The Middle Class Meltdown by Jeff D. Opdyke, The Sovereign Investor.
Last week, I explained why the Federal Reserve finds itself caught between Scylla and Charybdis, two Homeric sea monsters that ultimately will necessitate that Janet Yellen and crew raise interest rates gingerly, over a much longer period of time than is widely expected, and at a pace that could see rates go up in increments lower than expected.
That thesis was built on the idea that raising rates as the market currently expects would lead to two problems, which stem from a stronger dollar resulting from higher rates:
1) It would undermine Asian economies, causing a possible currency crisis that would the hurt the world economy, including ours.
In August, Mohnish Pabrai took part in Brown University's Value Investing Speaker Series, answering a series of questions from students. Q3 2021 hedge fund letters, conferences and more One of the topics he covered was the issue of finding cheap equities, a process the value investor has plenty of experience with. Cheap Stocks In the Read More
2) It would necessitate higher rates on U.S. Treasury paper as the government rolls over existing bills, notes and bonds. Those higher rates hide the potential to create a currency crisis here at home.
But there is another set of facts that hints at the quandary the Fed faces. They, too, imply that the rate increases to come must be muted … otherwise, the bedraggled U.S. middle class is toast.
Last week, I told you that owning gold and silver is one of the antidotes. Though it doesn’t look like it at a moment when the dollar is the tallest elf in the factory, our greenback faces challenging days ahead because of the level of American debt (both government and consumer), the incompetence in Congress and the Catch-22 that the Fed faces. It needs to raise rates to correct imbalances it has created, yet doing so risks a potential crisis that kneecaps the U.S. economy and calls into the question the wisdom of a dollar-centric world.
Today, we add to the strategy with big, stable, dividend paying income stocks, such as Southern Co., a large utility in the Southeastern U.S. currently sporting a 4.7% dividend.
At the heart of Fed’s problem is the heavily indebted American middle class.
America in Trouble
I write a great deal about the $18 trillion or so in federal debt our government has accumulated in our name. That’s a difficult number to visualize because the value is so large it means nothing in practical terms. So, our fact for the day: America’s governmental debt, laid end-to-end as dollar bills, would exceed the one-way distance to the moon more than 7,100 times. That’s a lot of dollars.
But here’s the thing: Personal debt in America is approaching $17 trillion. So the American consumer isn’t much better off than the American government — and at least government has the power of taxation and ownership of some printing presses to raise all the dollars it needs to paper over its debt.
It’s that debt, and the state of the American middle class today, that creates the Fed’s domestic struggle.
Consider some recently reported data points that underscore the desperation percolating through the typical American household today:
- Nearly one in five American children living with married parents receives food-stamp assistance today, almost double the rate prior to the Great Recession.
- More than 60% of Americans do not have enough savings to cover a $500 repair bill or a $1,000 emergency-room visit.
- More than half of American households have less than one-month of income in savings.
- Nearly 40% of existing jobs on America pay less than $15 an hour. Worse, nearly half of all new jobs are low-wage jobs, and about 48% of the projected job openings nationally do not even pay $15.
- Finally, the American middle class, once more than half the households in the country, has continued to shrink and is now about 43% of the country — and a large portion of those are retirees who have pensions to supplement their Social Security income.
Those are not the statistics of a fundamentally strong nation.
We are internally weak — a service-sector economy populated by low-wage workers who live their life on credit, one paycheck to the next, struggling to feed their children without government support.
Now, imagine what happens when the Fed raises interest rates…
Escape the Fed’s Low Rates
As rates rise, the cost of credit escalates. Mortgages begin to move beyond the capacity of low-income borrowers to afford a house, and those who relied on adjustable-rate mortgages to buy their homes in recent years will find their monthly payments rising, possibly to an extent that causes another (albeit smaller) round of foreclosures.
Higher rates trickle through the bond market, raising the cost of capital for the companies that operate apartment complexes, thus forcing rents higher, which hits all those American families who can’t afford a house.
Interest rates also go up on credit cards and auto leases, pushing up the cost of repaying those debts. And it begins to create inflationary pressures across the consumer landscape that will likely rise faster than a low-wage worker can keep up with in an economy where consumers demand low prices, which prompts retailers to keep a lid on wages.
U.S. consumers are a huge player in the American economy. Rising rates weaken them even more than they already are, and thereby threaten the economy.
The Fed certainly knows this. It’s all part of the calculus it’s playing with as it plots its coming course.
Yellen & Co. simply cannot raise rates meaningfully. The potential detriments in Congress and on Main Street severely limit the Fed’s path and its ultimate destination. Interest rates are destined to say low for many more years. Neither the government nor the U.S. consumer has the capacity to reduce its debts, and any series of meaningful rate hikes threatens disastrous knock-on effects in the economy.
Buy high-yield stocks such as Southern Co. now while the shares are relatively cheap. When the consensus view comes around to the realization that the Fed rates hikes are going to be tepid, money will flood back into dividend plays.
Until next time, stay Sovereign …
Jeff D. Opdyke
Editor, Profit Seeker