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Thread: a 4 pronged attack on the US economy

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    Banned Melonie's Avatar
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    Default a 4 pronged attack on the US economy

    from John Maudlin's Inverstor's Newsletter ..

    "A Four-Pronged Attack Upon the Economy

    Let's turn to those smart guys at Cumberland Advisors for an analysis of how much pressure the consumer is under. They think the Fed might come to a full stop as they are concerned the economy will roll into a recession if the Fed continues on its current path. I have noted in past letters that increased energy prices are going to take a toll on consumer spending. But it is not just energy. Increased interest rate costs on mortgages, the new Alternative Minimum Tax and Katrina all make this worse. They put a pencil to the problem to give us an estimate of the cost and the potential hit to consumer spending.

    "Energy is the largest of a four pronged attack upon then economy.We will compare the size of these 4 prongs with Disposable Personal Income (DPI) to demonstrate the magnitude of the problem and why they may lead to a consumer led slowdown.

    "Quickly, DPI is about 9 trillion dollars according to the latest Bureau of Economic Analysis (BEA) estimate. It is what the 295 million of us have left to spend after taxes and some other minor adjustments. It is the source of our consumption spending and our debt payments. Fortunately, BEA data break out the energy costs we incur.

    "Prong 1. In winter 2004 total energy costs in the U.S. were about 4 1/2% of DPI. We define energy as gasoline, natural gas, heating oil and electricity. By early summer 2005 that had climbed to 5 1/2%. For the next year we are estimating post-Katrina energy cost using near term futures prices. We get over 6% of DPI. It's not just gasoline. Consumers will see it in their monthly heating oil bill or natural gas or electric bills. Budget plan folks are in for their first alarm when the September billing statement arrives in the mail. A 1 1/2% shift against a $9 trillion and gradually rising DPI is over $130 billion. That is our conservative estimate. Note: a 12% increase in the price of energy equates to about a 1/2 point of DPI.

    "Prong 2. Mortgage interest rates hikes are already baked in the cake. See our housing bubble series of a few weeks ago archived at . About 2 full percentage point increases on about $1 trillion of adjustable mortgage debt will trigger $20 billion of additional mortgage payments on about 5 million households. They will phase in over the next few months.

    "Prong 3. The Congressional Budget Office (CBO) estimates that 14 million taxpayers will be hit with the Alternative Minimum Tax (AMT) starting January 1st. Unless Congress acts (not deemed likely at this moment) the temporary AMT adjustments from the Bush tax cutting will expire. We guess that will average about $2000 per household. AMT addition is $30 billion.

    "Prong 4. The ongoing costs of Katrina will continue for the many months; offsetting occurs when the recovery efforts and rebuilding strongly kick in. Eventually a massive amount of new debt will be issued: federal $50 billion; state and local governments ($10 billion); commercial and housing ($ unknown, could be another $50 billion or more). That money will be spent over the next several years. About $25 billion of insurance proceeds will arrive sooner. We think this rebuilding process is going to take a lot of time. Katrina reconstruction is much more difficult than Florida's 4 hurricane hits last year. Preliminary damage estimates are already over a $100 billion with about 3/4 are uninsured.

    "Add these up. Without Katrina destruction it is over 2% of DPI. Our numbers are conservative. Add Katrina and the high end is closer to 3%. "Consumers will certainly retrench; the first issue is how much. The second issue is how big is prong 4 and how long until the recovery phase catches hold."

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    Member Sophia81's Avatar
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    Default Re: a 4 pronged attack on the US economy

    Melonie,

    I'm always impressed by your breadth of knowledge and your intelligence. (Now that I seem like a brown noser...)

    I am interested to know how you think a troubled economy will affect the income of us girls in the exotic dance industry. Or, in your experience, how does a troubled economy affect dancer income?

    I know that in a depressed economy alcohol & porn sales will stay stable or go up rather than going down like other entertainment expenses (e.g. movies). Would this carry over to exotic dance clubs and dancers? Would income stay stable or go up, should we expect some decrease in income, or will the hustle just be different?


    Sophia

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    God/dess montythegeek's Avatar
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    Default Re: a 4 pronged attack on the US economy

    Prong 1 is real--but you have not seen the consumer reaction yet. Guess what, consumer turn the thermostat back when the price goes up. When heating oil or natural gas prices surge like they have, people do not use less heating oil in the summer because they do not use much anyway. You do not see the reaction until they buy less in January to refill tanks. This distorts the meaurement.

    Take Mwlonies purchase of 900 gallons of heating oil (wise move BTW), It shows up as a 3rd quarter expenditure. Any subsequent reduction in purchases shows up much later when she does not buy it.

    Prong 2 is vastly overstated. Any adjustment to a an adjustable mortgage happens 2-7 years later, not instantaneously with the move capped. Every single mortgage of this type shows the signer exactly how much the payment can move and the worse case scenario==a requirement under Federal law. Furthermore the author figures a higher flexible mortgage payment hurts disposable income--it does not. It will affect discretionary income--income after basics like shelter and food and heat.

    Three confounds four. While I have no love for the AMT as a political item, higher AMT taxes reduce the amount the Feds borrow. The $s do not differentiate between people who pay $1 more and people who pay $10m more. #4 treats all Katrina borrowing as if it happens very soon. The impact of disaster relief happens over years. The Authority is there quickly- spending takes time. 9/11 money is still being spent today 4 years later.

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    Default Re: a 4 pronged attack on the US economy

    Monty for the most part I agree with everything you said. I also think that a prong #5 got left off the list. Insurance settlements for Katrina damage are going to run in the hundreds of billions. But unlike gov't assistance which is paid for by T bond sales and/or printing press new money (a.k.a. inflation) and/or increased tax rates, insurance payouts are going to have to come from the liquidation of insurance company assets. I'm not exactly sure which insurance companies are most heavily exposed to Katrina damage claims, and I'm not sure where in fact their billions are invested at the moment, but it seems to me that a lot of insurance company owned real estate, bonds, stocks etc. are going to have to be sold to cover the claims payouts. Logically this will increase the 'supply' of these things on the open market and drive down prices of these things even further in the absence of new buyers. ... AhOooGah Dow Jones Blue Chip stocks !? The 'Max Pain' theory i.e. a major burst of inflation prior to insurance company payouts being made in inflated dollars ?

    As to prong #2 adjustable rate mortgages, I agree that the FULL effect of rising interest rates won't materialize for years. However, there will be nearly instantaneous increases to the limit of the one year caps. For many ARM holders, even a 1% rate increase this year will translate into say $200 a month in extra mortgage payment, which will directly and immediately affect the 'discretionary income' remaining.

    In regard to the impact on club customers, your alcohol and porn analogy applies to some degree to blue collar club customers. IMHO if higher prices on 'necessary items' leaves blue collar workers with less 'discretionary income' (thanks Monty for the correct terminology) to be spent on 'luxury items' like trips to a club, then certainly club income potential will suffer. This will probably take the form of blue collar customers still going to clubs, but spending less money once they get there - which will hurt dancers worse than clubowners since the clubs will still collect the cover charge and drink minimum from the customer's pocket before the dancers get a crack at the rest of the customer's money.

    I would also make the argument that upscale 'show clubs', whose customers typically have much higher levels of disposable income i.e. an extra $50 a week in gas & utilities = pocket change, won't see any noticeable effects on their income potential. Actually, many upscale club customers i.e. bankers, stockbrokers, lawyers etc. will be profiting big time from the Katrina aftermath (i.e. lawyers earn money both from new home closings and bankruptcy filings, stockbrokers earn money on buys and sells) so business may be better than ever in the top shelf clubs. However, it is these white collar club customers who are going to be heavily hit by the AMT coming back in full force (assuming GWB's original AMT tax rate reduction is not extended), but this will probably 'wash' against higher customer earnings.
    ~
    Last edited by Melonie; 09-11-2005 at 07:38 AM.

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    God/dess montythegeek's Avatar
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    Default Re: a 4 pronged attack on the US economy

    Melonie,

    You touched on a lot of things, so here are a few.
    1. The big insurance loser is the US governement flood insurance progra, run by FEMA. An estimated 40% of those in NO had flood insurance since flood insurance is required for any kind of a mortgage in a designated zone.

    Direct wind damage will be bad for insurers but that is their business and there is a disaster somewhere almost every other year.

    There is also the re-insurance market to consider. US Co A sells part of its exposure to Swiss Company B. B gets to pay off from its international assets. Less than half the tab goes to domestic companies in the end. Spread over the world it is small potatoes in the global insurance flow of policies and reserves. Big bucks but a small share of the total.

    Comments about club styles are subjective since distance can swamp "class". A club 50 miles away from the customer's home is more vulnerable than the one down the street and one in FLA is not as heavily influeced by heating costs as in one in Boston. Joe Lawbook does not see his income change from KAtrina. Lawyer A may be.

    The underlying economy matters more for most experiences than a local hit. There is a disproportionate gain to dicretionary income over time and the economy is coming back. Disasters like Andrew, the Loma Prieta earthquake. or mudslides can be wiped out by the fact that a 1% "cut in the growth rate" of disposable income is swamped by the 2.5% overall real increase.

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    Default Re: a 4 pronged attack on the US economy

    Quote Originally Posted by Melonie
    ... insurance payouts are going to have to come from the liquidation of insurance company assets....
    Has anyone seen any preliminary estimates re the exposure of the major insurers? Although there may well be a few that were still "throttling things" in an attempt to beat the odds and effectively pocket a higher percentage of the premiums for the policies they've written by not laying-off a reasonable amount of their potential exposure to reinsurers, from all indications I've seen they actually learned their lesson after whatever hurricane it was that totalled South Florida (8-10 yrs ago?) almost took a couple of them down - including some of the "biggies" like State Farm. In this regard, some of the more conservative (but less profitable on a yr-to-yr basis) insurers like USAA had actually laid off over 80% of their potential exposure and weathered the hit just fine, whereas others had laid off little to nothing and damned near went under because of that one hit.

    Beyond reinsurance, know they reacted in other ways to limit their potential exposure to an amount within their respective abilities to handle, even in a "worse case scenario" event as well. For instance, recall State Farm ceased writing new policies on anything in Louisiana lying south of I-10 / I-12 soon thereafter, and their public explanation was that in light of their overexposure in the Florida hurricane, they would not issue any new policies in the "coastal areas" of the state until they had dropped below whatever number/percentage of policies written they had now determined they should be at risk for should a similar type of loss occur in Louisiana.

    Finally, in the case of Louisana, at least, think you'll be surprised at how much was just flat-out uninsured... is a very poor state and much higher percentage of population just runs naked.
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    Default Re: a 4 pronged attack on the US economy

    Finally, in the case of Louisana, at least, think you'll be surprised at how much was just flat-out uninsured... is a very poor state and much higher percentage of population just runs naked.
    Well, if true, this would lead to the conclusion that much of New Orleans will never be rebuilt - in particular the low lying residential areas. By simple deduction, this would lead to the conclusion that Baton Rouge is going to be a 'gold rush' due to the permanently relocated businesses forced to leave New Orleans.

    Back on the 'larger picture', I was unaware just how high a percentage of their exposure that many US insurance companies had laid off to Swiss Re and similar reinsurers. Yes this would certainly tend to 'spread the pain' of any forced asset liquidations on a worldwide basis. I can also relate on some theoretical level with Everett McKinley Dirksen's famous quote 'a billion here, a billion there, pretty soon you're talking about REAL money !" - i.e. that 100 billion sounds astronomical in terms of the GDP of three badly affected states, but is a drop in the bucket in the world wide economy.

    Monty, I have my doubts about your apparent conclusion that the US economy has (irreversably) turned the corner to the upside, such that Katrina's economic fallout will simply be a 'bump in the road'. I smell a round of calculated money printing inflation of the US dollar, increasing federal, state and local taxes, increasing costs of 'necessities', but little if any increase in pay rates, continuing loss of US manufacturing/union jobs etc. I also smell an end to increasing real estate values, which will bring to a halt the string of equity extraction refi's which have served as the major source of money for US consumer spending as of late. Thoughts ?
    ~
    Last edited by Melonie; 09-11-2005 at 03:58 PM.

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    God/dess montythegeek's Avatar
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    Default Re: a 4 pronged attack on the US economy

    Quote Originally Posted by Melonie
    . I also smell an end to increasing real estate values, which will bring to a halt the string of equity extraction refi's which have served as the major source of money for US consumer spending as of late. Thoughts ?
    ~
    Melonie,
    I hate to disappoint you but that train left the station over a year ago. Look at the 5-year chart of the 10 year bond at
    http://finance.yahoo.com/q/bc?s=%5ET...l=on&z=m&q=l&c=
    The 30-year mortgage rate is 1.5-1.6 percentage points higher than than this rate 90% of the time. The low was June 2003. The mortgage refinancing boom was 2002 and 2003--maybe stretch the impact into 2004.

    The majority of people who refinanced and took equity out still ended up with lower payments after the fact because they took them out at rate up to 12-13%. They still ended up with lower payments, EVERY MONTH.

    Meanwhile nonmortgage debt has fallen half a percent of that 9 trillion disposable income since 2001 and 2002 and early 03. The consumer ain't flush but he is not in the shape of what gets flushed, either.

    No company can afford to own 100% of their exposure in anything like a known disaster area other than the US Government. Even the companies which insured the World Trade Center reinsured to pool the risk on a few office buildings. And not just with big companies like you mentioned, tons with small outfits.

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