Ask Not What Your Country Can Spend For You

Ask what you can spend for your country.  At least, some folks might like it if you did.  The Federal Reserve is in trouble.  The economy is meandering.  Unemployment levels have reached full employment, but labor force participation levels are low.  The Fed accentuates the negative and projects gloom about employment.  Wages stagnate, and, net of inflation, are lower than a generation ago.  The dollar is strong, which encourages imports while discouraging inflation. The Consumer Price Index is dropping, leading some to conclude that we have deflation.  This conclusion is a classic example of how statistics mislead.  Prices are higher if you take out energy costs.  If the price of everything except energy is going up, and energy is dropping a lot, do we really have deflation?  Or a misleading statistic?

But we digress. The Fed has greatly reduced its quantitative easing measures, since they didn't seem to be doing much good any more.  It's holding short term interest rates lower than a snake's belly.  But it can't do more.  The Fed is now low on ammo and can't expend what it has left; it has to hold something in reserve in case the economy belly flops.

There's no possibility of fiscal stimulus.  The federal government tied its budget into knots with the sequestration law, which requires automatic spending cuts each year through 2021.  Congress and the White House can get around the cuts by passing specific legislation providing for something other than sequestration.  But, given how the daily love fest between Congress and the White House consists of brickbats, but not bouquets, the chance for fiscal stimulus is lower than short term interest rates.

That leaves you, dear consumer.  The U.S. economy is about 70% consumption, and if consumers don't consume, the economy reaches for one of those little airline bags.  So spend, spend, spend.

Right?  Come on, right?

Or maybe not.  Consumers learned the hard way after the 2008 financial crisis that lavish spending and debt accumulation are shortcuts to financial ruin, and that saving improves the quality of your sleep.  Just because the Fed made it cheap to borrow doesn't mean borrowing is a good idea--soda is inexpensive but drinking a lot of it is a very bad idea.  If the Fed can't move short term interest rates above a complete goose egg, you have to suspect that maybe the Fed knows that the economy is a complete goose egg.  In which case, the last thing you want to do is spend freely.

We live with a contradiction:  our individual financial health requires acting in a way that is unhelpful to near term economic growth.  But those who are prudent can get through hard economic times, and it makes sense to put self and family first.  This leaves policy makers with controversial choices--negative interest rates, easing immigration restrictions to bring in educated, ambitious foreigners, and even more hotly debated measures (can you say Ex-Im Bank?).  How likely are these?

The truth is government policy is largely played out.  The economy will have to rise or fall based mostly on its own.  The next surge of growth, whenever that is, will probably come in a rush of technological innovation that may be hard to foresee.  Until then, the economy will likely meander.  If you're building up your savings and preparing for a tough slog, you'll probably be okay.  Ask not what you can spend for your country.  Ask what you can save for yourself and your family.

Rising Oil Prices: Has the Fed Been Too Clever By Half?

In eviscerating interest rates and quantitatively tranquillizing (we're way past easing), the Fed has sought to push investors into risk assets. Investors have responded. Stocks have risen sharply over the past six months. More disturbingly, oil and gasoline prices have bounced up, too.

The standard explanation for rising oil prices--demand from emerging markets like China and India--seems less plausible now that these economies are slowing down. The threat of Iran going off the deep end points toward higher prices. But Saudi Arabia's expressed intention to keep prices stable can't be taken lightly either.

However, the flood of liquidity that has come out of the Fed surely is a factor in rising petroleum prices, as all this cash has to find a home somewhere in the financial system. Rising oil prices create jobs in some parts of the country, but discourage consumers in all parts. While oil consumption won't fall much in the short term (because demand for gasoline is relatively inelastic, as economists would put it), consumption of clothes, food, vacations, and other things will suffer as gas bills snarf up the monthly budget. Recently improving economic statistics may reverse their trend.

The distribution of income enters the picture. Owners and sellers of risk assets benefit handsomely from the Fed's easing, while consumers (most of whom are middle class and hold little or no risk assets) are shortchanged. This matters in America, where consumption is 70% of the economy. One can see why QE 1, 2 and perhaps soon to be announced 3 haven't and won't boost economic growth that much. With the QEs, the Fed giveth, and it taketh away. The net gain to the economy is unclear.

Retire By Making Your Dollars Last

Managing your money in retirement is often depicted as a problem of how to allocate your portfolio, how quickly to draw down your net worth, when to begin taking Social Security and whether or not to buy long term care insurance. But managing one's financial assets is only part of the picture. Consider how you spend--the less your cash outflow, the easier it is to afford retirement. And you don't necessarily need to become a connoisseur of cat food or learn the dozens of ways to prepare rice and beans.

Pay off the mortgage. One of the most surefire ways to reduce month expenses is to pay off the mortgage. Since your retirement income will probably be less than your income while working, offloading the mortgage will improve the quality of your sleep.

Take the auto mechanic off your speed dial. Buy cars that are reliable and known for longevity. With the increased computerization of cars, the cost of repairs is skyrocketing. You don't have to buy a tinny econobox. If you can afford a luxury car, choose an Acura or Lexus, not some other brands that enrich repair shops.

When it comes to appliances, spare your back. High quality in home appliances isn't, to borrow a stock market phrase, closely correlated with price. The most reliable and long lasting washing machines and dryers tend to be the traditional, modestly priced top loaders. Currently fashionable side loaders have their attributes, but at the cost of higher purchase prices and less longevity. Plus you have to bend over or kneel down to get access to them. Your back and knees may have an opinion as to whether or not that's a good idea. Cheaper, more reliable, longer lasting, and easier on the back and knees is a pretty good bargain.

Use generics whenever possible. Generic drugs can be much cheaper than name brands. Why pay for a fancy name when the medication is the same at a lower price?

Avoid credit card debt. The most expensive loans most Americans take are credit card balances carried over from month to month. If you use credit cards, only charge what you can pay off at the end of the month. That way, you earn rewards, cashback bonuses, etc., without paying any interest. Why enrich banks in your golden years?

Hidden Bargains

If you want a Black Friday bargain, you have to be ready to be pepper sprayed, horse collar tackled, and perhaps trampled a few times. There are easier ways to get bargains.

Business Laptops. If you're in the market for a laptop, look at less expensive business models. Unlike laptops specifically aimed at consumers, business laptops are designed for heavy duty use, careless handling (it's the company's property, after all), and enough longevity that sales reps can convince corporate buyers the equipment is cost effective. Many business laptops are shock and spill resistant. They are often preloaded with good quality software. This, all for a price in the $500 to $700 range. Business laptops don't come in pastel colors, and are heavier than personal laptops (the additional ruggedness adds weight). But a well-made one delivers good value for the dollar.

Prepaid Cell Phone Plans. Prepaid plans give you direct feedback about your usage, by forcing you to buy more time when you're running low. These periodic demands for money teach you how much your yacking actually costs. You learn to reduce this negative feedback by controlling phone usage. You save by not paying for time you don't use.

Balanced Investing. A portfolio that's about 50% stocks and 50% bonds offers comparative stability in returns (see http://www.cnbc.com/id/45454073). Investors who enjoy stable returns are less tempted to trade, incur lower transactions costs, and face less of the volatility that tempts one to buy high and sell low. By reducing these negative factors, balanced portfolios can deliver good long term returns.

Renovated Homes. It's axiomatic among real estate professionals that home renovations, with rare exceptions, boost the value of a house less than 100 cents on the dollar cost of the renovations. This necessarily means a recently renovated home is a comparative bargain for the buyer who carefully researches prices and figures out where the actual market price is. A home that was renovated in the past year or two has a good chance of being a bargain. One that was renovated five or ten years ago may have appreciated enough that buyers don't really get a discount from the renovations (depending on the market). A beat up, water damaged foreclosure sale may a good deal. But so may be a sparkling recently renovated home. Do your research.

Year Old New Cars. Cars on a dealer's lot that are brand new, but one model year old can be an excellent bargain. The dealer will seriously discount them (sometimes with a quiet subsidy from the manufacturer) in order to make room for current year models. Year old new cars can be a better bargain than year old used cars, because they have no mileage but sometimes sell for not much more than a used car with 10,000 miles. Buying what the seller doesn't want is a good way to get a bargain.

Saving on Car Costs

When it comes to the cost of cars, people pay a lot of attention to the price they pay, their financing costs and the trade-in value they get. But the cost of owning a car can be as much or more than the cost of buying it. Maintenance and repairs can add greatly--or not--to your car budget. Insurance is also another major expense. An important way to reduce the costs of owning a car is to drive gently.

The harder you push a car, the faster it wears out. Charging down city and suburban streets as if you were driving in the Grand Prix puts a lot of wear and tear on the brakes, tires, transmission, and suspension. Drive the car gently, and the same items may last a lot longer. Take brakes. If you push the car hard, the brakes may need repairs every 30,000 miles, or maybe less. Drive the car gently, and the brakes may go 50,000 or 60,000 miles, or more, before needing work. If you put 100,000 miles on the car before you trade it in, hard driving could mean the expense of three brake jobs. Gentle driving may require paying for only one.

Tires offer similar savings. Properly inflated and rotated high quality tires, driven gently, may last 50,000 or 60,000 miles or more. The same tires on a car that's put through the paces every time you go to the grocery store may last only 25,000 or 30,000 miles--especially if you don't keep them properly inflated. If you drive the car for 100,000 miles before trading it in, you may have to buy two or three sets of replacement tires, or just one, depending on how you drive.

Suspension systems are vastly improved over the shock absorbers in the classics from the 1950s and 1960s. The shocks of that era might need replacement every 15,000 miles. Today's cars, with McPherson struts up front and better shocks in back, last much longer. Vehicles with rugged suspensions, like pickup trucks and SUVs with offroad capability, may, if driven gently, go 100,000 miles without needing suspension work.

Gentle driving also reduces the chances of accidents and tickets for moving violations, because you're likely to be going slower. That means a better driving record, which translates into lower insurance premiums.

Exhaust systems also last much longer than those of 40 years ago. Back in the days of the General Lee, a car might need a new exhaust system every 15,000 to 20,000 miles. Today, exhaust systems can have much greater longevity. Perhaps counterintuitively, it's a good idea to drive a car at least once every few days to prevent buildup of water condensation in the exhaust system. That will reduce the potential for rust, and help the exhaust system to last.

As for routine maintenance, do what the manufacturer recommends. This is especially important if the car is under original or extended warranty (which will require compliance with the manufacturer's maintenance recommendations). The manufacturer's maintenance schedule can often be found in the owner's manual; or maintenance work will be indicated when necessary by codes or lights on the instrument panel. However, be skeptical of routine maintenance the dealer recommends. Dealers make much larger profits from their service departments than from sales. They will push service managers to foist all kinds of unnecessary routine maintenance on unsuspecting customers. For example, fluid flushes (e.g., power steering or brake fluid) are frequently recommended when not needed. The time to listen to the dealer is when you have a specific problem you've asked the dealer to diagnose (and even then, be on guard).

When it comes to buying a new car, going through dealers' Internet Departments can be a money saver. See http://blogger.uncleleosden.com/2007/05/buy-new-car-without-haggling-and-save.html.

Steady is the Way to Save

Financial returns have gone to hell. Bond yields are evaporating, money market returns are zero, and stocks have gone negative more than most politicians. We're in an investment desert, with the prospect of retirement a cruel mirage. If you manage to retire, you fear that you'll run out of money before you run out of time on this planet. That would leave you with only Social Security. But the political right will ambush Social Security and if you plant a garden to survive, the white tail deer swarming America's suburbs will eat your food supply before you can harvest it. You're screwed. Unless you find a way to boost your net worth.

The most reliable way to build up your net worth is to save steadily, week after week, month after month, year after year. Then, if you compound your earnings (assuming there are earnings to compound), you leverage your returns (see http://blogger.uncleleosden.com/2009/09/if-you-love-compounding-compounding.html). How can you achieve a steady flow of cash into your saving and investment accounts? Here are a few ideas.

Pay yourself first. Participate in any 401(k) or other employer-sponsored retirement program available to you. A portion of your paycheck will be automatically credited to your retirement account before you can spend it. You can also arrange with your bank to automatically transfer each month a fixed amount from your checking account to a saving account, IRA account, or mutual fund account. The key to saving is to live below your means. Paying yourself first is a great way of doing that.

Shop for Loss Leaders. Many stores offer extra low prices on select items to get you in the door, in the hope that you'll pay full freight for other items. Grocery stores are notorious for advertising loss leaders, and nailing you with high prices on staples. A way around this pricing scheme is to identify a cluster of grocery stores that are within a few miles of each other, so that travel costs aren't a big factor, and buy the loss leaders at each. You'll probably find that different stores often have different items on sale each week. It's hard for stores to win the loss leader game if they mark down the same items. So they frequently mark down different items to avoid competing directly against each other. If the stores are close to each other, you can drive to all of them easily and buy the bargains. When you frequently shop the same cluster of stores, you'll also learn how their regular prices differ. One store will usually have cheaper meat, another cheaper bread, a third cheaper milk. With this knowledge, you can save even more. While this strategy may not work well in rural areas and urban areas poorly served by the big supermarket chains, it does work for the majority of Americans who live in the suburbs.

Cheap gas. There are websites that report on gas prices in your neighborhood. None have complete information. But take advantage of the bargains you find. Since gas is an important monthly expense for most Americans, the savings add up.

Drive like a millionaire. Studies of the well-to-do report that the typical millionaire drives, not a luxury or sports car, but a standard sedan or mid-range SUV. Most millionaires became well-off because, among other things, they didn't burn up their income on big depreciating assets like expensive cars. Buy as much car as you need. A family of five or six obviously needs more vehicle than a single person. But don't confuse looking prosperous with being prosperous. Choose a Honda over an Acura, or a Ford over a Lincoln, and you'll look more like a typical millionaire.

Eavesdrop on your fellow passengers. We all know that mass transportation will usually be cheaper than driving, and it's kinder to the environment. Okay, strap hanging with a lot of other people trying not to look like sardines may seem like eating bologna with processed American cheese food on white. But view the glass as half full. Almost every day in public transportation, you can hear other people over-sharing too loudly on their cell phones. You learn what idiotic, messed up, contorted, perverse, and incredibly lunatic lives they have, and you will be amused, entertained, appalled, disgusted, and grateful. Grateful because however boring, unrewarding, difficult, and warped your life may seem, someone else has traveled farther down the road toward disaster than you. Don't worry about being an eavesdropper; they voluntarily, if perhaps unwittingly, made spectacles of themselves. Laugh while you bank your savings in commuting costs.

Veg out for free. If you're going to rot your brain sitting in front of a television, consider what you like to watch and find the cheapest way to get it. Check out resources on the Internet. A lot of cable shows can be accessed through your PC for free or a lot less than monthly cable charges. If you are a public television fan, many PBS stations post copies of shows on their websites that you can access later without charge if you miss the broadcast. Broadcast TV still does exist, and there are more channels now than ever. Of course, if you need to slobber on the sofa with shopping shows playing nonstop, cable may be your best option. But you'd be spending money in order to spend money. That isn't the way to get rich.

A pox on credit card interest. You won't enrich yourself by enriching banks. As interest rates for savers have fallen, interest charges for credit card customers have risen. Do you think someone might be getting shafted? If you carry over a monthly balance on your credit card, that someone can be found in the mirror.

Make Your Life Fit Your Closet Space. If you look at the typical American home (be it a single family house, a condo or an apartment), you'll notice that the closet space seems rather limited. Think about your friends and family--most or all of them have filled their closets and other storage space to 150% of capacity, and then stacked stuff up against walls and in other stray spaces. Most of America's housing stock was built in the 1940s, 1950s, 1960s and 1970s, with enough closet space for the needs of the times. It's only been in the last few decades that the warehouse-size walk-in closets found in newer suburbs have felt barely adequate. During the halcyon years of the 1950s and 1960s, when Americans thought of themselves as glowingly prosperous, people lived with a lot less than they have today and felt damn good about it. You can save a lot of money by making your life fit your closet space. Buy what you need. Buy what you want. But don't make a landfill of your closet space.

Facing a Never Ending Governmental Debt Crisis

As the federal debt ceiling scrum thrashes toward a short term solution, it's evident that we won't have a permanent solution for many months, maybe years. The Republican right made a mistake in thinking it could use the debt ceiling as a lever for reducing federal spending. The lever, it turns out, is one red hot tamale--not lifting the ceiling in time to prevent a government cash squeeze could blow up the stock and bond markets, slow economic and jobs growth, smack other nations with similar consequences, and worsen consumer malaise. The debt ceiling is like a nuclear weapon: too horrifying for actual use. So it doesn't provide much real leverage. Now, with time very tight, leaders of both parties are scrambling to stabilize an increasingly messy situation. Chances are they'll come up with something, but it will be short term, and the crisis will renew itself within months, if not weeks.

Across the pond, we have the same short termism managing an increasingly large load of governmental debt in the Euro zone. Greece's latest default spasm was quieted down with more borrowed money while a long term resolution was pushed off for a couple of months. The dominos in Ireland, Portugal, Spain and Italy quivered. High ranking EU officials debated what might be done without reaching agreement (sound familiar?). Banking officials in Europe applied extra lipstick to the latest round of bank stress tests, and admired the pigs as best they could. But the stink of the sty remained.

The sovereign debt problems on both sides of the Atlantic have taken on the quality of a sickening roller coaster ride, with crisis followed by crisis followed by crisis. Each crisis has the potential to blow up banks and sink financial systems, taking economies with it. With a frenzy of stress every few months, a toll on long term economic well-being will be extracted. You can't plan years ahead if your 401(k) is about to be torpedoed. A business can't hire for the future if its bank funding might evaporate in two months because a foreign nation 4,000 away can't get its national accounts straightened out. Just a few of the detrimental effects of such endemic crisis would include:

Lower business spending. It's well-known that corporate America is sitting on top of shiploads of cash, but not investing or hiring. While this reluctance to put money to work is due in significant part to overall economic sluggishness, the seasickness that comes from just watching the sovereign debt crises surely heightens cautiousness.

Less long term investment. The 2008 financial crisis drove large numbers of individual investors out of the stock markets. The sovereign debt dilemmas encourage further departures. With stocks still close to their two-year highs, it's easy to rationalize taking chips off the table, and some individual investors are doing just that.

More consumer malaise. If consumers keep hearing that the world as they know it will collapse in a couple of months, they won't: (a) buy a house, (b) buy a car, (c) buy household furnishings or equipment like washers and dryers, or (d) take a big vacation. Staycations devoted to buying bulk, discounted quantities of rice, beans, and ramen noodles will become all the rage.

Income stagnation, leading to economic stagnation. Incomes at almost all levels except the top 10 or so percent are stagnant. With federal deficits under scrutiny, governmental benefits may be trimmed. The continuing volatility created by these debt problems will only encourage the Federal Reserve to persist in its policy of never again allowing interest rates to rise. A future of low rates in America precludes a revival of the interest income on which millions of retirees and others used to depend. For an economy that's 70% consumption, income stagnation means economic stagnation. There's no possibility of growth if there's no income to spend. People aren't so crazy as to borrow money for consumption any more, nor are banks so crazy as to lend it. The inflation the Fed so desperate seeks won't spur consumption if there's no increased income to compensate for higher prices. Indeed, for most today, the response to inflation seems to be to stop spending on all but essentials.

A state of perpetual crisis precludes stabilization and growth. Today's sovereign debt crises are political problems more than anything else. Both Europe and America have the wealth to solve these problems. They just can't figure out how to allocate the burdens of the solutions. But the price of this political dysfunction is economic dysfunction. And that's our future, unless something really changes.

The Federal Reserve: Bank Nationalizer, Income Atomizer

The nationalization of the banking system continues. Even as healthier banks repay their TARP funds, the Fed is now proposing comprehensive regulation of banker compensation. It's not talking only about executive pay. It means to cover compensation arrangements down to mid-levels and perhaps even lower. The idea is to prevent banks from creating and accumulating the outsized and uncontrolled risks that led to the current economic mess. All the annoyed bank vice presidents out there have AIG-Financial Products to thank for the comprehensive scale of the proposed regulation. AIG-FP was one of many subsidiaries of AIG, the grand bailee of the financial services industry. FP, all by its little old lonesome, sold so many credit default swaps, and thusly saddled AIG with so much risk, that the U.S. financial system almost blew up when FP's counterparties began to demand collateral that it couldn't provide. As we all know, the American taxpayers, generous to a fault and holding bankers dear to their hearts, rushed forward with more than $100 billion to save AIG from bankruptcy.

Because the federal government, through its now engraved in stone too-big-to-fail doctrine or through federal deposit insurance, is on the hook for virtually all liabilities of all banks, there is a logic to comprehensive regulation of bank risk taking. After all, the banks' own signal failure to manage risk created the mess we're in, and there's not a lot of evidence that they've changed their ways. Indeed, bank risk levels now seem higher than before the economic crisis. (See http://blogger.uncleleosden.com/2009/09/risks-of-business-as-usual-in-banking.html.)

The Fed wants to ensure that banks have sensible pay policies. Can't argue with that. But government agencies don't regulate simply by prescribing policies. They have to follow up and verify that the banks are following their policies (that's called enforcement of the rules). Federal examiners would have to routinely review compensation of, say, bank vice presidents (those would be the folks that open checking and savings accounts, and make mortgage loans). We'd practically have the government managing the banks--all of them. Admittedly, many are the bankers that deserve a trip to the wood shed from which they would return with tenderized butts. However, having federal officials countersign bank employee paychecks implicates the government really deeply in the doings of the banks. The next time there is a banking crisis--and you can bet your last penny that there will be more banking crises--the federal government will bear even more blame than it has been smacked with this time.

Back in the bad old days of 3-6-3 savings and loan mortgage lending, cars had big fins and lousy mileage, too many martinis were consumed at lunch, meals were high in saturated fat and tasty, the real estate market grew steadily if not spectacularly, and the financial system was pretty stable. The government got this result by limiting the financial products that banks and similar institutions could offer and invest in. Banking was a dull industry with moderate profitability. But recessions tended to be short and recoveries tended to be fast. America was an optimistic nation.

Perhaps the unstated reason for the proposed comprehensive regulation of banker compensation is that the Fed doesn't want to admit error and re-regulate the types of financial products that banks can play around with. In the last 20 years, the Fed has led the charge for the deregulation of banking. It's wanted to allow banks to do anything they want, take any risk they want. No need to recap the result of all that. A simpler way to solve the problem of bank risk levels would be to again limit the products the banks play with. No more CDOs or CDOs squared. No more credit default swaps. No life insurance settlement backed bonds or other financial engineering of doubtful social value. If these products truly have social utility, some not-too-big-to-fail, not federally insured or guaranteed company will come along and offer them. If none does, those products will be revealed to be the sophisticated forms of gambling they appear to be.

Federal regulation of banker compensation is meant to prevent the morally hazardous status quo, where taxpayers cover losses while bankers bank big bonuses. That's a laudable goal but we ought not overly complicate the task of bank regulation.

Speaking of simple points, the Fed holds another periodic meeting next week, where it will decide basically to change nothing. Short term interest rates will be kept at zero and other accommodative measures will be kept in place, with only the gentlest of suggestions that they may ever so gradually be withdrawn but not if the financial services industry lets out even a mere whimper. As a not-so-academic exercise, one might consider what would have been the case if the Fed had, instead of moving interest rates to zero, just lowered them to 2%. A fed funds rate of 2% would have been quite accommodative by historical levels but would have been less conducive to inflation (not a threat at the moment) and to asset bubbles (whoops, please don't look at the stock market, whatever you do). There are a lot of people who hold savings in money market funds and bank accounts, and whose interest income has fallen sharply because of the Fed's indulgences for bankers (i.e., providing a zero percent cost of funds which the banks can turn around and lend at tidy profits). How much income have these unfortunate holders of capital lost? It's hard to say, but we can guestimate.

About $3.5 trillion is held in money market funds. Something like $5.5 trillion is held in bank money market accounts, savings accounts and other interest bearing accounts. That's $9 trillion right there, which multiplied by 2% equals $180 billion per year. Then add federal interest paying investments that effectively have variable rates, like U.S. Treasury bills, TIPS, and U.S. Savings Bonds, which may total in the range of $3 trillion. Multiply this by 2% and you get an additional $60 billion. Then, there are those very unfortunate auction rate securities and perhaps some commercial bonds held by individual investors, and the aggregate income lost from having a zero rate instead of 2% probably totals over a quarter trillion dollars.

A quarter trillion dollars may not seem all that big in America's $14 trillion economy. But ask retailers if they'd like customers to have an extra $250 billion to spend. Granted, not all such interest income, if it were received, would be spent. But even if some of it were saved, those savings would probably have a wealth effect that would make recipients feel a little looser with other income.

Clearly, America's savers cannot look forward to very much interest income for a long time. Thus, the Fed constrains consumer spending even as it tries to foster it with its ultra cheap money that banks don't lend to consumers.