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Revisiting the Underlevered American Household

Exactly one year ago, my pal James Altucher penned a Real Money article, The Underlevered American Household. I found it perplexing -- I didn't see why anyone would want to lever up more in the fiscal environment we were looking into.

My response was a Real Money (sub only) column titled Ignore Statistical Oddities at Your Peril.

But I also found his column instructive in that it forced me to more carefully articulate some ideas I had been kicking around for a while.

One year later, that process still resonates with me. Here's my takeaway from our debate last year:

1) Always pay attention to statistical anomalies: They are invariably informative. If for no other reason, they make you think about how we gather and use data. In the "under-levered case," I had to consider different time frames, chew over context.   

I thought it was important that the savings rate went negative for the first time in three quarters of a century. That oddity got my attention -- and for good reason. Since then, the economy has likely slipped into a recession, and the Dow has fallen 12%.

2) All book keeping is double entry: James reminded me that for every purchase, there is an opposite asset acquired. Its easy to occasionally forget that.

However, just because each side of a ledger entry is quantitatively "balanced" does not mean they are qualitatively "equal."

That's important to remember, because . . .

3) Assets fluctuate in value, but debt is persistent:  We heard similar debt-to-asset ratio arguments in 1999, as proof that things weren't at all dangerous. However, even after stocks then -- or at present, houses -- dropped in price, the underlying debt used to purchase them persisted. So much for the vaunted asset-to-debt ratio

Its another lesson too quickly forgotten from the 2000 crash: Always distinguish how debt and assets behave in differing economic conditions.

4) Spending habits change as the economy cycles: The savings rate reflected that. People continued to spend not their wages & income, but their assets, in order to maintain a lifestyle and/or a standard of living.

Note that this is more than just miles driven or which cars get purchased due to high oil. Our entire mind set shifts as the cycle turns from expansion to plateau to contraction to bottom. People cut back, spend less, hunker down. While that eventually leads to pent up demand, lifting the expansion when it rolls around next, its a process that takes a few years to play out.   

Which leads to . . .

5) Real, inflation-adjusted income matters: Despite real income being negative, as a nation, we took a long time to adjust our consumption habits. Consuming more than earnings has significant repercussions. 

Instead of seeing wage gains being used to raise living standards, we consumed Household equity as if it were actual income. There is an enormous difference between borrow and spend, versus earn and spend.

Which is precisely what the negative savings rate was warning those how were paying closer attention . . .

>

Sources:
The Underlevered American Household   
James Altucher
TheStreet.com, 6/21/2006
http://www.thestreet.com/p/_rms/rmoney/marketanalysis/10292988.html

Ignore Statistical Oddities at Your Peril 
Barry Ritholtz
TheStreet.com, 6/26/2006
http://www.thestreet.com/p/_rms/rmoney/marketanalysis/10293756.html

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Sunday, June 22, 2008 | 08:30 AM | Permalink | Comments (33) | TrackBack (0)
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Comments

quote from above "People continued to spend not their wages & income, but their assets, in order to maintain a lifestyle and/or a standard of living"

I'll be blunt and point out what you all know
People continued to spend OTHER PEOPLES MONEY
thats what has kept us going, what a system of unbalance, and reward for the masters of that trade

Posted by: Greg0658 | Jun 22, 2008 8:57:40 AM