This Is Going to Get Real Ugly

Many years ago, in Brisbane’s Queen Street Mall, we watched a busker creep up behind an elderly gentleman and yell ‘gotcha’. Initially the street entertainer got the laugh he was after.

But not for long.

When the unsuspecting bypasser fell to the ground and began convulsing, amusement turned to anxiousness.

Fortunately, a doctor in the crowd rushed forth to apply CPR until the ambulance arrived. The doctor was of the opinion that the sudden shock had triggered cardiac arrest.

The moral of the story is that nasty surprises can have potentially fatal consequences.

At present, the vast majority of people — like the innocent gent — have no inkling of the surprise that’s creeping up on them.

If you believe the financial press, the US economy is gaining in strength…

The Australian economy’s record-breaking recession-free run shows no sign of ending anytime soon…

China keeps pumping out amazing growth numbers…

And even Europe is showing signs of ‘green shoots’.

People are being lulled into thinking that everything is OK. They remain clueless as to what’s tiptoeing behind them. Which is precisely what the authorities want: Not to spook the crowd.

They know that without confidence — real or fake — the system starts convulsing.

But the powerbrokers cannot keep all the data out of earshot of everyone. For those who can tune out to the noise of the crowd, the footsteps behind us are quite audible.

Dissecting the US economy

Whether we like it or not, whatever happens in the US is exported to our shores sooner or later.

By all official accounts, the US economy is well and truly out of intensive care. In fact, it’s apparently recovering so well that there’s talk of the Fed slowly unwinding quantitative easing (QE).

At this stage, the talk has not been backed by action…perhaps this is in an exercise in QT — ‘quantitative teasing’.

What makes me think that?

The Fed must surely be in possession of the following chart:

Federal budget tax receipts 27-11-17

Source: MacroMavens
[Click to enlarge]

The chart shows the year-on-year change in US federal government tax receipts…revenue generated primarily from income tax and consumer spending.

Let’s look at the pattern here.

During the mid-to-late 1990s (the dotcom boom), tax receipts increased each year (from the year before) by around 9%. Why? People felt wealthy. They borrowed and spent accordingly.

Look at what happened after the tech bubble burst — tax receipts plummeted.

Confidence (and a good deal of wealth) was lost. The illusion was gone…at least temporarily.

Bring on the US housing bubble and, to no great surprise, government coffers enjoyed a reverse in fortune, soaring skywards.

The events of 2008/09 was a repeat of post-2000. Confidence and money was lost yet again.

The result: Fewer taxes paid.

When you throw trillions of freshly-minted dollars at an economy, you’d expect a bounce in the tax take. That’s exactly what happened after 2009.

But the chart shows us that something is different this time.

Even though the US share market is going gangbusters and the housing market is recovering (the wealth effect), tax receipts have been on a downward trend since 2015.

Tax revenues are in decline DURING a market boom, which is curious.

And the decline is not just being felt at the federal level.

According to MacroMavens, a firm providing research and economic commentary to institutional investors:

The problem for both the State & Local and Federal governments, simply put, is that receipts have slowed to a trickle while there’s been no commensurate slowdown in outlays on the other side…

Governments at all levels are feeling the pinch at a time when outlays — social security, healthcare, propping up under-funded pension plans, etc. — are on the increase.

That’s not a good equation. 

Why are taxes slowing to a ‘trickle’?

Probably because the ‘meat’ in the economic sandwich is getting thinner.

The ‘middle class’ is being squeezed.

While wage stagnation is a recent phenomenon in Australia, the average US worker has been feeling the pressure since the early 1970s.

Adjusting for inflation (and making an allowance for a shrinkage in hours worked per week), US household income has gone nowhere in over 50 years.

Hypothetical real weekly earnings of production 27-11-17

Source: Advisor Perspectives
[Click to enlarge]

To make a bad situation worse, household outlay in the 1960s was lower (in inflation adjusted terms) than today.

For example, the average home was valued at two times annual income, now it’s four times. Households did not have to pay internet and mobile phone plans, cable TV subscriptions, water rates, etc.

To bridge the growing gap between income and outlay, the American consumer has been drawing on two sources: credit and transfer payments (government handouts).

Consumer credit and transfer payments as % retail sales 27-11-17

Source: MacroMavens
[Click to enlarge]

Whenever the US economy hits a bump, there’s a corresponding increase in accessing credit and transfer payments to make ends meet.

As MacroMavens puts it…

…installment debt and government transfer payments now account for every dollar of discretionary spending (as measured by Retail Sales) and then some.

Consumers relying on more consumer debt and government welfare to keep their heads above water hardly fits the description of a strengthening economy.

To me, it looks more like an ailing economy being heavily medicated to create the impression of improved health…a Weekend at Bernie’s-type recovery.

My guess is that the Fed doesn’t/can’t/must not believe its own spin, which is why any unwinding of QE is a case of ‘all talk and no action’.

However, my speculative musings are probably misplaced.

The Fed — true to form — might not actually have a clue about the true state of affairs. After all, this is not without precedent.

Irrespective of what the Fed does or doesn’t do, there’s no turning around the fortunes of the US middle class — or for that matter any other country’s middle class.

An excess capacity to produce ‘things’ cheaply, automation, artificial intelligence and millions of aspirational people in China and India means wage suppression in the Western world is permanent, and not temporary.

Deflation, not inflation, is in our foreseeable future.

This is the unpleasant ‘gotcha’ that’s going to deliver a very nasty surprise to those geared up for an inflationary lift in asset prices.

Deflation favours cash — not debt.

Unfortunately, far too many households are at risk of suffering a form of financial cardiac arrest.

Whether they survive or not is going to be dependent on the level of indebtedness and exposure to so-called ‘growth’ assets.


Vern Gowdie,
Editor, The Gowdie Letter

Vern Gowdie has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top five financial planning firms in Australia. He has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

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