James D. Sinegal, the president and CEO of Costco, has no palace guard and no profile to speak of, particularly compared to a retail legend like Sam Walton. Yet he's the guy who in 20 years has taken Costco from a startup to the FORTUNE 50 using, as surely as Mr. Sam, highly distinctive practices. He caps Costco's markups at 14% (department store markups can reach 40%). He offers the best wages and benefits in retail (full-time hourly workers make $40,000 after four years). He gives customers blanket permission for returns: no receipts; no questions; no time limits, except for computers—and even then the grace period is six months.
But some of the practices that made Costco great have lately come under attack by Wall Street. The company's margins have been squeezed by rising labor costs and by Sam's latest run at its nemesis. Costco has twice reduced its earnings outlook this year; after the second warning, in August, its stock dropped 21%, to $29. For the fiscal year ended Aug. 31, Costco's earnings rose 3%, to $721 million, on a 10% rise in revenues. The stock has climbed into the mid-30s, though it's well below its all-time high of $58 in May 2000. Analysts have pounded on Sinegal to trim the company's generous health benefits and to otherwise reduce labor costs. But he's taken only limited steps in that direction, like modestly increasing employees' share of health-insurance premiums. That doesn't satisfy critics like Deutsche Bank analyst Bill Dreher, who recently wrote, "Costco continues to be a company that is better at serving the club member and employee than the shareholder."
Sinegal just shrugs. "You have to take the shit with the sugar, I guess. We think when you take care of your customer and your employees, your shareholders are going to be rewarded in the long run. And I'm one of them [the shareholders]; I care about the stock price. But we're not going to do something for the sake of one quarter that's going to destroy the fabric of our company and what we stand for."
Today is Ms. Salad's last day of work. While she's not leaving out of her own volition - an incident where her boss made racial comments about her made it impossible to keep working there - she won't be collecting unemployment (though we may just file a claim anyway just in case she qualifies). In any case, we'd planned on her leaving at the end of the year anyway so that we can have kids. Both of us are nearing 35 and my family is getting anxious.
Don't worry about me. My job is enough for us to get by and we've been planning for this for several months, but I was interested how our decision will impact the economy.
First, we'll be paying a lot less taxes, particularly since we bought a house early this year. I filled out an amended W-4 for my work and the worksheet recommended that I declare "married" and "six deductions". Not wanting to be greedy and not actually having a child yet, I declared four deductions. That alone reduced my withholding by 29%. I'd be interested to see how much the housing bubble has been guilty of reducing federal revenue. Even with the new tax law it is still better for us to itemize. Houses are so expensive that ten months of interest payments alone are more than the standard deduction, and that's for a median priced house here in DC. As so many people have bought expensive houses (or refinanced their way into them), I'm sure that has significantly reduced income taxes nationwide. In addition, we're on track for a very large refund this year, because as we moved into the new house we finally donated a lot of our redundant furniture, clothing, computers, and other crap to charity.
Second, it will mean a lot less spending. To live with one income we just can't bop down to Home Depot and buy $1000 worth of lumber to install a floor. We've set up a reserve fund for emergency expenses and as that exceeds our budgeted amount we can do extra stuff with it. But our spending on home improvements is going down, as well as for all other discretionary expenses.
Finally, it's going to mean a smaller contribution to our retirement plan. Both of us had been contributing 10% of our income to our 401k accounts. Her contributions will cease, and mine will have to be cut in order to increase my paycheck to what we have budgeted. That's less money for stock and bond funds to invest.
Even though the official unemployment rate is 6%, this has not tracked the number of people that have left the labor force in the last three years. If we used a constant labor force participation rate, the unemployment rate would be about 7.5%. All these people are contributing less taxes, less spending, many have to pay more for insurance, they've had to reduce their contributions to retirement plans or if they are less fortunate, dip into them or other assets to put food on the table.
Without a sustained increase in employment, these trends are going to continue. Government budgets are going to be strained. The projected federal deficit for 2004 is between $500-$550 billion. My home state's budget for 2004 has cuts for every single program except education and health care. Health insurance premiums are scheduled to go up 16% on average next year. God forbid if we have a cold winter. Heating oil prices are up around 20% from last November. Natural gas prices are up 10%. In short, it's going to take a lot more than 100,000 jobs to fix things for most Americans. We need 2.6 million just to get back to where we were three years ago, and about 3 million have entered the potential labor force since then. It's hard to see how more tax cuts are coming, with the budget problems we already have. If we were to see any kind of economic slowdown from here, I shudder to think what would happen.
At the least, I feel better for not contributing so much to this debacle anymore. My wife is extremely happy she'll be able to do more in the garden and "detox" from her late job. I'll actually have more free time, since our schedule was affected by our joint commute. When we have kids we won't have to worry about arranging our work schedules for doctor's appointments, etc. I think after we get used to our less lucrative, yet less stressful life, it may be hard to go back. That should make the folks at Home Depot, and especially in the White House, worry a little.
You walk through the automatic doors into a cavernous space, brightly lit.
An elderly woman greets you with a radiant smile and a charming "hello." You see two or three others, also dressed in blue, like the smiling woman. You then slowly wander through a space the size of two football fields, through stacks of merchandise 20 feet high.
Along the way you encounter stacks of cans and boxes, pillows and stereos, furniture and clothing everywhere; you are practically the only person in the store. It's quiet, except for the sounds of "The Girl from Ipanema," wafting down from somewhere above you.
No, this is not an all-night grocery store at 4 am Sunday morning.
This quiet, almost desolate, place is Wal-Mart on the 14th of the month. The throngs of greedy, sharp-elbowed bargain hunters are not there.
This isn't a scene from Wal-Mart's future, either. This is how it is right now, today. You see, Wal-Mart's foundation customer has finally gone bust.
That's not idle speculation. It's based on an ingenious method Wal-Mart has developed for judging the liquidity of its core customers. Wal-Mart knows the paycheck-to-paycheck consumer is its lifeblood. It also knows that most paychecks are issued on the 15th and the 30th of each month. Government-issued checks come out at the end of the month. If you want to know how the wage earners are doing, you have keep track of the middle of the month.
So each month, Wal-Mart adds up all the sales from all of its stores on the 14th of the month, when consumers are out of money. Then Wal-Mart subtracts that figure from all the sales from all of its stores on the 15th of the month, the day Joe and Mary Paycheck get paid. The resulting difference is perhaps the single best measure of the liquidity of Middle America.
"The consumer's liquidity crisis is the worst that Wal-Mart has seen and is the most pronounced in the last five to seven years," according to a recently issued Deutsche Bank report, quoted in Grant's Interest Rate Observer.
Lower interest rates have been great for homebuilders, mortgage lenders and car dealers. But Wal-Mart doesn't sell homes or cars. In fact, money once spent at Wal-Mart now goes into the new house and/or the new car. The company cites the rising cost of gasoline as a drag on earnings.
The trend of all relative prices in the economy over time is to regress to the mean. There are many reasons for this. The first is that consumers substitute cheaper items for more expensive items. But more powerful than this is the budget constraint - if something gets too expensive relative to your income, then you either sacrifice many other things to get it or borrow heavily. And even borrowing has a constraint - you can't borrow so much that lenders won't think you can pay it back.
The two most important relative prices in the economy are savings (income versus expenses, aka "profits" to businesses), and net worth (assets less liabilities, aka "stockholder equity" to corporations). Consumers are already aware of the pressure on savings: there aren't any, and while incomes stagnate from lack of jobs and smaller bonuses and raises, expenses are squeezing consumers no matter where you look.
But a more troubling concern is net worth. Total U.S. assets are around 4.5 times our GDP. In 1945 this ratio was about 2-1. Total liabilities are about 3 times GDP. As recently as the 1960s, the ratio was about 1.5-1. Ultimately, Boomers won't be able to eat their house or 401k after they retire. They will need to either sell their house or (failing that) take out something like a reverse mortgage to generate income. Either way, they will put downward pressure on housing prices by consuming the value of those assets, and the ratio of assets and debt to GDP will return to its historical mean. Sooner or later. And its much easier to regress to the mean through falling asset values than by increasing income, unless that increase is via large amounts of inflation. This is why Denning believes we have a "box seat to a historic event: the forced deleveraging of the American financial economy."
Lots of work to do before my family comes into town for Thanksgiving. Lots of cleaning and prep work to do at home as well. Mrs. Salad's last day on the job is Friday (she will be in the unemployment claims for the week ending 11/28). You can check out Angry Bear, MaxSpeaks or Wampum, who are still as busy as ever.
I have a backlog of longer topics, but very little time, so it may be just snippets and prowling the messages for the next few weeks. If anyone out there has anything to say, you can treat all the posts as open threads and I'll edit the post to highlight what everyone is talking about.