2013 Economic Perspective

Once again fiscal cliff issues are the topic du jour in Washington D.C.  Since President Obama took office in 2009, Congress has not passed a budget.  Instead, a series of continuing resolutions were passed to fund the federal government to avert a government shutdown.  What can we expect in 2013?

Before I answer the question let’s examine recent economic, fiscal, and monetary history.  To properly understand this data it is imperative that you cast aside the narrative espoused by government and the main stream media and look at the facts.

Indicator FY ending Sep 30, 2008 Today (or FY ending Sep 30, 2012)
Outstanding Debt 10.9 trillion 16.5 trillion
2008 budget deficit 459 billion 1.327 trillion (FY ending 2012)
Federal Expenses 2.982 trillion 3.796 trillion (FY ending 2012)
Federal Revenues 2.523 trillion 2.469 trillion (FY ending 2012)
Entitlement Programs + Debt Interest 1.863 trillion 2.569 trillion (FY ending 2012)
Revenue/Expenses as % of GDP 17.7% / 21% 15.8% / 24.3% (FY ending 2012)
Debt to GDP ratio 76.6% 103%
Americans on Food Stamps ~27 million ~48 million
U.S. Household Debt ~13.4 trillion ~12.9 trillion
Labor Participation Rate 65.8% 63.6%
Fed Reserve Balance Sheet ~890 billion ~ 3.1 trillion
Fed Funds Interest Rate 1.81% .15%
10 Year Treasury Yield 3.85% 1.65% (FY ending 2012)
Base Money Supply (M0) ~1.1 trillion ~2.85 trillion
Money Supply (M2) ~7.7 trillion ~10.45 trillion
Total Credit Market Debt Owed ~51.7 trillion ~56.3 trillion
Gold Price ~875 ounce ~1580 ounce
Gasoline Price ~1.85 gallon ~3.73 gallon

Fiscal and Monetary Policy

The $800 billion stimulus passed shortly after President Obama was sworn into office in 2009.  Many consider this a singular event.  However, the stimulus funding was rolled into the baseline expenditures. In effect, there have been five stimulus programs totaling $4 trillion dollars since 2009.

Undoubtedly, $4 trillion of additional spending and nearly $6 trillion of additional debt has achieved absolutely nothing unless the objective is dependency on the federal government.

Fiscal policies created multi-year trillion dollar deficits that result in poor Federal Reserve monetary policies.  The Federal Reserve has been through several quantitative easing periods where the Fed is buying the government’s debt, purchasing mortgage-backed securities, executing repo transactions with the primary dealers, and funding foreign central banks.  The base money supplied has nearly tripled since President Obama took office in 2009.

To minimize interest payments on the debt, the Federal Reserve is pursuing a zero-interest rate policy (ZIRP) which sets interest rates artificially low.  This policy punishes savers and retirees living on fixed income while supposedly stimulating consumerism by expanding credit market debt.  Eventually, the debt buyers will demand higher interest rates to continue buying U.S. Securities.  If interest rates return to historical averages of roughly 5%, then the interest payments on the outstanding debt will increase from $275 billion to nearly $1 trillion per year.

As the money supply expands and the currency is debased the government can pay off the debt with cheaper dollars.  However, the government’s interests are inimical to our interests.  Cheaper dollars means a loss of purchasing power.  In the real world it requires more dollars to purchase the same goods and services.  Moreover, those that are able to save are penalized due to low interest rates.  The real interest rate (interest rate – real inflation) is negative.  By putting excess earnings into a savings account, certificate of deposit, or money market account your principle is eroded due to the Fed’s ZIRP policy.

Tax Policy

As of 2013, tax rates have increased on the so-called wealthy and the payroll tax deduction has reverted back to its historical 6.2%.  In addition, new taxes under the Affordable Care Act take effect this year.  Taxing and spending are the two policy issues that receive the most attention by voters.  This is an area where politicians lie, deceive, cajole, evade, and manipulate on a routine basis.

The simple truth is most of the tax burden is paid by the top 10% of earners.  In fact, the top 3% of earners pay 52% of individual income taxes.  We have a heavily progressive tax system that would make Karl Marx proud.

The Internal Revenue Service published Publication 1304 – Individual Income Tax Returns 2008. The data is summarized below:

AGI Range

# Returns Filed

AGI Total (Thousands)

Total Tax Paid  (Thousands)

Per Filer AGI

Per Filer Tax Paid

Percent of AGI

Percent of Tax Burden

>= 1 million

321,294

1,076,046,308

249,019,686

3,349,102

775,052

13.02

24.1

200K –999.9K

4,054,365

1,385,961,656

287,598,531

341,844

70,936

16.77

27.9

100K – 199.9K

13,851,341

1,845,103,256

232,270,420

133,208

16,769

22.33

22.5

50K – 99.9K

30,925,946

2,193,691,414

184,553,934

70,934

5,968

26.55

17.9

1 – 49.9K

93,297,623

1,762,057,537

78,138,354

18,886

838

21.33

7.6

Total 142,450,569

8,262,860,171

1,031,580,925

*AGI – Adjusted Gross Income

  • A mere 2/10ths of one percent of tax returns filed had an AGI > $1 million. Yet, 24.1% of the entire tax burden is paid by this group.
  • Those filers with an AGI > $200,000 represent 3% of all tax returns filed.  Yet, 52% of the entire tax burden is paid by the top two groups.
  • Compare the top bracket with the bottom bracket and you’ll find the per filer AGI ratio from the top to bottom bracket is 177 to 1.  A filer in the top bracket has an AGI 177 times that of the lowest bracket.  However, the per filer tax paid ratio between the two brackets is 936 to 1.  A filer in the top brackets pays 936 times that of the lowest bracket.
  • 47% of all income tax returns filed had no tax liability.  That is 67 million income tax returns filed that paid nothing in federal individual income taxes.

Employment, Inflation, and Household Income

In further support of the narrative, the government publishes misleading and inaccurate data regarding employment, inflation, and wages.  Unemployment figures are manipulated by two factors; the magical disappearance of people from the work force, and adjustments performed by the Bureau of Labor and Statistics.

If we examine the participation rate for the twenty year period of 1989 through 2008 the average participation rate is 66.52%.  From 2009 through 2013 the average participation rate is 64.4%.  As of the latest BLS unemployment report the participation rate is 63.5%.  We would reach full employment once the participation rate drops to 58% though tens of millions more people would be unemployed.  The last time the participation rate was 63.5% was June 1979.

Year Civilian Work Force Not in Labor Force Employed Participation Rate U3 Rate U6 Rate U3 RateUsing 20Year Avg
1989 186,393,000 62,523,000 117,342,000 66.5% 5.3% 5.3%
1994 196,814,000 65,758,000 123,060,000 66.6% 6.1% 10.9% 6.1%
1999 207,753,000 68,385,000 133,488,000 67.1% 4.2% 7.4% 4.25%
2004 223,357,000 75,956,000 139,252,000 66.0% 5.5% 9.6% 6.32%
2009 235,801,000 81,659,000 139,877,000 65.4% 9.3% 16.2% 11.38%
2013 244,828,000 89,304,000 155,524,000 63.5% 7.7% 15.2% 12.45%

Source – Department of Bureau and Labor Statistics, Non-Seasonally Adjusted employment status.  U3 is the publicly released unemployment rate which doesn’t count under-employed workers or workers discouraged from looking for employment.  In 1994, under the Clinton administration the official unemployment rate (u3) no longer included discouraged workers.

The second issue with the unemployment rate is the adjustments made by BLS.  BLS makes two adjustments; the birth/death rate adjustment and seasonal adjustments.  We’ll examine the July 2012 unemployment figures (as this was done during the election cycle for political purposes).  The July report headline number (preliminary) was 163,000 jobs added on expectations of 100,000 jobs.  In addition 155,000 people left the work force as well.  The June 2012 report was revised lower from 88,000 to 64,000 jobs added.   The July report includes the two adjustments I mentioned.  The seasonal adjustment applied by the BLS was +377,000 jobs.  The birth/death rate adjustment was +52,000.  Compared to July of the previous year the birth/death rate adjustment was a mere 5,000.  So, there was a 1000% increase in the birth/death rate adjustment year over year.  The total adjustments by the BLS totaled 429,000 jobs.  If you subtract 429,000 from the 163,000 jobs added it results in a decline of 266,000 jobs.  But this fact isn’t reported by the government, the main stream media, or most of the alternative news sources.

An alternative source for real unemployment and real inflation data is John Williams’ website www.shadowstats.com.  According to Williams the real unemployment rate is actually closer to 22%.  His most recent chart is included below:

unemployment-rates

The other item heavily manipulated by the government is the inflation rate.  We know this as the Consumer Price Index (CPI).  The headline CPI number published is referred to as the CPI-U (Urban Consumer).  The term “core” inflation is often used which excludes changes to both food and energy.  The term core inflation is an illusion because we all need food and energy.  Government bureaucrats invented the term to managed inflation perceptions.

Over the past 30 years the CPI calculation has changed dramatically.  The calculation used during the Carter and Reagan years is more robust and accurate than the calculations used since Clinton took office.  Traditionally, inflation measured the cost of maintaining a certain standard of living.  A fixed basket of goods with stable weighting was used to measure the price differences month over month, and year over year.

In the early 1990s, the CPI calculation was changed because inflation was rising.  One impact of rising inflation was the impact to Social Security payments.  By law, social security increases were tied to inflation rates (known as COLAs or cost of living adjustments).   If SS payments increased according to real inflation rates SS would become bankrupt sooner rather than later (not to mention under Clinton SS payments became taxable income).  In other words, this was a political maneuver to cut Social Security without having to actual say your cutting Social Security.

To address this, the CPI methodology was changed to a cost of satisfaction measurement rather than a cost of living measurement.  The Clinton administration revised the calculation to change the basket of goods and to change the weighting of the basket of goods as well.  The result was a lower CPI rate. Further revisions have occurred since then and the gap between the 1980 CPI calculation and the current CPI calculation has widened significantly.  The aggregate impact of the methodological change is 5.1%[i].  Below is the CPI chart since 1980 using official BLS numbers and using the 1980 calculation.  The most significant divergences between the “old” and the “new” methodology begin in the early 1990s.

inflation-rates

I have two final points on inflation.  First, the effects of the Affordable Care Act on inflation are just beginning.  I anticipate the ACA will drive up health care costs and inflation.  Secondly, inflation will occur due to a loss of purchasing power due to currency debasement.

What does all this mean for household income?  Using 2011 constant dollars as the basis of comparison, real wages in 1961 averaged just over $49,000 per person.  By 2011, real wages averaged just over $47,000 per person.  In 2011 constant dollars there has been a $2,000 decline in real wages over a fifty year period.

According to Sentier Research, in January of 2009, the median annual household income was $54,962.  In June of 2012, the median annual household income was, again, $50,945.  The rising cost of food also hits middle-class families directly in the pocketbook.  According to the U.S. Department of Agriculture’s Center for Nutrition Policy and Promotion’s most recent data (June 2012), for the moderate-cost food plan for a family of four, the average cost per week is $236.60.

From 2009 to 2012 the median annual household income decreased by 7.3%.  The annual food cost is $12,303.  In the average family let’s assume both people work and each drives 20,000 miles per year.  Assuming an average of 20 miles per gallon for both vehicles and the current gas price average of $3.65 per gallon the average family spends $7,300 annually on gasoline.  Combined the family spends $19,603 on food and gas.  That represents 38.5% of the gross household income.

Let’s assume the family has no federal, state, or local tax liability, but they do have Social Security and Medicare taxes withheld from their paychecks.  At 7.65% the family pays $3,897 in taxes.  Added to the food and gas costs the family has spent $23,500 on these items.  That is 46% of the family’s gross income[ii].

The graph below (published on shadowstats.com) but from Sentier Research shows the decline in real household income since 2000.

What to expect in 2013

The two things we can count on from the federal government are; they will continue to assault your rights and your wallet.  Regardless of the Republican and Democrat composition in the House and the Senate an agreement cannot be reached on balancing the federal budget, cutting spending, reforming entitlements, or raising/cutting taxes.  The debt ceiling is raised routinely.  The sequestration process was supposed to reduce future spending by roughly $88 billion per year or 2.37% of federal expenses.  A simple cut in future spending cannot be agreed upon without the typical demagoguery, name calling, and threats.

Congressman Paul Ryan has prepared a 91 page budget that reduces future spending to a 3.4% rate per year, and includes entitlement reform and replacing Obamacare.  The plan balances the budget in ten years.  Ryan’s budget is D.O.A.  The Senate won’t consider it and the President will declare it dead on arrival.  While Obama is in office there is no chance Obamacare will be replaced.  The house recently passed a continuing resolution that included funding for Obamacare.  I suspect any budget passed by the House will not pass the Senate and signed into law by the President.

I will give Congressman Ryan credit for pointing out what should be obvious to anyone with an IQ north of 80.  We have a fundamental spending problem!  Charts in Ryan’s presentation show that federal debt as a percentage of GDP will reach 250% by 2040.  Spending on social security, medicare, health care, and net interest will be 30% of GDP by 2040 on revenues of roughly 18% of GDP.  Moreover, Ryan’s plan calls for a major simplification of the tax code including the elimination of the Alternative Minimum Tax (AMT), two tax brackets, and a lower corporate tax rate amongst other things.  While positive it is a small step in the long journey to reform government.

Given the recent history, I expect 2013 to look eerily similar to 2012.  The federal deficit for FY 2013 will exceed $1 trillion.  The outstanding debt at the end of FY 2013 will exceed $17 trillion.  The participation rate in the employment markets will remain around 63.6% or decline slightly.  The Fed will continue their ZIRP, expand their balance sheet to nearly $4 trillion, expand the money supply, and buy more debt and mortgage-backed securities.  I anticipate real wages will remain stagnate or continue on a downward trajectory.

Sadly, but predictably, the narrative that we are in an economic recovery will continue.  The stock market at all-time highs provides the illusion of a recovery.  While people may feel better because of nominal gains in the stock market, corporations are reaping benefits of cheaper dollars and the Fed’s push for more consumerism through credit market debt to pump up the economy and the stock market.  Consider, Zimbabwe had one of the best total stock market returns over the past ten years, yet with those gains you could barely purchase a dozen eggs.  Most stock market gains are in 401Ks that are untouchable except for retirees.   Stock market gains do not create real wealth and prosperity.  The increase in the production of goods and services creates wage growth and real wealth and prosperity.

In the not too distant future, expect to hear more talk and perhaps congressional action around private 401K accounts.  Eventually, Congress will act to require a certain percentage of 401Ks be invested in U.S. securities.  Today, there is nearly $19 trillion in 401Ks.  I believe it’s only a matter of time before Congress acts to tap into this source of “revenue”.  This notion isn’t all that unrealistic given that the EU, ECB, and other powers in Europe are attempting to tax bank deposits as a means of bailing out to-big-to-fail banks.  Just two weeks ago, there was absolutely no indication of a crisis in Cyprus.  But, given how the EU is handling this situation it is a clear case where they’ll do anything to save the system at the expense of the saver.

Do you think this could happen in the U.S.?  Before you answer, consider there are roughly $8 trillion of deposits in U.S. banks insured by the FDIC.  Now, does FDIC insurance mean your deposits are secure?  The Deposit Insurance Fund (DIF) balance as of Dec 31, 2011 was $11.8 billion.  It doesn’t take a genius to figure out there isn’t enough FDIC insurance to ensure all these deposits.  By law, the FDIC can borrow up to $30 billion from the U.S. Treasury to cover additional loses.  Anything beyond $30 billion requires an act of Congress.  Moreover, the FDIC Act explicitly states that it is up to the FDIC to decide when you are reimbursed for your deposits.  This could mean weeks, months, years, or decades.  After the EU announced plans to tax deposits bank runs started.  The government immediately shut down all the banks.  They call this a bank holiday.  If any run on banks occurs in the U.S. expect the same reaction.

Most of what will occur in 2013 will be political posturing and preparing for the 2014 elections.  I don’t expect any substantive changes to current policies this year.  In other words, expect more of the status quo from Washington.  I wish I could be more optimistic, but experience has demonstrated Washington is broke and broken.

The global economy and financial condition of certain countries is important to monitor.  Geo-political events are difficult to predict.  The economies of Japan, Italy, Spain, Greece, and France must be watched closely.  The situation in the European Union (EU) is unstable and the future of the Euro and the EU are still unsettled.  Of course, the Middle East remains a powder keg with the situation in Syria and Egypt, and the issues/concerns around a nuclear capable Iran.  A wild-card like North Korea with its recent rhetoric regarding nuclear strikes and the tension between China and Japan is also building.  Needless to say, much is happening on the world stage that could impact us at home.

In closing, we must recognize the U.S. is on an unsustainable path.  By its very definition what is unsustainable must end.   Without any real monetary and fiscal policy changes the only questions are when and how.  Given our experience with the people in Washington the past couple/few decades is it possible for any real change to occur in a timely manner to avoid financial calamity.

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