07, 2008 at 7:04 PM, bubuzim (95.56) wrote:

Thanks FC for that morning laugh.  I already got the exacto knife out and disengaged my investments from the American economy.  No pain at all. :)

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#6) On January 07, 2008 at 9:27 PM, abitare (35.58) wrote:

dwot,

Marc Faber is on www.bloomberg.com video he is worth watching. 

He likes cash for the next three months. Report this comment
#7) On January 07, 2008 at 11:01 PM, dwot (47.53) wrote:

I am cash for the next year at least...

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#8) On January 07, 2008 at 11:07 PM, dwot (47.53) wrote:

And I am back in the NWT, so no videos for now.  Bandwidth is expensive up here.

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#9) On January 08, 2008 at 8:04 PM, TMFCrocoStimpy (94.99) wrote:

dwot, I can't seem to find the reference in your previous posts to where the spending 130% of income for the past 5 years came from.  Could you post that again please?

Thanks,  Stimpy

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#10) On January 08, 2008 at 9:52 PM, dwot (47.53) wrote:

"Persaud, one of the most prescient voices on international finance in the post-Sept. 11 era, noted that the American consumer boom was financed with real-estate debt: Americans have spent 130 percent of their income over the past five years. "They borrowed money against their property," he said."

Last paragraph on the first page. 

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#11) On January 10, 2008 at 12:29 AM, FleaBagger (28.92) wrote:

dwot-

I hate to be the one to burst the doom and gloom bubble, since we all seem to be having so much fun, but are retirees and semi-retireds backed out of that statistic? They spend quite a bit more than they earn, especially with the reverse mortgages these days. Yes, people do spend too much and save too little, but 30% more than income? I smell factual manipulation.

As for the assertion that spenders turning to savers would devastate the economy - in what sense? It would benefit those doing the saving (and yes, investing) as much as it would harm those doing the selling of luxury goods. The amount of real wealth comes not from numbers on a page, but from the amount of productive labor, and saving what you were spending doesn't inherently decrease that (though we do tend to work more when we're more materialistic). As for the people who lose their jobs or their businesses when materialistic people stop consuming conspicuously, they will be able to get other jobs or start other businesses in other industries. That's what inustrious and entrepreneurial people do.

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#12) On January 22, 2008 at 8:26 PM, TMFKopp (98.42) wrote:

I'm on board with FleaBagger... what you've pointed out makes a lot of sense at first glance, but you would have to work through the economic ramifications of the changes you're suggesting. For instance, if borrowers suddenly did turn into savers you'd have a glut of liquidity out there and intrerest rates would end up falling, and this would start to encourage borrowing again -- if not on a consumer level, then from businesses. I just don't think it's as simple as "people start saving, economic output disappears."

I'd also like to see some more back-up for the 130% assertion -- it smells a bit like data mining to me. According to data from the Bureau of Economic Analysis (bea.gov) annualized personal income as of Q3 '07 was $11.7 trillion, while personal consumption expenditures were $9.8 trillion. Looking back to the full year 2006 personal savings (personal income less taxes and personal consumption expenditures) was $39 billion.

I won't argue the fact that personal savings has declined preciptously, the data show that very clearly, but the assertion that consumers are consistently spending 130% of their income seems to be a little off the mark -- at least at the macroeconomic level.

If you're interested in some current thinking on personal debt in the US, its potential ramifications, and the huge gray area around personal debt, you may want to check out some of the Federal Reserve working papers. Here are a couple that I thought were pretty good:

https://www.federalreserve.gov/pubs/feds/2007/200737/index.html

https://www.federalreserve.gov/pubs/feds/2007/200752/index.html

matt 

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