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4 CREDIT BUBBLE
BULLETIN Z1, QE3 and
deleveraging Commentary and
weekly watch by Doug Noland
As you read my
opening summary of the Federal Reserve's latest
quarterly Z.1 "flow of funds" report, keep in mind
the Fed's recent decision to move to an altogether
more aggressive monetary policy stance.
For the second quarter, total
non-financial credit market debt expanded at a
5.0% rate, the strongest expansion since Q4 2008
(14 quarters ago). Debt growth increased from Q1's
4.4% rate and was almost double Q2 2011's 2.6%.
Corporate credit market borrowings expanded at a
6.9% pace, up from Q1's 4.7%. Total household debt
expanded at a 1.2% pace, the strongest growth
since Q1 2008. Consumer credit grew at a robust
6.2% rate, the strongest in 19 quarters (Q3 '07).
Home mortgage credit
contracted at a 2.1%
pace, an improvement from Q1's 3.3% pace of
decline. State & local borrowings increased at
a 0.8% pace, compared to Q1's 1.2% rate of
contraction.
For the quarter, total
non-financial credit expanded at a seasonally
adjusted and annualized (SAAR) $1.946 trillion.
This was the strongest debt expansion since Q4
2008's SAAR $2.082 trillion. And for comparison,
the current pace of debt growth compares to 2008's
total growth of $1.906 trillion, '09's $1.063
trillion, 2010's $1.437 trillion and 2011's $1.326
trillion. In the past, I've posited that our
maladjusted bubble economic structured requires in
the neighborhood of $2.0 trillion annualized
credit growth to retain reflationary momentum
throughout the economy and asset markets.
And while corporate and consumer credit
(non-mortgage: ie credit cards, student loans,
auto and installment debt, etc) are now expanding
robustly, the credit system remains largely
dominated by the historic expansion of federal
debt. Federal borrowings expanded SAAR $1.183
trillion during the quarter, down from Q1's SAAR
$1.428 trillion, but up notably from Q2 2011's
$792 billion pace. Federal borrowings expanded at
a 10.9% pace during the quarter, up from the 8.2%
rate from a year ago. In 16 quarters, Treasury
debt has expanded a historic $5.775 trillion, or
110%, to $11.026 trillion. Outstanding Treasury
debt expanded 24.2% in '08, 22.7% in '09, 20.2% in
'10 and 11.4% in '11.
Consensus thinking
has it that our system is progressing through a
difficult "deleveraging" process. In contrast, I
see much more system reflation than actual
deleveraging. Sure, household debt has declined
$800 billion since the end of 2007 to $13.456
trillion. Meanwhile, federal debt has expanded
more than seven times the decline in household
borrowings. Indeed, total non-financial debt ended
Q2 at a record $38.924 trillion, having expanded
$6.550 trillion, or 20.2%, in 16 reflationary
quarters. As a percentage of GDP, total
non-financial debt has increased from 124% of GDP
in June of 2008 to 249.4% to end 2012's second
quarter.
The ongoing inflation of system
incomes made possible by the historic expansion of
federal debt has been the key dynamic of this
latest reflationary cycle. For the five bubble
years 2003 through 2007, national incomes jumped
32% to $12.396 trillion, with compensation rising
29% to $7.856 trillion. National incomes and
compensation dropped 3.8% and 3.3%, respectively,
during the recessionary year 2009. Importantly,
however, over the past 12 quarters national
incomes have jumped 13.7% ($1.662 trillion) to a
record $13.791 trillion, while compensation has
risen 9.5% ($743 billion) to a record $8.563
trillion. Q2 national incomes were up 3.7% y-o-y,
with compensation 3.3% higher.
Income
gains have supported spending growth, corporate
profits and renewed asset inflation. This
reflationary cycle has seen household net worth
bounce back strongly. Household assets ended Q2 at
$76.127 trillion, up $1.423 trillion y-o-y and are
now only about 3% below the late-2007 peak. At
$62.668 trillion, household net worth (assets
minus liabilities) has inflated $9.335 trillion,
or 17.5%, over the past eight quarters to less
than 3% below bubble period highs. And while real
estate values remain significantly below bubble
highs, the value of household sector financial
asset holdings has reached new records at about
$52 trillion. Household financial asset holdings
have inflated $8.505 trillion in 24 months, or
19.6%.
"De-leveraging" discussions have
been intriguing. Hedge fund manager Ray Dalio has
been public with his framework. According to
Dalio, deleveraging can be broken down into three
processes: austerity, debt restructuring and money
printing. He has even referred to the ongoing
"beautiful deleveraging" here in the US that has
supposedly found the right mix of austerity,
restructuring and printing appropriate to ward of
deflation while promoting slow growth.
As
one would expect, most financial market operators
focus their analysis on the financial aspects of
so-called "deleveraging". And, no doubt about it,
the titans of today's gigantic global leverage
speculating community are precisely those players
that have most adroitly played the ongoing cycle
of global central bank reflationary policymaking.
Their astounding financial success provides them a
public forum in which to shape both the analytical
debate and general viewpoints.
I tend to
believe that conventional thinking - albeit from
central bankers, bond and hedge fund kings, or FT
and WSJ columnists - is wrong on deleveraging.
Deleveraging is not predominantly a financial
issue. Economic structure matters - and it matters
tremendously. Importantly, true deleveraging
requires that system debt loads are reduced to a
level supportable by the capacity of an economy to
produce real wealth.
A system can achieve
stability and robustness only when a sound economy
supports a manageable amount of system financial
assets. Yet with a highly unsound economy, ongoing
rampant inflation of non-productive debt and
highly unstable financial markets, from my
framework our system remains very much in a
financial leveraging credit bubble cycle.
Today, a consensus view holds that money
printing will inflate incomes and prices to levels
that reduce the overall burden of system debt. The
belief is that a doubling of federal debt in four
years has supported private-sector deleveraging -
in the process creating a more robust system.
Higher risk asset prices are viewed as
confirmation of the adeptness of this policy
course.
And while it's widely recognized
that we are witnessing experimental monetary
management, few seem to appreciate that we are
similarly watching an historic experiment in
economic structure. Never before has a
world-leading economy been so dominated by
consumption and services. This is especially
noteworthy in terms of historical comparisons of
deleveraging cycles. I would strongly argue that
if policymakers throw trillions of fiscal and
monetary stimulus at a maladjusted consumption and
asset inflation-based economy - the end result
will be an only more distended maladjusted
economy.
"Inflationists" have again come
to Fed chairman Ben Bernanke's defense, and it's
worth noting that some don't hesitate taking shots
at the "liquidationist" naysayers. And if I were
writing my Credit Bubble Bulletin back in the
late-1920s, I would be categorized as one of those
dreadful liquidationists - and one of Bernanke's
"bubble poppers".
My argument is along the
same lines as those economic thinkers who believed
that either a bubble economy and associated price
levels be allowed to settle back to sustainable
levels - or a runaway inflation of credit would
risk systemic collapse. Historical revisionism
notwithstanding, those knucklehead "bubble
poppers" had the analysis right.
Historic
bubbles require a spectacular backdrop. The
ongoing bubble period and the "Roaring Twenties"
share important similarities, especially in the
realm of extraordinary technological advancement.
Epic periods of innovation significantly impact
the evolution of economic structures, while they
also tend to stoke optimism as well as policy
mistakes. Resulting booms spur credit, economic
and speculative excesses.
And while such
environments beckon for tighter monetary
management regimes, during the '20s and throughout
this prolonged bubble policymakers administered
the opposite. The confluence of economic and
financial complexities was beyond the grasp of
policymakers.
Contemporary economies have
an unprecedented capacity to absorb inflating
credit/purchasing power. Apple expected to sell 10
million iPhone 5's this past weekend. Throw more
credit and higher incomes at our economy, and
folks can acquire more cool technology products,
enjoy more downloads, do more laser treatments or
dine at more upscale restaurants.
Literally trillions of deficits and Fed
monetization can be readily absorbed with hardly
an impact on the consumer price index. A services
and consumption-based economy is - at least during
a credit cycle's upside - something to behold -
and confound.
Our economic structure
certainly enjoys unmatched capacity to absorb
credit excess without engendering traditional
consumer price inflation. Yet there is indeed a
huge problem that no one seems to want to
recognize: Our system also has an unprecedented
capacity to expand credit that is backed by little
in the way of wealth-creating capacity.
Our government literally injects trillions
into the economy - credit that inflates incomes
and sustains consumption and elevates asset
prices. The downside of this economic miracle is
that, at the end of the day, there's little left
to show for the whole exercise except for an
ever-expanding mountain of suspect financial
claims. Moreover, market values of these claims
are sustained only by the unrelenting expansion of
additional claims/credit concurrent with
increasingly radical monetary management. This is
Minsky's "Ponzi Finance" at a systemic level.
A real deleveraging would see the economy
and financial markets weaned off of rampant credit
growth. Non-financial credit growth averaged about
$700 billion annually during the 1990s. This
inflated to about $2.4 trillion at the mortgage
finance bubble pinnacle in 2007. As I noted above,
we're currently running at an annualized credit
growth rate of nearly $2.0 trillion. This is
posing great unappreciated risk to system
stability.
A real deleveraging would see
price levels (and market-based incentives) adjust
throughout the economy in a manner that would spur
business investment - in the process incentivizing
sound investment-based lending and resulting job
growth.
Real deleveraging would see a
shift in the economic structure from credit-fueled
consumption to savings and productive investment.
Real deleveraging would give rise to our endemic
trade deficits shifting to surplus.
Real
deleveraging would see a meaningful reduction in
non-productive debt. Real deleveraging would see
market prices dictated by fundamentals rather than
governmental intervention, manipulation and
inflationism.
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