February 2010

It's a strange image, isn't it? Cute but crazy. But you'd be surprised how many people really think pigs can fly. Take these PIGS, for example: Portugal, Italy, Greece and Spain.

When the European Union was formed and the Euro became its currency, some of the prospective members didn't want to let the PIGS in. The finances of those four countries were a mess. But somehow, some way, the doubters became convinced that those PIGS could fly. They got in. Seventeen years later nothing's changed. Their finances are still a mess. The PIGS continue to spend more -- a lot more -- than they can afford.

Which brings us back to what where we left off last month: "The One Thing We Can Count On In 2010." Now it's time to dig deeper, so we'll look at:

• Why Warren Buffet Called America "Squanderville"
• How Spending Less Doesn't Necessarily Get Rid of All That Debt
• The #1 Obstacle To Making a Fresh Start In This New World Order
• What Life Will Be Like Without All Those McMansions

There's no denying that we're looking at a dramatic change in the way we conduct our lives. For example, how often have you heard and read economists wringing their hands over this? Since 70% of the American economy has depended on consumer spending they wonder just what will happen now that we're spending less.

`But it's only when you get caught up in the theories and statistics of the dismal science that you miss the fact that, in a sane world, we'd be happy about us spending less now. Of course, a world where pigs can fly isn't a sane world. And it hasn't been sane for decades. Maybe that's why Warren Buffet began referring to America as "Squanderville" a ways back. We just spent and spent and spent -- for the most part money we didn't have. And in the last couple of years, the residue of all the "Squanderville" years hit us like those snowstorms we've gotten in the Northeast this year. Now we've got a lot of digging out to do.

When we last looked at how business and consumer debt shot up starting around 1980, we left out government debt. But, of course, the flying pig syndrome found its way into government too. Take a look at this chart that goes back to 1957...

It's from a really interesting site called the "Grandfather Economic Report." Notice how national income rises along with Total American Debt -- until right around 1980. Debt rising (the red line) while income rises (the blue line) isn't too bad of a combination. And that's what happened from 1957 until around 1980. But around 1980, you can see that debt took on a life of its own.

Here's another chart from a recent Wall Street Journal Opinion column. This one starts in 1970. It shows how, for most of us, income has risen very little, especially when you factor in inflation. But even while income remained pretty flat, just look at debt:

The difference between these two charts and the ones we looked at last month is the impact of government spending. When we add in government spending and the fact that our income has hardly increased when adjusted for inflation, you come up with -- you got it -- spending a lot more than we can afford -- especially since 1980.

Looking back, doesn't it seem crazy? Put another way, why did we think pigs could fly?

To get our arms around this, we'll stick to consumers -- that's us. We'll put the government off to the side for a while. We all know government spends too much. Most of us don't need lots of proof to convince us of this point. But it's far too easy to let ourselves off the hook.

But wait. Didn't we already say that we're reducing our debt? Somehow, somewhere, some way, we consumers have stopped spending so much and started -- dare we even say the word? -- saving. And while that's really good news, there is one little problem...

If you've ever been buried in too much personal debt, you know it takes quite a bit of time and energy to dig yourself out. It doesn't happen overnight. That 30-40 year trend we showed you built a mountain of debt for a lot of people. So under normal circumstances, it would take a while to dig out. But, as we've said, things have been far from normal in our "pigs can fly" world.

Here's a good snapshot of just how out of control the average American's spending had gotten. This chart focuses on "household debt" which for most of us means mortgages and credit cards:

It shows how household debt -- our personal debt -- shot up relative to the total gross domestic product of the entire country starting around 2000. After turning up the spending in 1980, maxing out all those credit cards, we managed to ratchet things up another notch in 2000. We started using our homes as ATMs. That's what happens when you think pigs can fly.

In case anyone's forgotten the home ATM madness, it went like this: With mortgage rates low, and banks itching to lend, Americans decided to "tap into" their home equity for cash. Why let the equity just sit unused in your home? Take it out -- in the form of a loan -- and spend it. It's good for you and it's good for the economy. It seemed to make sense at the time.

So we sucked out all the equity in our homes and we spent and spent more -- until the sub-prime mortgage crisis hit in 2007, the first of a string of financial snowstorms we've been dealing with.

OK. We know it won't be easy dealing with all this debt. But, heck, we'll just break out the ploughs, snow-blowers and shovels. We'll clear out that mountain of debt and -- voila -- we'll be back to business as usual.

And to the extent we've toned down the spending, we've made a good start. Soon we'll be paying down debt and -- finally -- we'll start saving again...right?

Remember, we the people can't print our own money like the government does. We've got to earn that money first -- which brings us to the stark reality of unemployment.

Unemployment's up around 10%, not counting all those "discouraged" and "under-employed" workers the government leaves out of its statistics. Count those folks and we're up around 16.5%. And you don't have to crunch a lot of numbers to know that unemployed people lack the one thing they need to either service or pay down their existing debt: cash flow.

Now surely unemployment will come down, right? Of course - eventually. But to see just how long this could take, we'll need to crunch some numbers.

First though, we'll factor in what has to be considered very good news indeed: America's growing. Compared to places like Russia and most European countries, our population is not stagnant or dwindling. That's a good thing. America -- as opposed to those other places -- has a future.

But guess what all those new people need? Right -- jobs. To keep up with our increasing population, we'll need about 100,000 new jobs per month. But, of course, now that we've also got all those unemployed folks too, we need more than those 100,000 new jobs. We need jobs for all those unemployed too.

So let's add another 100,000 jobs a month for those folks. If we add the 100,000 jobs for the unemployed on top of the 100,000 jobs for the new kids on the block, that's 200,000 jobs a month. That'll at least halve the numbers of unemployed -- over the next ten years. (Ten years does seem like a long time, doesn't it?)

Just one thing: the economy has never created 200,000 per month. Oops.

(That's why when you hear people claim it's "no big deal," we'll "grow ourselves" out of this mess, you've got to check the numbers behind the optimism.)

Getting back to the idea that spending less will dig us out of all that debt, it looks like we can conclude that unemployment's going to be a tougher obstacle than most of us realize. So that saner, more normal world -- a world without mountains of debt, where pigs don't fly -- will take some time. There are no easy solutions.

So with all that under our belts, we can finally look at what all this will mean to us in the years to come, as we spend less, save more and pay down debt.

Take a good look at that flying pig again. How did we ever get to believe in this strange creature? Why did we let all this debt build up over the years? (And remember, we're just talking about consumer debt, not government debt.) Do you have any idea? We'd certainly like to know, because each time we think about it, it never adds up. But let's give it a shot anyway. Maybe if we look at what bewitched us all these years, we can get some idea where we're headed now.

Common sense dictates that we must have thought all that debt would make our lives better. But better than what? We struggled with this question. The fact is, one man's meat is another man's poison. So in the end, we decided to use that most basic American standard: life, liberty and the pursuit of happiness. You remember these, right? It's what our forefathers fought and died for way back when. Question: Which of these is enhanced by debt?

For example, think about how many people you know who've buried themselves in debt so they can live in a McMansion -- those enormous homes where you can go a week and never see anyone else who happens to live with you.

Maybe they're leasing two or three new cars every few years, each of which has GPS, Bose stereo, and videos for the kids, not to mention a computer chip that will parallel park the car automatically so you don't have to do it yourself. (McMansion owners notoriously can't parallel park.)

Or maybe they're in the midst of burying themselves -- or worse their kids -- in mountains of debt so the kids can attend private schools and the "best" colleges. You know those "best" colleges, right? They're the ones that give you those degrees that guarantee your kid a great job so he or she can buy a McMansion, lease 3 new cars and pay for private schools and the best colleges for their kids so their kids' kids can...Get the picture?

Maybe this explains how so many of us thought pigs could fly. Maybe. But can you find life, liberty and the pursuit of happiness anywhere in all this? We can't. So here's the good news.

Let's say all the McMansion owners foreclose on their mortgages, people stop buying a new car every three years, and we all stop feeding the tuition monster that's promising what it can't deliver. (We just covered the three biggest expenses most of us face: house, cars, education.) Then what? What will all that do to your dreams of a better world for you and your children? We can't tell you. You'll need to answer this question for yourself.

What we can tell you is that the man who proposed that life, liberty and the pursuit of happiness were among our unalienable rights also said: "Never spend your money before you have earned it."

You may not believe those simple words of Thomas Jefferson are as timely and important as we do, but believe this: It sure is a lot better than believing pigs can fly.

On to next month and a subject we first took up last May -- almost a year ago. We'll look at the profound impact the coming crisis in state and local debt will have on all our lives -- as well as a change in our original assessment of the risk of investing in municipal bonds. Until then, we leave you Jefferson's take on happiness:

"It is neither wealth nor splendor; but tranquility and occupation which give you happiness."

P.S. -- If you'd like a copy of a special report that explains why you need to consider converting your regular IRA to a Roth IRA this year, just feel free to hit "Reply" and let us know. Or you can always try our blog for timely comments on the whole Toyota government investigation -- including lessons you can apply to your personal financial planning.

Richard S. Esposito, ChFC
Lighthouse Wealth Management LLC
405 Lexington Avenue, 26th Floor
New York, NY 10174
Tel: 212-907-6583/Fax: 866-924-1952

Email: resposito@lighthousewm.com