The Fading of the American Dream

The 2016 election cycle proved one thing; tens of millions of Americans were only too happy to cast aside "business as usual in Washington" for an unknown and unproven quantity, Donald Trump.  A recent posting on this blog shows us who these disenchanted Americans are and and how their well-being had a significant impact on the ultimate result of the latest presidential election.

In this posting, I want to look at a study done by the Equality of Opportunity Project on upwards mobility in America which is defined as the chance that children will reach the top 20 percent of income distribution given parents who have incomes in the bottom 20 percent.  Here is a map which shows the geography of upward mobility for 741 metro and rural areas (aka commuting zones) with darker colours representing a lower chance of upward mobility:

Note that children in the south and east central parts of the United States have a much lower chance of actually grasping the American Dream than those living in the northeast, central and western parts of the nation.  As you can see on this map, there is a relatively interesting correlation between the regions with lowered future economic prospects and the outcome for in the 2016 presidential election:

A study by Raj Chetty and Nathaniel Hendren at Harvard University looks at the impacts of neighbourhoods on intergenerational economic mobility and evaluated the casual effect of the 100 largest commuting zones in the United States on a child's chances of success.  Here is a listing of the 10 commuting zones which have the largest positive casual effect on household income in adulthood:

To help you understand the causal effect, if a child grew up in Seattle rather than an average commuting zone, he or she would make and average of 11.6 percent more at age 26 (9.1 percent more for boys, 14.2 percent more for girls).  For instance, if the average level of household income at age 26 is $26,000, those who grew up in Seattle would earn an additional 12 percent or $3120.

Here is a listing of the 10 commuting zones which have the largest negative causal effect on household income in adulthood:

The authors note that there are five reasons why certain commuting zones have higher levels of upward mobility:

1.) less segregation by income and race.

2.) lower levels of income inequality.

3.) higher quality public schools.

4.) lower rates of violent crime.

5.) larger share of two-parent households.

Interestingly, the authors also found that, on a nationwide basis, there is a weak correlation between the cost of renting and higher levels of upward mobility except in large metropolitan areas with higher levels of segregation and urban sprawl where commuting zones with better prospects for upward mobility are much more expensive.

This study shows us that, while the American Dream of upward mobility is not dead, in many parts of the United States it is on life support.  The fraction of children that earn more than their parents has fallen from over 90 percent among children born in the 1940s to fifty percent in children born in the 1980s.  The authors' conclusion:

"We conclude that absolute mobility has declined sharply in America over the past half century primarily because of the growth in inequality. If one wants to revive the “American Dream” of high rates of absolute mobility, one must have an interest in growth that is shared more broadly across the income distribution."

If there is one thing that the 2016 election cycle taught us its that the growing economic inequality in the United States can have significant electoral repercussions.

Americans and Their Economic Well-Being

The Federal Reserve's annual "Report on the Economic Well-Being of U.S. Households" was recently released, providing us with an interesting snapshot on how American households felt about their family finances in 2015, keeping in mind that this was the 6th year of what is turning out to be a relatively long period of economic expansion after a devastating recession.  The survey used a sample of adults aged 18 and older and includes more than 50,000 individuals from randomly selected households.  It also included randomly selected respondents from lower income households where total annual income was less than $40,000. In this posting, I will pick out a few salient points concerning America's perception of their own economic well-being that are hopefully of interest to my readers.

The authors of the report note that the overall well-being of American families and individuals showed mild improvement on a year-over-year basis; 69 percent of respondents agreed that they were either "living comfortably" or "doing okay" compared to 65 percent in 2014 and 63 percent in 2013.  On the other side of the coin, 9 percent of respondents stated that they were finding it "difficult to get by" and 22 percent stated that they are "just getting by".  The 31 percent of Americans that are struggling financially represent roughly 76 million adults!  Here is a graphic that shows the percentage of American adults who are either "doing okay" or "living comfortably", showing how economic well-being varies with educational attainment and how it has varied over the previous two years:

Here is a table showing how financial well-being varies with family income, race and ethnicity, education and marital and parental status:

Let's look at the worst case scenarios.  When income level is considered, 49.3 percent of respondents with incomes of less than $40,000 have a negative sense of their economic well-being.  When race and ethnicity is considered, 37 percent of Hispanic respondents have a negative sense of their economic well-being.  When educational attainment is considered, 38.8 percent of respondents with a high school degree or less have a negative sense of their economic well-being.  When marital and parental status is considered, 53 percent of respondents that were both unmarried and had children under the age of 18 have a negative sense of their economic well-being.  Obviously, when close to half of some demographic groups have a negative sense of their economic status, the recovery since the Great Recession has left behind tens of millions of Americans.

Now that we've seen how Americans assess their own economic well-being, let's look at how Americans assess their financial challenges.  Here is a graphic showing how Americans felt about the financial challenges facing them and how these challenges varied with household income level:

Among the lowest income Americans, the greatest concern was their ongoing ability to pay their bills (i.e. short-term needs).  Middle income Americans are most concerned about the costs of health care.  In sharp contrast, the highest income Americans are most concerned about funding their retirement, a long-term concern that barely registers among the lowest income Americans.

Let's look at spending versus savings.  When asked how their saving compares to their income, 48 percent of American adults stated that they spent less than they made in the last 12 months, 31 percent stated that their income was equal to their spending and, most significantly, 21 percent of American adults stated that their spending exceeded their incomes with 6 percent reporting that they had no income at all.  Among low income Americans, only 67 percent stated that their spending was either less than or equal to their income with 19 percent having spending that exceeded their incomes and 13 percent having no income at all.  Switching gears for a moment, here is a graph showing how the savings rate for all Americans has varied since 1959:

Here is a graphic showing how the percentage of income saved varies with non-fully retired family income level:

A whopping 51 percent of families with household income less than $40,000 state that they have saved nothing during 2015.

With this data in mind, let's look at the financial hardships that faced American families during 2015 and how prepared they were for household economic crises. Here is a graphic showing the types of economic hardships that were faced by American families and the percent of respondents that experienced each type of hardship:

All-in-all, 18 percent of respondents experienced some type of household economic hardship, an improvement over the 24 percent from 2014.  

Now, let's look at how Americans fund family emergencies, things like car breakdowns, emergency visits to the dentist, doctor or a hospital or a home repair.  When it comes to emergency savings, the authors of the report asked several different questions as follows:

1.) Do you have enough savings set aside to cover three months of expenses should an emergency arise?  Forty-seven percent of respondents answered yes.

2.) If you were to lose your main source of income, could you cover your expenses for 3 months by borrowing money, using savings, selling assets or borrowing from family or friends?  Sixty-eight percent of respondents answered yes.

3.) How would you pay for a hypothetical emergency expense of $400.  Fifty-four percent reported that they could fairly easily handle such an expense from savings, on a credit card or by using cash.

Looking through the responses on family financial hardships, we find the following interesting data:

1.) 53 percent of Americans and their families do not have enough savings to cover three months of expenses if a family emergency arises.

2.) 32 percent of Americans and their families have no means to access three months of emergency funds.

3.) 46 percent of Americans and their families do not have the means to handle an emergency expense of $400 and would have to borrow money or sell something to do so.  Of these, 39 percent stated that the largest emergency expense that they could cover with cash on-hand is $100, 16 percent could cover an emergency expense of between $100 and $200 and 22 percent could cover an expense of between $200 and $400 using cash on-hand.

4.) 31 percent of Americans and their families would have absolutely no way to cover an emergency expense of $400.

Interestingly, the authors also looked at spending on emergency health care.  Twenty-two percent of respondents indicated that they had a major unexpected medical expense over the previous 12 month period with a median out-of-pocket cost of $1200 and an average out-of-pocket cost of $2782.  Here is a graphic showing what percentage of respondents needed emergency medical help of various types but didn't get it because they couldn't afford it:

While the authors of the financial well-being report for 2015 generally observed that there was an improvement in the financial picture of some American family units, it is interesting to note that a sizeable subset of Americans simply does not have the financial resources necessary to provide for emergency expenses, let alone planning for a future retirement.   Given that the long-term viability of the American entitlement programs is questionable, the financial future for millions of Americans looks rather bleak.

Explaining the Current Low Economic Growth Scenario

Since the end of the Great Recession, American economic growth rates have been quite modest, particularly when compared to historical levels as shown on this chart:

Real growth rates (i.e corrected for inflation) of the economy look even worse as shown on this chart:

As we can see on this graph from FRED, personal consumption expenditures have made up an increasing part of GDP, rising from 58.5 percent in the late 1960s to 69 percent in 2011:

In the first quarter of 2015, personal consumption expenditures made up 68.4 percent of GDP.  This means that the growth rate of the American economy is highly reliant on growth in personal consumption levels.  Unless households have a sense of confidence in the economy, they will modify their expenditures, a factor that has become apparent since the end of the Great Recession as shown on this chart:

In May 2015, the Federal Reserve released its annual "Report on the Economic Well-Being of U.S. Households in 2014".  In this report, the Federal Reserve gives us a sense of where the economy is headed, based on the sense of economic well-being of American households.  Here is a summary of some key aspects of the data:

1.) Economic Well-being:  Respondents were asked to compare their current financial situation to their situation five years previously.  While the percentage of households that felt that they were much worse off in 2014 dropped compared to 2013, 27.6 percent of households still felt that they were worse off in 2014 than they were in 2009 as shown on this table:

Overall, 23 percent of respondents felt that they were worse off than their parents were at the same age while 52 percent said that they were better off than their parents.

2.) Economic Fragility: Here is a graphic showing the percentage of households that could pay off an emergency expense of $400 using either cash or a credit card that is paid off in full at the end of the month:

Note that a majority of households of all ethnic and racial groups making less than $40,000 annually have not saved $400 for emergency expenses.  Overall, just 53 percent of respondents said that they would be able to handle an emergency expense of $400 fairly easily with 47 percent stating that an unexpected expense of this type would prove to be problematic.  Overall, only 45 percent of respondents indicated that they have set aside a rainy day fund that would cover three months of expenses.

3.) Household Spending and Income:  Here is a graphic showing the percentages of households (by income) that spend more than their income, spend their income or spend less than their income:

Overall, 41 percent of respondents stated that they spend less than they earn, 37 percent state that their spending is equal to their income and 20 percent state that they spend more than their income.  This is most obvious for lower income households, however, 15 percent of households earning more than $100,000 annually still spend more than they make.

Here is a graphic showing the percentage of household income saved for each income group:

Thirty percent of respondents stated that they saved nothing over the past year.

4.) Access to Banking and Credit:  Here is a table that shows the percentage of households of each income group that are fully banked, underbanked (i.e. they have a bank account but also use an alternative source of banking such as a pawn shop loan, payday loan etcetera) and unbanked (i.e. they have no bank account of any type):

Overall, 7.6 percent of respondents have no banking services of any type and a further 12.2 percent are considered to be underbanked.  

Here is a table that shows the percentage of respondents who applied for credit during 2014 that have been denied credit, offered less credit than they applied for or have put off applying for credit because they expected to be denied:

If the entire population of both those who applied for and did not apply for credit are included, 16 percent of respondents were either denied credit, offered less credit than they applied for or put off applying for credit because they expected to be denied.

5.) Retirement:  Here is a table that shows how much thought American households have given to planning for retirement by household income:

A total of 39 percent of respondents stated that they had given either "a little thought" or "none at all" when it came to retirement planning.  The higher income households have, in general, given more thought to retirement whereas 51.4 percent of households earning less than $40,000 annually have given little or no thought to funding their retirement.  Overall, only 21.6 percent of respondents of all income groups expect to have a traditional retirement where they work until they retire and then stop working all together as shown on this table:

When looking at both pensions and savings for retirement, 31 percent of non-retired respondents had no pension or savings of any type.  Among respondents, only 42 percent of those making under $40,000 annually have any retirement savings compared to 82 percent of households with incomes greater than $100,000.  A total of 45 percent of all respondents expect that they will have to work in some capacity to cover their household expenses when they retire and 26 percent expect that their spouse will also have to continue to work.

It is interesting to see that, six years into the post-Great Recession recovery, a significant portion of American households, particularly those with incomes under $40,000 annually, face future economic difficulties because they have no savings, no ability to cover emergency expenses and no retirement plan other than working until their health prevents them from doing so.  In large part, the results of this annual poll by the Federal Reserve show us why economic growth rates continue to be modest at best.  American households are not feeling terribly optimistic about the future and their pessimism goes a long way to explaining why, despite the Fed's near-zero interest policy, household consumption is growing at much lower rates than in the past.