A very important dialog this week in prudentbear.com
Noland quotes Laffer Associates;
The fundamental error people have made when suggesting that consumer debt has become unsustainable is that they are confusing stocks with flows. Debt levels are a stock, a fixed number. Debt service, the monthly minimum payment, is a flow, a recurring charge.
If we were to compare debt to income, as do most who suggest debt levels are too high, we would be comparing a stock variable with a flow variable. It can’t be stressed enough: whenever comparing economic data, be sure that the variables are only of one type. If we want to get a more accurate picture of the economic landscape from the household debt perspective, we would be much better served by comparing income to debt service burden (two flows), or wealth to debt (two stocks). (Nolands' emphasis)
Much financial reporting relies on hyperbole 'Consumer debt breaches new record' based on relations like that denounced above. At the bottom of this post is linked an article from last week which showed Canadian consumer debt now exceeds 100% of Income, an example.
Last fall, I used my credit cards to purchase IBonds. At one point, I had credit card debt (at 0%) exceeding my taxable income. Does that mean I'm bankrupt? No. The amount of credit card debt should be compared to my networth or liquid financial assets. As it were, once the 0% period elapsed, I paid down the credit lines.
Noland then offers the important observation:
The fundamental flaw with Laffer Associates’ analysis is that it disregards the crucial financial “flow” – the flow of new Credit that is the fuel for both the economy and asset markets.
...
the crucial “flow” of debt, sound analysis cannot ignore that Total Credit (Non-financial and Financial) expanded at an unprecedented annualized $2.82 Trillion (25% of GDP!) during the first half, a rate of 9.1%.
I believe he illustrates a valid concern, and would like to see a the Laffer group's thoughts on this matter. Is it true that US economic growth hinges on an ever increasing flow of consumer credit? Or is there an assumption here which may be only partially valid?
I would propose that there are two factors that should be considered.
First, it would be normal for total credit to expand in a period where home ownership breaches new records, as first time home owners take on new mortgage commitments and new housing stock is created.
Is it possible that credit growth in the US represents a rational response by consumers to take on debt, in light of very low rates, to purchase assets, much like my taking on credit card debt to buy IBonds cited earlier?
Second, from a global perspective, you have one class of citizen very focused on savings (an aside; those who've faced hardship are very 'savings' oriented) and another class willing to take on debt (those with a level of confidence in current circumstances and their future).
It is quite possible that citizens of the developed world, with a level of confidence in their situation and a measure of creditworthiness, are providing a sink for the savings of that portion of the world now undergoing rapid development and extraordinary savings rate. Beyond that, you have most of the developed world attempting to save for retirement. You might say there is increasing 'demand' for debt 'encouraging' the credit growth monitored by Noland.
Neither precludes the possibility that debt assumed to finance the housing construction boom will be repudiated, in part, at some point in the future.
But what about sustainability? How long can our system expand Total Debt at an annual pace of 25% of GDP? And what are the consequences of this unprecedented Credit inflation – with respect to financial and economic stability (both domestically and internationally)?
I would suggest, that debt will continue to expand until such time as rates move higher, impacting demand for credit, and/or the global savings rates (retirement and asian) decreases, impacting supply.
Noland concludes;
When Credit growth inevitably slows, or if interest rates spike significantly higher or the dollar dislocates on the downside, recession will be the least of our worries.
Credit growth could be sustained for some time by unusual and high savings flows resulting from the modernization and savings habits of the Chinese and other SE Asian economies, not to mention India. A general feeling of security and prosperity will not replace fear overnight.
Dislocation in the value of the dollar would likely have ramifications for global producers of commodities priced in dollars. Interest rates spiking higher could be the trigger for the legendary 'Weapon of Mass (Financial) Destruction' derivative bomb. But then so could a dislocation in the value of the dollar.
Thoughts for a quite November day.
Debt loads are soaring: $22,000 per capita and counting
(note the Debt to Income table at the end of the article)
nationalpost.com |
