Will Your Standard of Living Bubble Burst?

August 25, 2008 by  
Filed under Budgeting, Debt and Credit, Spending

This article is for consumers who may be living in a bubble of an inflated standard of living.  The economic data indicates that there are many of you out there.  To find out if that could be you, please read on.

Economic Bubbles Bring Worlds of Troubles

What is a “bubble” in the world of money and personal finance?  It is a situation where an asset or asset category has become inflated in value or worth based on non-substantive factors.  The asset value is supported by irrelevant air or fluff.  The U.S. economy, including its investors and consumers, having experienced two significant bubbles in the last decade.  The hard truth is that some of you may be about to experience another bursting bubble.  It is a very personal one:  your standard of living.

If you are over the age of 25, you probably clearly recall the “dot com” stock market bubble of the late 1990’s, and the dramatic bursting of that bubble shortly thereafter. 

Unless you are a caveman, you have also seen and perhaps personally experienced the popping of the real estate bubble in 2007.  Unfortunately, this bubble is still letting out its air.

This brings us to what Mr. ToughMoneyLove believes will be the next bubble to burst:  the standard of living bubble.  Why do I believe that?  Let’s examine the data.

Personal Incomes Have Not Increased

The graph below shows changes in the employment cost index (ECI) from 2003-2008 for different regions of the country.  (This data is brought to us from the U.S. Bureau of Labor Statistics.)  The ECI is a good indicator of total wages and benefits paid to U.S. workers.  Note that the rate of increase in ECI began trending downward in 2004 and has remained relatively flat since 2006.  Note also that the rate of increase has hovered at 3.5% or below.  This is below the current inflation rate, meaning that adjusted for inflation, U.S. workers aren’t making any more money now than they were in 2003.  That’s not good.


Personal Savings are Almost Non-Existent

The chart below shows the personal savings rate trends for U.S. consumers.  Note that it went negative in 2005.  It stayed very low through the first quarter of 2008 and then showed a jump in the second quarter.  Of course this jump was only to 2.8% of disposable personal income.  Folks, that is nothing to be excited or optimistic about.  Anyway, this tells us that U.S. consumers have little or nothing left over after they pay their monthly bills.  (If they do, they must be spending it in Vegas because they sure aren’t saving it.)  We are living paycheck to paycheck or worse.


You Can’t Use Your Home Equity – It’s All Gone

After the markets collapsed in 2000-2001, consumers remained optimistic and continued to spend.  (As the data shows above, they sure didn’t save.)  This optimism and spending was closely tied to the continued rapid appreciation in real estate values.  Consumers apparently figured that they could continue to spend and not save because they were building wealth through home equity.  To maintain their standard of living with increasing food and oil prices and flat incomes, they turned to their home equity.  HELOC’s became all the rage.  Now we know that the real estate bubble has burst, home values have fallen, and many homeowners are tapped out and even upside down on their loan balances.  There is no more using your home as an ATM machine.   Some lenders have frozen HELOCS altogether because of falling real estate values.  What is worse, suburban real estate values may continue to decline.

To Keep the Standard of Living of Bubble Inflated, They Turn to Credit Cards

With no access to extra cash from employment income or home equity, consumers have turned to their credit cards to maintain an inflated standard of living.

The table below is from the latest Federal Reserve Board statistical release on increases in usage of consumer credit on an annualized basis.  I have highlighted in red the most recent data (from June 2008) which shows a substantial increase.  The “revolving” debt number corresponds closely to credit card debt.  That number jumped big time in May, 2008.

            2007 2008
  2003 2004 2005 2006 2007 Q2 Q3 Q4 Q1 Q2 April May June
Percent change at annual rate 2 
     Total      5.3      5.5      4.3      4.5      5.7      5.6      8.2      3.9      5.0      4.9      4.2      3.8      6.7 
       Revolving      2.9      3.8      3.1      6.1      7.4      6.8      8.6      8.2      6.8      4.9      0.3      7.6      6.8 
       Nonrevolving 3      6.7      6.4      4.9      3.6      4.7      4.9      7.9      1.3      3.9      4.9      6.5      1.5      6.6 

What does this data tell us?  That consumers faced with a combination of (a) flat incomes, (b) increasing inflation, and (c) no home equity left to tap, are turning to their credit cards to maintain their standard of living.  Instead of cutting expenses, they are swiping cards at an alarming rate.

The Bubble Has to Burst

Consumer access to revolving credit is not unlimited.  Two things can and will happen.  First, consumers will reach their credit limits on existing lines of credit.  Second, banks have and will tighten up credit standards and deny more credit to stretched consumers.  The tightening of credit standards in the real estate markets has proven this.  Bottom line:  Consumers will not be able to use credit of any kind to maintain their inflated standard of living.

What You Can Do

By this time you are probably thinking” “Why is Mr. ToughMoneyLove bringing more bad news?  I am not in a standard of living bubble.  Even if I am there is nothing I can do about it.”

My tough love response to thoughts like this is that you had better be sure you are not in the bubble and, if you are, you sure as heck better find something to do about it.

Mr. toughMoneyLove’s recommendations:

1.  Get out all of your financial records and determine ALL of your spending for the past 6 months.  Then compare the spending to your income each month.  If your spending exceeded your income for 2 or more of those 6 months, you need to honestly consider whether you are using credit cards to prop up your standard of living.

2.  If complete and accurate spending data is not available to you, then calculate your net worth as of 6 months ago and as of today.  Excluding any paper losses in your investments and real estate, if your net worth has decreased, you should also honestly consider whether you have a standard of living that is being supported by credit cards.

3.  If you determine from steps 1. or 2. that you are in a standard of living bubble, you need to get out of that bubble before it blows up in your face. 

4.  I am no genius in reducing a standard of living by cutting costs because we have always lived below our means.  I do have some suggestions for saving money in some basic spending categories.  I have also talked in the past about small expenditures that can bust your budget so you can consider those as well.  Also, don’t forget the lunch time cash drain as a way to cut back. 

5.  Find a way to completely stay off the credit cards so that your standard of living bubble can shrink in an orderly manner.  Here are some ideas on how to avoid the use of credit cards.

6.  Set up a budget that defines your new standard of living that is not in the bubble.  There are a number of free online tools that will help you do that.

Mr. ToughMoneyLove brings the hard truth but he also wants you to succeed.  Be honest with yourself about being a bubble-dweller, take action now, and you can succeed.  When you do, please come back and tell me about it.

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4 Responses to “Will Your Standard of Living Bubble Burst?”
  1. Eric Hundin says:

    I found your blog on MSN Search. Nice writing. I will check back to read more.

    Eric Hundin

  2. MasterPo says:

    Good article. I agree about the CC’s.

    However, you and others who speak of savings and costs always overlook the most *significant* cost out there: TAXES!

    Between my Federal, State, FICA and Medicare tax I loose 37% of my pay before I even see it (over 40% when I lived in NYC and had to pay city income tax). With what’s left I then have to pay sales tax, use tax, excise tax, property tax, energy tax, disposal tax, import tax, port tax, required licenses/permits/registrations (another form of tax), government service charges, etc etc etc.

    I’d LOVE to say more! But how can I? And if I work really hard and make more money, I have a “silent partner” who will take even more the better I do.

    And now we have politicians promising to raise taxes more, how “unfair” it was they were reduced, and have you looked at all the green/global warming proposals out there? They ALL start with raising taxes more!

    It’s not always the individual’s fault.

  3. Matt says:

    Nice research here. Sadly, it will take such recent events to get the majority of Americans back into the savings & investing mentality. Too bad we require the “Three Stooges slap across the face” wake up call to get our own financial house in order.

    But hey – China and India can continue to buy all of our debt forever (sarcasm included)? Right?

  4. Matt – Unfortunately, for a lot of people its going to require structural changes in their standard of living. A lot of them have been living financially on hopes and prayers since the dot.com days, then through the real estate bubble. It’s all over for them.

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