Forgive me tonight for relying more heavily on other people’s material than usual, but 1) it’s good stuff, 2) it’s an end of summer weekend, and I’m suffering from diminished productivity (the Olympics haven’t helped), 3) I foolishly wasted a lot of time and energy corresponding with a reader who was mightily unhappy with my last post on the Fed. 3) perversely kept me from getting to a post I intend to write on Bernanke’s speech on Friday. Stay tuned.
I’m particularly keen about this post from Cassandra because it addresses, in typical colorful style, a pet theme: we have way way way too much debt out there, and the party is over. Weirdly, despite the appearances of a credit crunch, the flow of fund stats as of end of March showed that US debt outstanding was still increasing, and on a near vertical trajectory. The continued indulgence of our friendly foreign funding sources is a big factor (Brad Setser has called it the quiet bailout, and it comes so far to about $1000 per capita. Yikes). So the real squeeze has yet to begin.
Note that Peak Credit is also one of Mish’s themes.
Cassandra, who has seen deleveraging up close via living in Japan, riffs on what America has in store. Where else would you see a coinage like “wreckitude”?
From Cassandra Does Tokyo:
Does Peak Credit inevitably follow piqued credit? Well if you’re my age, and you thought so and positioned accordingly, you’d have been bankrupted a very long time ago – possibly as early as the late 1980s. And if you were a glutton for punishment, you’d have been toasted again in 1994, another time in 1998, yet again in 2002, and rubbing one’s nose in it, perhaps every year after that until midsummer two-thousand-and-seven. Dog days indeed for those bearish on the ability of the financial system to manufacture, distribute, and service debt, whether in real or nominal terms, or in relation to any measure of the economy or change in the growth thereof.
Yet as pessimistic on its sustainability (and wrong!!) as one would have been in the past, one should now be as optimistic one’s assessment that this is The Big One, that we’ve smacked head-first into the boundary of the maximum amount of debt that can be assumed by households, corporates and governments in our economy and be reasonably sustained with the fruits of our labour, and investment. Actually, I would posit that we long-ago pierced any reasonably sustainable threshold, and only through sheer inertia and the fortuitiousness of pulling of rabbits-out-of-hats have we lasted this long. But it is the anchoring of popular belief in faith and absent solvency from days long passed combined with the extrapolation a series of non-extrapolatable macro income streams which could cause any sensible human being believe or have believed that the boundary lay somewhere in front of us and not far behind us.
Culpability is not singular. Stern-Stewart, investor short-termism and systemic mono-focus, along with greedy managers replete with agent/principal dilemmas must assume blame on the corporate side. Selfish American Voters repeatedly demanding representatives requite incongruous financial goals with cynically lame and unsustainable fiscal policies, along with a near complete detachment from reality in regards to present consumptive desires in relation to both incomes and longer-term savings requirements are just as at fault as the monetary wrecktitude resulting from an unwillingness to accept mild deflation and cyclical recessions where required for reasons that – to this day remain inexplicable given that Continental Europeans seemingly had little difficulty distinguishing a bubble or accepting that both taxes and economic brush-fires are not inherently bad in The Big Picture.
So IF what we are currently witnessing, commonly termed as The Credit Crunch, is in fact, an expression of what I will term Hubbert’s financial equivalent – “Peak Credit” phenomena , and IF as I posit, we long ago untethered the financial wagon from the real economic train, what does this mean?
Many things, but first and foremost, that we are at a major and painful inflection that will impose a real Kunstleresque austerity upon Americans converging their desires with their means. In a word, this means “revulsion”, a somewhat arcane and long-forgotten term for large-scale write-downs and/or economy-wide elimination of outstanding debt(s). For this reflects the implausibility of servicing, let alone paying off obligations, and the consequences to those whose capital and assets were/are/will be vaporized. It will, undoubtedly, be fought by authorities, with certain costs borne by the state and socialized upon unwitting voters.
Japan wallowed in their own debt-shite for more than decade, and in the US it is (in present political climate of denial) even more natural that attempts to band-aid and stave off the inevitable reality will likewise be tried. In another time and another place, natural growth and demographics might have met inflation somewhere in the middle and the cycle would resume again without massive dislocation.
But this time it is different. This time, the encumbrances are too large. This time, there is competition for markets, and their value propositions are surpassing Americas. This time the patient is too soft, obese, relatively uneducated, faux-faithful, weak, politically compromised, and cronily corrupt. This time, the business cycle is turning dramatically for the worse, wealth effects are only beginning to bite, oil has peaked with a generation of adjustment between any remotely plausibly cost-effective replacement. And competition is even heating up in the emerging world for the remaining high-margin business. This does not sound like an environment that will assist households or government to rebuild balance sheets and make good on obligations without great sacrifice from ordinary people and even greater sacrifices from the monied class. This sounds like an environment where creditors and debtors will be required to sit down and negotiate what can and might plausibly be paid, or converted into equity, or stretch maturity with lower rates – anything to keep it as an “asset” and a performing one.
“Peak Credit”, like Peak Oil, thus forlornly reflects the necessity of increasing demand for credit from borrowers to sustain the unsustainable, at precisely the time when supply is constrained and shrinking, for suppliers are squarely confronting the reality that new sources are limited, and in any event, the demanders (even if supplied) have diminishing hope in the current environment of returning what was lent.
Some will think that these ruminations border on the insane. And I will admit that when I walk out of my office door to the local trendy coffee bar, there is scant evidence where I live that Peak Credit is anything but a financial phenomena – limited to the flippers in Vegas or the spec developers in Fla. or CA. But perhaps that’s because the most insidious aspect of Peak Credit is its disruption to the chain of dependencies that bore its hallmark over the past two-and-one-half decades.
So inexorable and complete has the rise of credit been in its permeation of every crevice of life that no one blinks when multi-trillion dollar GSE balance sheets are supported by but the thinnest veneer of equity – even AFTER large potentially (no, probably) impermanent increases in underlying asset values; when dogs receive pre-approved credit cards by mail; that its sheer ubiquity produces persistently negative rates of saving; when corporates use leverage in lieu of a margin of balance-sheet safety on the enterprises they are meant to steward in order to conform and placate the markets’ twisted short-sighted ideal of optimal capital structure leaving them woefully exposed to cyclical fluctuations; where data-mined models themselves based on limited data replace good common sense; where leaders defer to unsustainable plebeian notions of what constitutes prudent fiscal policy producing errors in judgment that make the trench warfare of the first world war appear sane. If this is what God’s country resembles, imagine the financial horror in hell…
“Peak Credit” will wreak as monumental changes upon American consumptive life as Peak Oil, and these cannot help but exert a massive deflationary pull – at least until such time as the parties agree to squarely face reality that confronts them, and in an interconnected world, everyone else.
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Some months ago, Bill Gross noted that anyone who,
having attended college, had not been on the receiving end of a chain letter, and not joined, could not be said to have received a college education. The most important part of the “learning experience” is
when you have to go off campus to sign up new recruits, because everyone else is already “in”.
The U.S. has had to to go outside the “lower 48” for many years now, and the new recruits have caught on. How far away are we from Satyajit Das moment
when, “We interrupt this program to announce that
the U.S. has defaulted….”
Yves, I love reading these posts. We have front row seats to one of the greatest dramas in history. Inflation, deflation, will the hero fall? Unfortunately our seats are really on stage and we get to participate. Will China feel we are too big to fall and give us one more bubble (via iTulip type infrastructure buildup) or do we turn our backs on credit and go deflation (Mish route although I don’t think he sees us embracing it as a virtue). I am definitely rereading and getting more Austrian econ books as I think fiat money is just too powerful for mere mortals (but hey it’s ONLY paper right?). I don’t remember if you have placed a bet on the in/def battle but you always have very ineresting pieces on both sides.
if you look at total credit market debt as a % of GDP from the 1920s onward (it’s now 350% as of Q1’07) a couple things jump out:
1) credit peaked at 260% of GDP in the early-30s and took two decades to bottom at 130%, below the 150% level that preceded the credit spike
2) we’re of course well above those levels now [post gold standard?] after a brief pause in the early-90s (for the RTC/securitisation revolution)
so if you’re of the opinion that debt/GDP cannot rise indefinitely, even tho it has for six decades, and that there are very good reasons why this cannot continue, then we could be in for a big fall… of course, we have learned from our mistakes, right?
On other blogs one sees numerous comments to the effect that the outcome here will be much worse than in it was in Japan, because the Japanese have so much more in savings.
I wonder.
It used to be said that the national debt was no big deal because “We owe it to ourselves.”
Now, mostly, we owe it to others. In a way, we are like those trendy Californians who used serial refinancings to do a lifetime’s worth of discretionary spending in a few years. Are they really the ones who will end up as the big losers? Won’t the losers be the lenders?
The only reason a dollar would ever buy 8.2 yuan worth of Chinese goods, or 120 yen worth of Japanese goods, was that the Chinese government would pay 8.2 yuan for a dollar, and that the carry trades enabled/forced by the Japanese ZIRP enabled/forced others to pay 120 yen for a dollar. A dollar just wasn’t worth that much. When you pay more for something than it’s worth, you’ve lost money as of that instant, regardless of how long you may be able to avoid recognizing the loss in official accounting.
Insofar as this issue is concerned, I’ve yet to see an intelligent disaggregation of aggregate credit on any blog or anywhere else. It’s always the number at the top compared to some vaguely, similarly constructed number some many decades ago.
There are no shortcuts to useful analysis.
good post, anon.
and until then, we will muddle thru the same old analysis on blog after blog…. which to some spells opportunity!
What a pair of jerks. You obviously don’t know what it takes to put together market size estimates, let alone market composition estimates. Corporations pay tens, as much as hundreds of thousands if they go to a big name for custom, proprietary research. And you want it free on a blog?
And do we have any good reason to think detail would change the main conclusion, that debt in aggregate has risen to an unsustainable level? That depends on debt service. If you look at those debt to GDP charts, the period when debt/GDP peaked previously was DURING the Depression, when GDP had fallen sharply but debts hadn’t yet been written off.
Let’s see. The chart is kinda hard to read, but it looks like, in 1930, which was on the cusp of things getting awful, which is I’d say where we are now, debt to GDP was well under 200%, say 180%, So it’s roughly double then where it is now.
To believe we aren’t in a worse situation, you have to believe debt servicing costs are roughly half what they were in the 1920s to offset the vastly higher nominal level now. Now we do have much longer maturities on housing debt, but offsetting that is that mortgages in the 1920s were seldom for more than 50% of the value of the home.
Other factors to consider: many states had usury laws back then, and there simply wasn’t that much consumer credit, so you didn’t have a large percentage of consumers paying huge real rates. Yes, consumers who borrowed back then surely paid through the nose, but they were few and far between. Auto finance? Credit cards? Please.
And half the corporations with public debt now are rated junk. And that chart doesn’t capture all the lovely contingent liabilities, like CDS, monoline guarantees, Fannie and Freddie guarantees. That sort of thing was rare to non-existent then.
That doesn’t mean we will necessarily have a Depression, but it does say this is a very big mess.
So when you put all that together in a chart and compare it to the 1920s, let me know.
Yes we are at Peak Credit. For centuries now we have had the luxury of exponential energy growth therefore productivity growth through technology. This is coming to an end.
After all is said, credit is the promise to pay in the future. This promise is a claim on natural resources. The problem comes in the form of fractional reserve banking whereby multiples of existing debt are needed in the future while natural resources are finite and indeed are becoming ever more costly to bring to market.
Since our money and credit creation are based on geometric debt creation ( future promises ) while marginal wealth creation ( future wealth) is decreasing and turning negative the equation becomes unsustainable and debt must be destroyed.
The answer is the creation of our money by our treasury without debt while fazing out fractional reserve banking by constant lowering of allowable leverage for banks. Only when debt equals savings will the economy balance. Interest rates can float to sustain this balance.
anonymous 4:18
You hyper-dolt. I said analysis. The information is readily and freely available according to sector breakdown through existing Federal Reserve flow of funds reports and the national income accounts.
Yes, we are peaking on many fronts but most notably on a profound absence of common sense.
Agreed Dean. All along, it’s just been too good to be true. Anyone paying an ounce of attention could figure it out. It seems like all you have to do is promise easy money that no one has to work for (price appreciation), and everyone jumps on board.
I don’t know if anyone has just come out and said it yet, but a lot of Americans got played for suckers.
i think we need to disaggregate credit too.
we’re all sitting here talking about consumer debt, but that’s just the tip of the iceberg.
the US gov’t is in far worse shape than the US consumer, or any sub-prime borrower, and has much bigger liabilities.
ironically, if you think along these lines, we may have reached peak CONSUMER credit, but not peak GOV’T credit. there’s a big difference between the two. especially since the fed can buy one, and not the other (at least not yet, anyway)
corporate credit is probably somewhere in the middle.
For years we were told “buy and hold”. If you bought microsoft at $5 back in the old days you’d have a fortune today.
Now with Cramer on TV and his advice that buying and holding is not the way to get rich, you have 6 month rotation or even 3 month rotations.
Everyone kept saying in 1999 that it was a new economy. Then the taxi cab drivers who were talking about Qualcomm to their fares got taken to the cleaners. No more legions of day traders.
Those that made a little bit of money then turned to the real estate market because we were all told real estate equals wealth and that to keep up with the Jones’s, you had to buy and sell homes like they did.
During the time that the little guys were playing flippers with their houses, the private equities and hedgies were playing flippers with everything.
Now, here i am, the ant…having watched the grasshoppers making the mcmansions in the neighborhoods and get the beemers in the driveways, and now it seems that everyone one is going to default or walk away from what they owe on the credit cards, credit lines or helics, but they still have the mcmansions and the beemers.
and i’m wondering if i should have been a grasshopper.
I only have my Y2K closet that I still keep stocked with 3 months of supplies.
“…I would posit that we long-ago pierced any reasonably sustainable threshold, and only through sheer inertia and the fortuitiousness of pulling of rabbits-out-of-hats have we lasted this long.”
——
Fraud, theft by deception, and a global strike capability haven’t hurt, either.
Michael McKinlay – again, the only one here being right on the MONEY.
Did somebody say credit?
Oh, no, that was debt.
How does more debt sound as a solution to the problem?
Did somebody say I.O.U.S.A. ?
The national Debt?
Former House Banking and Currency Committee Chairman for 16 years criticized that process:
“I have never yet had anyone who could, through the use of logic and reason, justify the Federal Government borrowing the use of its own money….I believe the time will come when people will demand that this be changed. I believe the time will come in this country when they will actually blame you and me and everyone else connected with the Congress for sitting idly by and permitting such an idiotic system to continue.”
Sooner or later, folks are going to get real.
Yes, this is THE crisis of capitalism.
No more bubbles.
About time.
Austrolibertarianism ?
Time to read :
The Chicago Plan & New Deal Banking Reform
Visit monetary.org.
Let's gt on with it.
The chart of total debt as a percentage of GDP scared the willies out of me, especially in comparing the current madness to the mess in the 1930s, which seems quite mild in comparison.
After some anxious hours, and wondering when I might see the beginnings of a crash, it dawned on me that the chart in no way showed our current plight, as all of the debt vaporization and recreation by the Fed over the past year was absent from it.
While I doubt that we have made much of an impact — after all, we need to lose trillions of dollars of debt without also losing similar amounts of GDP, a rather large order — we have probably made some impact. Anyone care to hazard a guess (or better yet, actual data) as to the amount of mortgage debt that has gone up in smoke over the past year?
We can manage a rough count of the amount of Wall Street write-downs that would contribute to lowering the total debt line, but I’m curious how much the individual has contributed to the cause thus far.
Because the only way we are going to escape this monster is to destroy debt at a very rapid clip, without also managing to destroy GDP along with it.
If we destroy both debt and GDP in matching amounts, the monster will devour us all.
6:19, I sympathize with 4:18 and don’t like your attitude.
One, why do analysis if you haven’t said what questions you want to answer? What exactly do you want learn from disaggregating the data? Boiling the ocean is generally not a useful exercise.
Two, you complain about comparisons over long periods of time. Yet simple calculations like that can be highly useful and revealing, for instance, Robert Shiller’s work on home price increases since the late 1800s. These debt/gdp charts and tables often have footnotes on methodology, which shows they made some effort to be consistent over time.
Three, you only want current flow of funds data? That’s trivial. Why don’t do it yourself? You seem to prefer to curse the darkness rather than light a candle. Many people who comment here and on the more active econblogs are generous with links, ideas, and their own analysis. But you’d rather shit on what is offered rather than doing anything to contribute.
Fourth, I suspect going back to 1920 and trying to categorize the data in a consistent fashion is NOT trivial. I would suspect categorization and data gathering methods have changed. Which again point to why you haven’t done it yourself. It’s work.
Mish reminds me of a talking head from the Main Stream Media, relying on Fed’s numbers and charts, a disservice. Those fictitious findings couldn’t be further from the truth. Without oil breaking below $100 and the SOW breaking above 12,000 you can get a good feel for what is about to happen….a crash. The US$ has completed its dead cat bounce and reality will set in.
Without proper accounting there is no way to know how much worthless paper the Fed’s alphabet windows have exchanged for Treasuries. It’s indiscernible but you know for certain the debt will be rolled over/into generations to come.
RE falling to a affordable wage ratio is a much needed correction. The over leveraging of that market will take care of itself or the Courts will see to it.
The TIC report is going to rock your world and continued inflation to fund internally will be the only option……Sad.
I pondered a while the assertion the US Govt is still creditworthy, and I think there’s a defect in that pipedream. There are 80,000 local govt units and 50 US states headed for insolvency. I don’t care how many SWFs and foreign CBs prefer to hold and roll Treasuries til doomsday. If govt disbursement exceeds 50% of US GDP, there is no way out after that tipping point.
I agree with every sentiment and most every word in Cassandra’s summation . . . except the concept that credit in aggregate will henceforth decline, the implication of the ‘Peak’ adjectival. To me, jest makes a good surmise here; consumer credit may very well have peaked, but public and quasi-public credit is an independent trajectory which has only paralleled consumer credit. (And yes, corporate credit is also a beast of separate species.)
Historical instances are no sure parallel, particularly given the speed and integration of sovereign _facilitated_ capital movements at present compared to historical instances, when major capital was more substantially under private thumb. In other instances where a major sovereign creditor of the scale of the US got into bad trouble, credit did not necessarily dry up and build down, though. Now, if you are say Argentina (multiple times) or Sweden and Norway in the 90s, you _have_ to put your house in order because world capital markets can, do, and will cut you off dead. Credit in such circumstances goes down, and fast or slow revenue comes up to find a new balance. But massive sovereign creditors just have too many assets, revenue flows, and capital pools. Think Spain in the 1500s, France in the 1700s, Turkey at various times, Japan in the 1990s: they got credit, it’s the terms that changed. So there are always offshore lenders who will ‘help them out’ like the good pushers they are. For a quote at a very dear rate, or against prime sovereign assets.
What also changed in those cases, though, was the method of payment. Since real production wouldn’t do, faux money of various kinds was made to go forth and also serve—with the outcome that repeated credit/inlation spikes tended to follow for such big incontinent sovereigns. Even Japan has in effect pixelated digits to ‘pay’ for its stimulus efforts and capitalize its banks to go forth and carry. Even though historically most such major sovereign junkies serially defaulted, someone would always lend to them again; I mean, if they were paying _this_ quarter, the lenders made a killing at what they were charging. Many of these cases ended in political implosion, notably in opposition to further sovereign indebtedness. I’m not advancing that as any sure scenario for the US, but to me it’s even money on that outcome as opposed to ‘getting clean and sober’ public capital-wise. At best.
And Orion, I _adore_ the iTulip reference. I hope you have a tm on it, ’cause it’s going to go global, methinks.
Anonymous 1:44
I made a comment on disaggregation of summary credit measures. It was a general observation about the typical depth of data analysis in this area that several commenters agreed with, and not an attack on this post. In fact, “Cassandra” is imaginative and interesting as usual, coming up with the idea of “peak credit”. I didn’t complain about comparisons over long periods of time. I complained about superficial comparisons based on the tiresomely repeated debt/GDP ratio. You commend Schiller’s work (I do as well), without noting that it has absolutely nothing to do directly with aggregate credit data. You note the difficulty of historical data comparisons. I guess that’s your excuse for accepting superficial analysis. I’m not the one putting forward the historical comparison, and your solution is that anybody interested in such analysis do the work themselves – a solid defence against the point of criticism. You obviously have no idea of the scope of flow of funds data, as it includes detailed sector balance sheets of gross assets and liabilities, and illustrates the netting effects overlooked by those who stop at the level of the gross debt/GDP ratio. As one example, the US gross foreign asset-liability position approaches $ 20 trillion, only a small part of which constitutes net exposure. Most of the debt floated overseas is offset by overseas assets held by the US. Where’s the analysis on this? As for the questions that need to be asked, that’s a function of the willingness to explore the evidence a little more deeply. People investigating a crime scene don’t ask the right questions until they examine the scene on the ground and they don’t take a summary description of it over the phone. Several others seem interested in this area, but as you sympathize with 4:18, you are awarded the silver medal in his category.
8:19, You continue to prove my point. You continue to complain about other people’s failure to do work on an unpaid basis yet are unwilling to do any on your own. Why are you complaining rather than contributing?
First, the reason for citing the debt/GDP ratio was not the absolute level, but the trend over time. Thus looking at the composition now isn’t very meaningful unless you can make reasonable historical comparisons. Have you looked into the level of detail and method of data capture in the 1920s and 1930s? I suspect not.
Second, the netting argument is specious. The netting argument holds only if the same people who hold the assets also hold the liabilities. Think a big corp with foreign subs is going to bail out, say, Fannie? Since many of them pay zero taxes (the average tax paid by large corps is 6% of revenue), they won’t even share to a meaningful degree in the tax hit.
Richard Kline discussed this earlier:
“Re: NIIP, this is not the point. Nor is the issue of US investments overseas? If those investments were in the hands of the Federal government, and their proceeds were turned right around to pay off our _external sovereign and quasi-public debt_, then those ‘balances’ might matter. But those profits go into private hands whereas the payouts for our public and quasi-public debt must be financed from public revenues. Said revenues are manifestly inadequate for the still increasing external public debt. If what you are proposing, then, is that the US nationalize all offshore investment profits if and as they are repatriated, and use that revenue to pay off our sovereign debt, than we may get closer to ‘being in balance.’ It is much not my impression that you suggest anything of the sort. Ergo income and outgo are NOT in balance—because they are billed to quite different parties. Abstarct total quantities obscure more than they reveal; peel them back, and you’ll find different answers. “
Argentina, Chile, Russia as of 1998 all had favorable net international asset positions due to hot money, prior to their collapses.
You seem to want the level of detail you’d get from a research report. Yes, sometime blogs and the media get their hands on them, but mainly not. And there is a obvious reason. It takes time and money (and often access to data services that is in turn an expense). Those guys are protective of their intellectual property and go to some lengths to restrict it to paying clients. But you complain that it isn’t offered here.
So as I said before, either quit complaining or do the work. If you’d like to share it here, or create your own blog, I’m sure there would be an appreciative audience. But bitching and doing no work of your own is cheap and lazy.
masterful bloggism
Cassandra kicks ass. Sharp writing too.
there is an irony to peak credit in that finance must mirror the real economy or create bubbles
every small town bank knows that dumping money on an enterprise doesn’t create wealth
peak oil and peak credit is the collision of faustian western finance with the earth
capitalism and environmentalism are thrown together in a Dantesque dance.
I posted Peak Credit on Jan 8th on our goofy http://www.mobiustrips.net and sent the idea to Kunstler about the same time. For what it is worth.