Page 1 of 4 CREDIT BUBBLE BULLETIN Z1 and the doves
Commentary and weekly watch by Doug Noland
From the Federal Reserve's Q2 2013 Z.1 "flow of funds" report, Total (non-financial and financial sector) System Credit increased $176 billion during the quarter to a record $57.563 trillion. Total Credit jumped $1.971 trillion over the past year.
Non-Financial Sector Borrowings increased at a 3.1% rate, down from Q1's 4.5%. Corporate borrowings accelerated to an 8.4% pace, up from Q1's 6.8%. Federal borrowings expanded at a 2.5% rate, slowing sharply from Q1's 10.1%. State & Local debt growth slipped from Q1's 2.4% to 1.1%. Total Household Sector borrowings expanded at a 0.2% rate compared to Q1's 0.5%
contraction. Non-mortgage Consumer Credit grew at a 5.6% pace, down slightly from Q1's 6.2%. Surprisingly, mortgage Credit still hasn't been able to turn the corner. Household Mortgage Debt contracted at a 1.7% pace, somewhat less than Q1's 2.1% rate of decline.
Total Non-Financial Debt (NFD) expanded at a seasonally-adjusted and annualized rate (SAAR) of $1.251 trillion (down from Q1's SAAR $1.974 trillion) to a record $40.938 trillion. During the past year, NFD expanded $1.678 trillion, or 4.3%. Despite all the talk of "de-leveraging," NFD has inflated $6.679 trillion, or 19.5%, over the past four years. While Household Sector Liabilities declined $686 billion in four years, during that period outstanding Treasury securities jumped $5.550 trillion.
Already strong business credit growth accelerated. Total Business borrowings increased SAAR $742 billion during Q2, up from Q1's $594 billion. Though little changed for the quarter, corporate bonds were up $879 billion, or 7.2%, over the past year to a record $13.026 trillion.
Financial Sector borrowings increased at a 0.5% rate to $13.902 trillion during the quarter. With the Federal Reserve's balance sheet excluded from Financial Sector tabulations, the rapid expansion of Fed holdings continues to restrain overall Financial Sector growth. And chiefly because of Fed balance sheet inflation, Financial Sector borrowings remain today significantly below the $17 trillion level reached back in 2007.
Financial Sector Credit market borrowings increased only SAAR $63.6 billion during the quarter. As for detail, GSE securities jumped SAAR $137 billion and Other Loans and Advances gained SAAR $126 billion. Corporate (financial sector) Bonds declined SAAR $250 billion. MBS increased SAAR $40 billion and Depository Institution (bank) Loans gained SAAR $28.1 billion.
Meanwhile, Federal Reserve assets expanded SAAR $1.116 trillion during Q2, with holdings of Treasury Securities growing SAAR $548.5 billion and GSE-backed Securities expanding SAAR $548.7 billion. In nominal dollars, Federal Reserve assets increased $283 billion during the quarter to a record $3.526 trillion. Fed assets were up a whopping $571 billion in two quarters. In five years, Fed assets have inflated $2.574 trillion, or 270%.
Bank ("Private Depository Institutions") assets increased nominal $351 billion during the quarter to a record $15.595 trillion, a notably strong 9.2% growth rate. However, over half of this expansion is explained by the ballooning of reserves held at the Fed. Yet Bank Loans did expand SAAR $206 billion and Consumer Credit SAAR $47 billion. Mortgages contracted SAAR $16 billion, while Miscellaneous Assets expanded SAAR $436 billion.
There continues to be scant evidence of a general upswing in traditional lending. Beyond slow growth in bank loans, Credit Union liabilities were little changed during the quarter (up $54 billion, or 5.8% y-o-y) to $997 billion. Finance Company assets were down slightly for the quarter and shrank $39 billion, or 2.6%, from a year earlier.
Elsewhere, Security Credit expanded at a 5% rate during the quarter to $1.512 trillion, with year-over-year growth of $101 billion, or 7.2%. Funding Corps were little changed during Q2, with assets up $101 billion y-o-y, or 4.7%, to $2.232 trillion. Real Estate Investment Trust (REIT) liabilities were down slightly during the quarter, yet jumped $69 billion, or 9.5%, from a year ago to $794 billion. Security Broker/Dealer assets declined slightly during the quarter to $2.083 trillion, although assets were up $30 billion, or 1.5%, from Q2 2012.
Despite the ongoing contraction in mortgage credit, the GSEs continue to grow. Agency Securities (debt and mortgage-backed securities) increased a nominal $58 billion during Q2 to $7.648 trillion. Agency Securities increased $107 billion over the past year.
Rest of World (ROW) holdings of US assets increased (nominal) $216 billion during Q2 to a record $21.437 trillion. Interestingly, Interbank Assets increased $267 billion (to $588 billion). Treasury holdings declined by $121 billion to $5.601 trillion. Uncharacteristically, "official" (central bank) Treasury holdings declined $81 billion (to $4.009 trillion) after having increased $368 billion during the previous four quarters. ROW Agency Securities holdings dropped $65 billion during the quarter to $876 billion, with a two-quarter decline of $130 billion.
Belying weakened credit growth, National Income increased $123 billion during the quarter, or 3.4% annualized, to a record $14.448 trillion. Total Compensation increased $63.4 billion, or 2.9%, to a record $8.812 trillion. On a year-over-year basis, National Income gained 4.1% and Total Compensation rose 3.0%. It is worth noting that National Income increased about 50% in the 10 years leading up to the 2008 crisis. National Income dropped 3.8% in 2009 - only to then fully recover in seven quarters.
While credit and economic growth may be relatively restrained, perceived household wealth is going gangbusters. Household Sector Assets increased another $1.343 trillion during Q2 to a record $88.369 trillion. Household Assets were up a notable $7.692 trillion, or 9.5%, over the past year. Over two years, Household Assets inflated $13.389 trillion, or 17.9%. Since the end of '08, Household Assets have jumped $16.921 trillion, rising from 498% of GDP to 530%. Meanwhile, Household Liabilities were little changed both during the quarter and over the past year at $13.548 trillion. Since the end of 2008, Household Liabilities have declined $686 billion, or 4.8%.
Household Net Worth (assets less liabilities) has become a focal point of my macro credit analysis. For the quarter, Household Net Worth inflated another $1.342 trillion, or 7.3% annualized, to a record $74.821 trillion. At 449% of GDP, Household Net Worth is within striking distance of the record 470% of GDP back at the 2007 peak of the mortgage finance bubble. Over the past year, Household Net Worth jumped $7.690 trillion, or 11.5%. Net Worth rose a notable $13.388 trillion, or 21.8%, over two years. In arguably the single most pertinent macro data point, Household Net Worth has surged $17.607 trillion, or 30.8%, since the end of 2008.
It's worth our time to dig just a little into the composition of Household Assets. At the end of Q2, Financial Assets accounted for 70%, and Non-Financial Assets 30%, of Total Assets. This compares to a 65%-35% split at the end of 2008. In nominal dollars, Financial Assets increased $15.237 trillion, or 33%, since 2008, while Non-Financial Assets gained $1.684 trillion, or 7% to $26.516 trillion (Real Estate, at $21.123 trillion, comprises about 80% of Non-Financial Assets).
Even more striking is the growth divergence between Household Financial Assets categories since 2008. In particular, safer "money"-like holdings have notably lagged the historic expansion in "risk assets." Total Deposits (bank and money market), the bedrock of perceived safe and liquid "money," increased $982 billion since the end of 2008, or 12%, to $9.026 trillion. Treasury holdings rose about a Trillion to $1.2 trillion, and agency securities increased $597 billion to $1.65 trillion. In total, deposits, Treasuries and agencies rose $2.58 trillion, or 28%, to $11.865 trillion.
Meanwhile, since '08 Household holdings of mutual funds and equities have surged $10.640 trillion, or 85%, to $23.191 trillion. Pension Fund Entitlements jumped $4.675 trillion, or 33%, to $18.737 trillion. It's no longer true that American households have the majority of their wealth in savings and real estate. These days, and much the product of experimental monetary policy, Household perceived wealth is wrapped up in the risk markets.
Post-crisis macro credit analysis has provided myriad curious anomalies. Incomes have grown steadily in the face of stagnant Household debt growth. Real estate price inflation has reemerged despite an ongoing contraction in mortgage credit. Household Assets and Net Worth have surged in the face of ongoing weak private-sector debt growth. In sum, there's been a resurgent bubble economy in the face of relatively modest overall system debt growth. This is definitely not how it traditionally works.
Those of a bullish persuasion would argue these dynamics confirm the underlying strength and stability of the US economy. I'll counter with the view - one supported by Fed data - that massive federal deficits and Federal Reserve monetization have created unprecedented and deeply systemic financial and economic distortions.
An economy on firm footing would be one demonstrating at least a reasonable balance within the real and financial sectors. One would hope to see sound money and productive credit financing capital investments throughout the economy - liquidity/spending power entering the system primarily in the process of financing economic wealth creation in the real economy (as opposed to financing consumption and asset speculation).
We instead these days see unprecedented government liquidity injections directly into securities markets, with resulting asset inflation and myriad distortions. In the real economy, massive federal deficits and ultra-low interest-rates have inflated incomes, corporate cash flows and earnings. Inflating asset markets and Household Net Worth drive sufficient consumption to sustain a deeply imbalanced economic structure.
Not unpredictably, after about five years of unmatched debt monetization and liquidity injections, the Federal Reserve today struggles with even the most timid reduction of monetary inflation. Perhaps Fed officials appreciate the dependency US and global economies have developed to speculative and inflating securities markets, along with the dependency inflated markets have to ongoing Fed and central bank liquidity injections.
On September 27 from Bloomberg (Joshua Zumbrun): "Chicago Federal Reserve President Charles Evans, who votes on policy this year, said the central bank should press on with record stimulus with inflation too low and unemployment too high. 'More accommodation is appropriate, and the biggest problem we have is we're stuck at the zero-lower bound...' Evans ... said concerns that stimulus is leading to too much exuberance and financial instability should be addressed with regulatory tools rather than by raising interest rates. 'It strikes me as remarkably natural to use other tools if they're available,' rather than raising interest rates to fight asset-price bubbles ... 'Without meeting our inflation objective, if we increased interest rates, all the theory I know suggests inflation would be lower.'"
Evans states that the Fed has not been able to provide as much stimulus as it would like. History will not be kind. Clearly, the core dovish contingent on the interest rate-setting Federal Open Market Committee will at this point find some indicator - the unemployment rate, gross domestic product, or Consumer Price Index - to justify running with this historic experiment in monetary inflation. And, if necessary, they will fall back on a so-called "tightening of financial conditions" for justification/rationalization. I thought Steve Liesman's September 24, CNBC interview with New York Fed president William Dudley did a good job of illustrating the confused and slippery slope the Fed is now sliding. It's worthy of historical record.
Dudley: "I think it's a question of why financial conditions are rising, and is the tightening of financial conditions modest or large relative to your expectations. At the end of the day, we set monetary policy to affect financial conditions and financial conditions affect the real economy. So let's imagine that financial conditions tighten by more than what we anticipate. We want to take that into consideration in terms of our economic forecast. And I think what happened between May and prior to this last meeting, the tightening of financial conditions was quite large, especially in terms of the mortgage market."
Liesman: "So does that mean you're sort of targeting, at least in your heads if not spoken, a range for rates that is acceptable for you in order for you to eventually move forward?"
Dudley: "No, absolutely not. I mean, we're looking at growth momentum of the economy. We're looking at how financial conditions are likely to affect that growth momentum going forward. But if the economy is not that strong and financial conditions are tightening, that's going to reduce our confidence in the economy growing fast in the future."
Liesman: "But part of the reasons why it would appear financial conditions tightened so much was because markets seem to be forever preempting or running ahead of the Federal Reserve - in the sense that it's going to tighten or bring forward future interest rate hikes."
Dudley: "We want to be very clear that the decision on asset purchases is pretty independent of the decision about actually raising short-term interest rates. We have been very clear that conditions for raising short-term interest rates are: we would expect the unemployment rate would have to fall below 6.5%, assuming the inflation outlook is still okay and inflation expectations are well anchored. In that case, we're going to wait until the unemployment rate falls past 6.5%. And that's a threshold, not a trigger. Under certain economic circumstance, we could wait a long time after the unemployment rate falls below 6.5% before we actually raise short-term rates. So people should delink these two choices. The decision on tapering is how fast are we adding accommodation - how much are we increasing our balance sheet. The decision on raising short-term interest rates is a tightening. People shouldn't conflate the two."
Liesman: "You keep saying that. You've said that several times and the chairman has said that several times. Other members of the FOMC have said that several times. But it doesn't seem like the market is agreeing with that. They seem to think a taper is a tighten."
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