Financial Disaster is Looming, Here's Why

As the nation faces The Great Resignation, $15 minimum wage for federal employees and an influx of money from stimulus and tax credits businesses are forced to up their game to compete for employees. Lets face it, money is readily available and as such $15 per hour is not as enticing as it used to be. In fact, no wage holds quite the same value any more. This may sound good, but it spells disaster for the middle and lower financial classes.

Employers are competing for employees, that's usually a really good thing, but in this case it could be really bad, here's how.

Frank's Good Fortune

Lets imagine its 2019 and a man, we'll call him Frank, is applying for a job as an underwriter for a bank and he is really good at what he does. Frank has applied at several banks and 3 of them wanted to hire him. The first offered him $50k, the second $52k, and the third $55k. He tells bank one and two of bank three's offer and bank one offers to match while bank two offers $56k. The cycle continues and before its all over Frank lands a position with bank three at $60k per year. The average underwriter in his city earns $49k per year with a cost of living of about $44k per year. Frank is earning roughly $16k more than what is needed for the average person to live a life of moderate comfort in his city.

Now its 2022 and Frank has earned himself a nice raise, with it he is now earning $65k per year. Competition has increased across the board however, and now those same three banks are fighting for every candidate, not just the stars like Frank. So the fight we saw for Frank plays out over and over until the average pay for underwriters is now up to $55k. That's great right? Well, comparatively Frank is now earning $10k more than average rather than $11k, so he's actually lost ground for all his hard work. That's not a big deal though, everyone works hard and their raises were long overdue right? I certainly think so.

Lets zoom out though. The same thing has taken place with the tellers. In fact, its happened with the mechanics, retail workers, accountants, store managers, truck drivers, and everyone else. Except now, those who were earing $7.50 per hour are now earning closer to $18/hr. The competition for those employees became more fierce because, with all the extra payments and large increase in minimum wage for some jobs devalued $7.50 significantly more for them than for those earning more.

Sarah's Wages

Think of it this way. Sarah is single and earning $400 per week and you have a child. She does have government assistance to get by but she still has to fight every day to survive and provide for her child. $7.50 is a meal for her, its important. Suddenly she is getting $900 per month as a tax credit. That is more than a 50% increase in what is coming into her bank account. That is life changing while it lasts. And for that time $7.50 no longer represents survival and as such allows her to be more choosy in her employment. I.e. if business A is offering $7.50 to perform grueling labor and employment is a guarantee if she applies while business B is in a restaurant earning $8.00 but she may not get the job, she is no longer forced to choose the guaranteed option. In other words $7.50 is no longer as valuable as it once was and she can hold out for higher wages.

Lets Compare

Now imagine you're Frank. At $65k per year your income is roughly $5,400 per month. That same credit represents only 16% of his monthly income. His ability to feed his family was never in question. He had disposable income and now this $900 per month is something he can invest or spend on whatever he chooses. If it disappeared he would miss it, but its not devastating. This did not devalue wages for Frank to the same extent that it did for Sarah.

Still, at this point it seems like an absolute win. However, now with those who were earning $7.50 per hour or about $15,600 per year are starting to earn as much as $35k or more. That means that comparatively Frank is now making $20k less.

That's still okay. Sarah doesn't deserve to live any less than Frank does. If I'm having a steak I'm not upset because Sarah has upgraded from ramen noodles to a happy meal. I'm excited for her!

Now it Falls Apart

The problem is that these wages come with a cost. Make no mistake, the cost will not come from the pocket of the rich.

Who owns the business where Sara and Frank Shop? We will call her Lucy. Lucy sees that her profit margin was 35% but now she's paying her employees 50% more. Her suppliers have also raised prices and her costs are up by 10%. She has to raise prices to break even, but she really wants that margin she once had. She looks around and sees that competitors are in the same boat and will raise prices soon as well. She also sees that those who were earning $15k now have thousands greater income and don't value $7.50 nearly as much as they used to. In fact, its not a meal any more, now its something extra. So she raises her prices to the maximum level at which she believes customers will pay while maintaining optimal sales volume. Her margin is now 45%.

Break it out

Lucy's sold her product for $10.80. Her cost was $8 and her markup was $2.80. Payroll and overhead ate up $1.50 of that leaving her with a profit of $1.30 for every unit sold.

As she adjusts pricing as discussed her new cost is now $8.80, her 45% margin makes her sales price $12.76. Payroll and overhead are now around $2 which means her total cost per unit is $10.80 and her profit is $1.96 which is almost 51% more.

That's Good Right? Business Owners Need a Profit Too

Sarah's happy to pay $12.76 for Lucy's goods, after all she couldn't buy them at all a year ago. But everyone is now doing this and Sarah is paying more for food now too. In fact, landlords realized more money means that occupants can now afford to pay more as well. So Sarah's rent increases significantly. In fact, mortgage rates have dropped so housing prices skyrocketed, allowing landlords even greater opportunity. Sarah's run of good fortune is quickly being ripped apart by everyone who wants a piece of her newfound income.

Remember Frank? He's not immune to these price increases any more than Sarah. While Frank's salary has grown its not done so proportionally. While Frank may not be renting his home his cost of food, fuel, vehicle/repair, home maintenance, and all other costs have increased dramatically. Now that $44k that it cost to live in moderate comfort is suddenly $50k. Now his wages are $15k above and beyond the base comfort where they were $16k. His peers are now $5k over the cost where they were $6k.

Make no mistake, the cost will not come from the pocket of the rich.

Sarah's cost for moderate comfort is even higher because for her, it costs more to rent or buy a home and it will take years to save for a good down payment. Her ability to find a comfortable living is no more within her reach than it was before.

Where Does Everyone Stand Now?

Frank is comparatively earning $2k less comparted to his peers. Frank and his peers are earning $1k less income above living costs. The actual purchasing power of that excess income is lesser than it was in 2019 due to inflation. I.e. Franks excess is $15k but its only worth roughly $14k compared to 2019.

Sarah and her peers are earning significantly higher incomes; however, their cost of living has kept pace and coupled with inflation their situation is little improved.

Lucy is earning 51% more on all sales, meaning that with sales volume remaining comparable to prior years, her income has increased by 51%. While the purchasing power of that income has declined, the overall ability to make purchases has increased. With the increased income her ability go secure loans at lower interest has improved or remained unchanged. She is able to pour funds back into the business and grow and expand operations if she so desires. Essentially, she is making more money and has gained greater ability to increase her earnings as well.

The middle and poorer classes have at best remained unaffected, but in most cases have suffered a setback. The wealthier Americans have gained opportunity and unprecedented income growth.

What Can We Do?

Now is the time to develop multiple streams of income if ever there was a time. Investing in something that can generate revenue for you on its own is ideal, but develop streams however you can. Keep in mind that there are only so many hours in a day and inflation will almost always exist. Investing your time and energy in something that will earn passive income is the best way to protect your financial future. Especially if you can use that passive income can invest in more passive income. The power of compounding interest is remarkable and can make a world of difference.