(From Annaly Monthly Commentary June 2009 - released July 9):
By: Jeremy Diamond, Ryan O’Hagan, Kevin Riordan, and Robb Calhoun | Annaly Capital Management
Annaly.com
...On the other hand, the world is surely feeling the effects of a massive debt contraction in the U.S., even as the Federal Reserve and U.S. Treasury heroically step into the breach. According to the Federal Reserve flow of funds data, the whole domestic nonfinancial sector (household, consumer, non-financial corporate, farm and state and local government debt) has shrunk as a percentage of total credit market debt (CMD) from over 70% at its peak in the early 1970s, to just 50% of the total today. In dollar terms, this sector has now declined two quarters in a row; up until now, there had never been even one quarterly contraction. In this bucket are both mortgage debt and consumer credit. Mortgage debt outstanding has fallen over $100 billion since its peak in the first quarter of 2008, and consumer credit has fallen in seven of the last eight months, the worst string since 1991. The domestic financial sector (ie, repo, financial corporate debt, etc.) now makes up over 30% of CMD outstanding, up from less than 3% back in the 1950s, but it contracted over $70 billion during the 1st quarter (the first quarterly drop since 1975).
On an aggregate, economy-wide basis, can you call this deleveraging? Technically, no, because the staggering growth in federal government debt has so far made up for the contraction in other sectors (see the blue line above). But the U.S. government only accounts for 13% of CMD (down from nearly 45% after WWII). In the last three quarters alone, U.S. government debt has increased over 30%, or $1.5 trillion. We are witnessing the deleveraging of the non-federal sector and the re-leveraging of the U.S. government. While we are uncertain about the government’s ability to keep total CMD outstanding from falling (the latest YOY growth rate is the weakest in the time series), this much is clear: a negative print for CMD growth will be a bell-ringer. And stagnant debt growth will mean stagnant economic growth and a strong deflationary undertow.
On that last point, we have three observations to go along with the seemingly inflationary portent of a doubling of the Fed’s balance sheet and the monetary base. First, it’s been a step function, not a persistent trend. It took the Fed only 5 months to ramp the monetary base from $840 billion to $1.7 trillion, but for the last several months it has trended sideways or down. Second, not coincidentally, excess reserves at the Fed also increased by roughly $800 billion over the same time. Those reserves are just sitting there, earning interest, not permeating the economy. Third, money supply growth (as measured by M2 or MZM), while higher than average, hasn’t even broken the highs of 2001 and 2002. The mechanism by which the Fed generates money supply growth is being hampered by a financial system still in distress, and a consumer that lacks the willingness and ability to create new credit. It all makes one want to go take a roller coaster ride at Six Flags....
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