The economy started expanding in the first quarter of 2003. Where is the money to pay for this expansion coming from? According to statistics from the Bureau of Labor Services, non-supervisory wages are near stagnant since 2000. US savings is at 0%, and have been decreasing since the early 1980s. So consumers’ increased spending isn’t from an increase in wages or money they put aside for a rainy day. That leaves one source: debt. Steve Church has done a great analysis from the Federal Reserve’s Statement of Financial Flows, which clearly demonstrates debt is the US consumer’s main source of new money for expenditures.
The analysis uses a corporate cash flow model. For those of you who are unfamiliar with this accounting format, it essentially states where money for a specific period comes from and goes to. Every year, money comes in from a variety of sources and is paid to a variety of activities. The cash flow statement shows where money comes from and where it goes.
For those of you who have detailed knowledge of a cash flow statement, you will notice that I am simplifying certain definitions for the lay-person. This is not supposed to be a presentation to a group of MBA’s, but a presentation to a group of non-MBA’s so more people can understand what is going on beneath the surface of the US economy.
I have summarized the cash flow statements for ease of reading purposes. If you want to see the spreadsheet, go here.
The figures below from the Federal Reserve’s Statement of Flows:
2003
Savings: Households net operating assets in 2003 were 357 billion dollars. This is the total of savings and depreciation additions.
This is where a cash flow statement starts. It presumes people will spend first from what they already have.
Investment: Households net financing activities in 2003 were 1.142 trillion dollars. This is the total of mortgage, savings and other investment activity.
This tells us what consumers spent their savings on. This is money the consumer spends during the year.
Financing: Households net debt acquisition in 2003 was 866.9 billion. This is the total new debt minus repaid debt.
Outside of savings, this tells us where consumers got the rest of the money they used during the year.
2004
Savings: Households net operating assets in 2004 were 365 billion dollars. This is the total of savings and depreciation additions.
Investing: Households net financing activities in 2004 were 1.341 trillion dollars. This is the total of mortgage, savings and other investment activity.
Financing: Households net debt acquisition in 2004 was 1.044 trillion. This is the total new debt minus repaid debt.
Let’s look at these numbers in a bit more depth.
First, before we get to the top line of the cash flow statement, we’re going to add another figure: wages. If wages increased significantly, than it is possible the wage increases were used to finance the national economic expansion. According to the Bureau of Labor Services, wages for non-supervisory employees have grown 4.35% from January 2003 to December 2004. Over the same time, inflation increased 4.67%%, making inflation adjusted wage growth a -.32% from January 2003 to December 2004. Because consumers aren’t making any more money, increases in wages are not responsible for consumer purchases during the period on the cash flow statement (2003-2004).
The top line of the statement is for savings. “In the strictest definition, savings are that part of your production that is in excess of your consumption.” In other words, savings is what is left over after you pay your bills and other expenses. Depreciation is added to operating expenses because depreciation is essentially an accounting method of allocating the cost for a capital over that good’s expected useful life. This allows a purchaser to allocate the cost of a capital good more effectively. While a depreciation deduction technically lowers your operating income for tax purposes, you don’t really pay the money allocated to depreciation. Therefore, from a cash flow perspective, depreciation is added back to monthly operating income to determine monthly operating income.
You’ll notice that cash flow from operating activities is positive. This means what you would think it means: that after savings and depreciation, consumers added money to their personal stash of money from savings and depreciation.
The next big area of the cash flow statement is from investing activities. Loosely defined and investing activity is one that will hopefully increase cash flow in the future. It shows there was a net cash outflow to investing activities greater than the cash inflow from operating activities. This means that after money from operating activities, (savings + depreciation) and money spent on investing activities, household’s cash balance is negative.
So, how do households make up this difference between investment activities and operating activities? They borrow heavily.
The third section of this annual household cash flow statement reveals a very important reality of the current expansion. After deducting annual totals for repayment of debt, households are borrowing between 2.5 (2003) and 2.85 (2004) greater than their income savings.
However, that is not the scariest conclusion the paper draws.
This paper analyzes the sources and uses of household cash flow. We use the basic corporate cash flow statement format to identify operating, investing, and financing cash flow. In order to meet current financing and investment requirements, we discover that households need to generate new cash equal to at least 13% of GDP every year.
Prior to 1993, the sources of household cash flow were split about 55% from income and 45% from new debt. Beginning in 1993, new debt increasingly became the source of cash flow. In 2005, new debt of about 12% of GDP should provide nearly 86% of household cash flow.
We are simply borrowing to create wealth.