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Sunday, June 09, 2013

Z1 and the next credit crash

Karl Denninger doesn't see much more good news in the current Z1 release than I do.  It's not overtly bad, at first glance, but even if the pattern of corporate debt expansion combined with household contraction isn't immediately problematic, it is clear that the continued expansion of government sector debt is only keeping the economy in a state of disinflation.
Consumer debt has gone exactly nowhere.  The so-called "recovery" has been carried by business debt that has grown at a rate roughly double that of economic expansion, and the government is growing debt at a rate more than triple that rate.... Note that the absolute level of debt to GDP, however, refuses to go under 350%; it has now started rising again but is entirely coming from two sectors -- business credit and the Federal Government. The problem with this paradigm is that we're doing the same thing that led to the 2008 blowup -- we've learned exactly nothing.  In real terms our GDP is in fact contracting by about $500 billion a quarter, after adjusting for debt expansion -- that's $2 trillion a year, more or less.
I prefer to look at what I call Zn, which is Z1 estimated as if it had continued to grow at the sixty-year historical rate of 2.36 percent that was required to fuel the post-WWII economic growth.  Regardless of when one begins, Zn tracked Z1 very, very closely until 2008, and the gap is still widening.  Although Z1 grew 1.28 percent, (47 percent of which was federal government debt), that didn't prevent the disinflationary gap from growing another $1.1 trillion in Q1.

The credit demand gap is now approaching $25 trillion, which is not only more than the entire annual GDP, but amounts to 43 percent of total outstanding credit market debt.  And federal sector debt, which in 2005 was less than half the household sector debt, now virtually equals it in size.

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37 Comments:

Anonymous Joe Doakes June 09, 2013 10:07 AM  

I don't understand why this is significant. I tried the follow your inflation-deflation debate with Nate and I read your book but I'm still struggling.

From the book, I get you are saying the US economy is collapsing, but the collapse is being masked by government spending which somehow results in phony economic statistics to beguile the masses a little longer. Is this post further evidence to support that conclusion? If so, how so?

If your theory is correct, the above post proves it and you can figure that out, wouldn't the heavyweight financial guys know it, too? All the stock people, the currency speculators, the bigshot bankers, Goldman, etc? Why would they play along? Why isn't there an enormous run to get their money out before it all collapses?

Anonymous bob k. mando June 09, 2013 10:14 AM  

OT:
Hollywood now issuing overt demonic rape porn into theaters -
http://www.latimes.com/entertainment/movies/moviesnow/la-et-mn-this-is-the-end-mpaa-rating-20130604,0,3201458.story
"...“This Is the End” includes several sex scenes, including one between a demonic beast and a human, and a satanic creature even more well endowed than Mark Wahlberg’s Dirk Diggler in “Boogie Nights.”

Anonymous bob k. mando June 09, 2013 10:17 AM  

Joe Doakes June 09, 2013 10:07 AM
Why isn't there an enormous run to get their money out before it all collapses?




that's like asking why everyone didn't get out of CDS's before the collapse, even though they all knew it was corrupt and they all knew that they were backstabbing their customers even as they sold the products.

there's an AWFUL lot of money to be made ... so long as you can find a greater fool to take your seat at the table before the music ends.

and in the end, aren't we all dead?

Anonymous Salt June 09, 2013 10:36 AM  

We've all been told debt doesn't matter. I'm quite sure we have not been lied to.

/s

Blogger IM2L844 June 09, 2013 10:39 AM  

Why isn't there an enormous run to get their money out before it all collapses?

Some people will make vast fortunes if there is a collapse. Remember wealth doesn't vanish into thin air. It simply shifts around and the old money never lets a financial crisis go to waste. They are the Einsteins and Rembrandts of creative bookkeeping with immense teams of professional obfuscators.

Blogger James Dixon June 09, 2013 12:15 PM  

> ...but the collapse is being masked by government spending...

Not masked, delayed.

> ...which somehow results in phony economic statistics to beguile the masses a little longer.

The statistics are quite phoney, they're just misleading. For instance, those 175,000 jobs created last month? I'd be willing to place a small wager most of them were part time jobs of less than 30 hours/week.

> ...wouldn't the heavyweight financial guys know it, too? All the stock people, the currency speculators, the bigshot bankers, Goldman, etc? Why would they play along?

Those people work within their system. They have a vested interest in the system continuing to work. They're extremely unlikely to be the ones to spot the problems within it. There are other reasons too, but that's a good one to start with.

Anonymous scoobius dubious June 09, 2013 12:28 PM  

"so long as you can find a greater fool to take your seat at the table before the music ends. and in the end, aren't we all dead?"

Hmm. Depends, sorta. For instance, in R.L. Stevenson's story "The Bottle Imp", the guy who gets left holding the bottle has a lot more to worry about than just being dead.

"For instance, those 175,000 jobs created last month?"

Those 175,000 minimum-wage scut-work jobs created last month were immediately gulped down by the 275,000 mestizos also created last month. No one in DC can math!

...or actually, it's worse. In DC they can indeed math, and they're doing all this on purpose.



Anonymous Van June 09, 2013 12:46 PM  

Dixon-

Most of the 175k jobs pay below the national average. This has been the case most months. Job creation more/less keeps up with population growth, so we only break even; unemp,loyment goes down because people leave the workforce. Meahwhile, the employment rate is unchanged as the percentage of the population feeding from the trough grows.

Not a pretty picture.

Blogger RobertT June 09, 2013 12:54 PM  

As you indicated, household contraction coupled with corporate expansion is a recipe for disaster. Corporations are expanding into a smaller market. That foolhardiness is directly attributable hired management who have no skin in the game operating under absentee and detached ownership. All the incentives reward gambling like an immortal riverboat gambler in a risk free environment - bonuses are handed out if you don't fail and golden parachutes are handed out if you do." The other side of the coin is that the corporate form of business allows for capital accumulation without risk to the investor, but it has become a cancer. You don't have to be a genius to imagine alternative that would work better.

Blogger Nate June 09, 2013 12:57 PM  

"I don't understand why this is significant. I tried the follow your inflation-deflation debate with Nate and I read your book but I'm still struggling."

Its entirely possible that you're just not capable of grasping this then. I don't see either Vox or myself being able to dumb this down any more than we already have in the debate.

When you see those posts... and the length of them... you have to remember... that's the cliff notes overly simplified version.

Blogger Unknown June 09, 2013 1:08 PM  

Those people work within their system. They have a vested interest in the system continuing to work. They're extremely unlikely to be the ones to spot the problems within it. There are other reasons too, but that's a good one to start with.

Yeah, I think that's the gist of it. They know their system, or at least think they do - consider themselves experts on it. There's a lot of hubris too. I mean, look, at heart the entire financial system is just a bunch of somewhat arbitrary numbers, right? If things aren't working and you are important or clever enough, you just re-write the numbers to make it work.

Well, no, there is a connection between those numbers and reality, but I think the banksters have so thoroughly obfuscated their industry, even they no longer see it. They have come unmoored from reality, and either don't realize it or else think it's a good thing. Plus, they're invested in the system up to their eyeballs. If any of them do feel the tug of gravity, what could they do? Get out now and be ruined by their former colleagues who are still in full profiteer mode?

Blogger John Williams June 09, 2013 1:09 PM  

Why isn't there an enormous run to get their money out before it all collapses?
There will be. Especially with all the automated trading systems. In the meanwhile everyone is making to much money to quit, besides they all believe that they are to smart to be the big looser when it does crash.

Anonymous Van June 09, 2013 1:30 PM  

How far down the ladder do you get before everyone is ignorany?

My father-in-law's financial advisor is either an idiot or is blatantly lying to him, including citing the dropping unemplyment rate as evidence that "people are going back to work." For over a year I've been explaining the employment numbers, the debt, increasing use of welfare/EBT/disability, low wages, etc. But she's the expert (yes, she), so he just grins like I'm clueless.

Anonymous LeeS June 09, 2013 1:43 PM  

I spoke with my Dad's Edward Jones financial advisor a few weeks ago, he also stated that the economy was improving.

Anonymous Van June 09, 2013 1:49 PM  

Either they're clueless and accepting the lies they're told, or they're lying to keep their clients. The truth is that the economy appears to have stabilized (for now), but it stabilized in a very weak condition. Everything the in-law's advisor cited to show improvement is easily disproven.

Anonymous LeeS June 09, 2013 2:02 PM  

They make their money selling financial products. If they told the truth their clients would pull their money and bury it or buy gold or whatever. Just try and push your father-in-law to keep as much money liquid as possible. That's probably the best you can do.

Anonymous allyn71 June 09, 2013 2:26 PM  

"...Why isn't there an enormous run to get their money out before it all collapses?" - Joe Doakes June 09, 2013 10:07 AM

There are many reasons why the system is sputtering along, but don't forget that many have left realizing it is all a charade. A quick poll here would show that many people have left/minimized their exposure to the banking system and stock market compared to their exposure circa. @ 2006. Additionally, look at volume and % of retail volume to show the exodus from traditional markets.

Another indicator showing the exodus from traditional systems is the universal shortage of PM that all metal depositories/mints are showing. Look at the premiums over spot prices. The US Mint is selling 1/10th ounce Gold Eagles at 40% over spot. That is decoupling and a strong indicator for the true market value of physical gold, a barbarous relic that some think is a substitute for fiat money. (That relic business is sarcasm for the sarc impaired)

So there is ample evidence that in fact people are making the exodus and heading to the exits. The reason you don't recognize it is primarily two-fold. 1. is Central Bank intervention to try and keep up the place (see QE, HFT's, 0% prime, etc) and 2. traditional media that are invested in helping Govt./Banksters keep up the charade. Most corporate media is too invested in this model to tell the truth for those that know how F'ed up things are. If the media was honest and showed the decline how do you think the ad business they depend on would be?

That can be taken to many of the other mid to low level members of the financial industry. They are so dependent on the system that they can't think of any other way and just keep going to work hoping things will work out. They really are just thankful they got their bonus last year and paycheck last pay period. If you have spent any time with a low-level trader you soon realize that they are very good at the micro but not so good at the macro. They don't think big.

As far as those that are higher up the food chain that could be said to be responsible for managing the system. Think of our financial system/currency as a old milk cow going dry on a large estate/plantation. The plantation manager still makes sure that someone goes out and milks that cow everyday getting what they can out of it.

That doesn't mean that they aren't going to the auction house with an eye out for a replacement (see Bildeburg, Russian/Chinese currency agreements, Iran-India oil for gold, etc.). They are managing the plantation and as soon as that old milk cow is no longer producing more than the hay they are eating, the cow goes to town and the new one comes in. Just prudent you see.

Anonymous allyn71 June 09, 2013 2:46 PM  

Thinking about it a little more in the context of why more are not taking their assets out, it goes beyond just those that are involved in the financial industry.

Most people are paralyzed by normalcy bias. They can't act because they think everything will just go on like it always has thankful they got paid last week.The realization of the consequences of financial collapse are to horrible to contemplate so they don't and just keep going on figuring it will all work out.

Hence the sheep analogy, same mindset as a band of sheep going along following each other mindlessly.

Anonymous Van June 09, 2013 3:23 PM  

Allyn,

Normalcy bias -that was the point of my question about how far down the ladder you go before you get to the ignorant rather than dishonest (was mid-workout so didn't explain). This morning I heard a radio show giving financial advice - the same advice you always hear. Diversify, 401k and Roth IRA, in 50 years you'll have $X at an average growth rate of 7.2%, on and on. Everyone says the same thing, qoting each other (consensus!!!), assuming what is has always been and will always be.

None of these assholes does an ounce of independent analysis. Just follow the crowd.

Anonymous allyn71 June 09, 2013 3:31 PM  

I don't think there is an answer to how far down the ladder you go as if there is a line. For me a better way to think about it is by a percentage of awareness. The higher up the socio-economic ladder you go the higher percentage of people are aware of this.

That said, don't assume that someone giving out standard mantra advice on the radio about what to do means that they are unaware about what is going on. Maybe they are milking that cow for all it is worth and it is in there interest to keep you going along with it with they get the last few drops of milk.

Maybe the assholes are doing independent analysis but they just aren't telling you about their conclusions.

Anonymous JI June 09, 2013 3:50 PM  

What is the "credit demand gap"?

Anonymous Van June 09, 2013 4:06 PM  

I'm sort of contradicting myself on the liar vs idiot issue. Just thinking out loud I guess. Either way, I don't listen to the experts anymore. Well, not the mainstream ones.

Anonymous allyn71 June 09, 2013 4:44 PM  

"What is the "credit demand gap"?" - JI June 09, 2013 3:50 PM

JI, the answer that will give you the best insight is to read Vox's book Return of the Great Depression and the past post here about monetary/economic policy.

The short answer is that all money in our system is created from credit.

The "credit demand gap" is the difference between the rate of current demand for credit (money) and the expected historical rate based upon a 2.36% annual increase as seen in the post-war era.

The gap is the amount of credit (money) that hasn't entered the economy from the historical expected.

Anonymous Stilicho June 09, 2013 8:04 PM  

Most people are paralyzed by normalcy bias. They can't act because they think everything will just go on like it always has thankful they got paid last week.The realization of the consequences of financial collapse are to horrible to contemplate so they don't and just keep going on figuring it will all work out

Indeed. Normalcy bias is a powerful force. Mix equal parts conditioning and an ostrich-like tendency to avoid harsh truths and you get a result that is greater than the sum of the parts. To escape its effects you have to think logically and deal honestly with facts and that is extremely difficult and painful for many people if not simply impossible.

As for the future, what if they threw a credit party and no one came...

Blogger James Dixon June 09, 2013 8:31 PM  

> ...he also stated that the economy was improving.

If I may be contrarian for a moment.

I think they are actually correct, and the economy has started improving, at least in the sense of jobs picking up. However, I think the reason for that job pickup is what I noted above. Whole industries are converting to an entirely part time work crew to avoid the onerous demands of Obamacare. You can do the math. If you convert your employees to 28 hours a week, and still need the same number of hours worked, you need 30% more employees.

> The truth is that the economy appears to have stabilized (for now), but it stabilized in a very weak condition.

Yes. That's why I think the job creation is an artifact of Obamacare.

Anonymous Van June 09, 2013 9:00 PM  

James Dixon -

Definitely. Many jobs created are part time, but it's even worse: over the time that unemployment dropped from about 10% (maybe 10.1% in December of 2011) to 7.6% now, job creation has just barely outpaced growth in the working age population. And that's with the higher than normal percentage of part time jobs. Imagine if those four part time jobs were three full time jobs.

Also, the unemployment rate is calculated from a survey of households, while the jobs created/lost is obtained from an entirely separate survey of businesses. Among other things, this allows more opportunity to pick one number and emphasize it.

For example, you can have a month where 250,000 jobs are created but unemployment doesn't move because each job was part time and taken by someone already working. But hey, 250,000 jobs created!!!

Anonymous allyn71 June 09, 2013 10:07 PM  

"As for the future, what if they threw a credit party and no one came..." - Stilicho June 09, 2013 8:04 PM

I would say that is the premise of Vox's OP. Since 2008 the party has been going on but no one (besides the govt) is showing up.

Blogger Nate June 09, 2013 10:40 PM  

""As for the future, what if they threw a credit party and no one came..." - Stilicho June 09, 2013 8:04 PM "

This is what Vox fails to grasp. This leads to hyper inflation. Not deflation.

Anonymous Stilicho June 10, 2013 9:27 AM  

""As for the future, what if they threw a credit party and no one came..." - Stilicho June 09, 2013 8:04 PM "

This is what Vox fails to grasp. This leads to hyper inflation. Not deflation.


A few points from Keen:

1) Reserves are not necessary for lending. In fact, aggregate lending comes first, followed by creation of reserves to "support" it.

2) Credit growth requires a lender willing to make a loan to what he considers a credit-worthy borrower. It takes two to tango.

What we see from looking at the Z1's is that the Fed's money creation has significantly increased the banks' reserves, but commensurate lending has not followed. The money multiplier theory is not working as advertised. Second, the primary "credit-worthy" borrower who is actually increasing its borrowing is the federal gov't. To the extent this money is then spent into the economy, it will have some inflationary effect, ceteris paribus (see, e.g. bubbles in Treasuries and stocks fueled in part by banks' use of easy Fed money) However, this is a different animal than hyperinflation (as you know). Additionally, I know you consider the credit money created by re-lending loan proceeds in the fractional reserve banking system to be ephemeral because the whole chain is ultimately based on the original base money. Fair enough, but the problem is that this is just another example of leverage gone wild. The nature of such credit creation is that it is not all due at the same time, so this helps hide the leverage to some degree. If the chain breaks down and collapses due to a default, the whole thing can unwind rapidly as succeeding notes are called and we see credit deflation (and banksters jumping out of windows). In a just world, your model would make more sense (only actual money would matter), but, in our financial system, leveraged credit is the coin of the realm. If Nate borrowed money to buy a new cnc milling machine, he would have to give the lender a security interest in the property, a UCC lien would be filed, and no other reasonable lender would loan Nate money using that machine as collateral. In the financial system, assets are routinely rehypothecated, client assets are pledged as collateral for the fiduciary's debts, and no one seems to know who actually owns anything (the answer is that all your stuff are belong to GS and JPM). When this system suffers its inevitable breakdown, the Fed cannot replace the leveraged credit with base money as fast as it deteriorates. That is the deflationary scenario I foresee.

Blogger James Dixon June 10, 2013 9:43 AM  

> ...is that the Fed's money creation has significantly increased the banks' reserves, but commensurate lending has not followed. The money multiplier theory is not working as advertised.

AFAICT, this is because the banks, now freed from the requirement to keep their investing and loan divisions as separate companies, are investing the money themselves rather than loaning it out.

Anonymous Stilicho June 10, 2013 10:05 AM  

Yep, James, those prop trading desks are primary drivers of bank profits these days. It is much easier to get a few points return on billions in Fed-provided free liquidity than it is to hunt down and kill a genuine credit-worthy borrower in the wild.

Anonymous allyn71 June 10, 2013 4:05 PM  

"When this system suffers its inevitable breakdown, the Fed cannot replace the leveraged credit with base money as fast as it deteriorates. That is the deflationary scenario I foresee." - Stilicho June 10, 2013 9:27 AM

That is how I see it as well Stilicho. I have refrained from jumping into the fray as I was curious for both sides to present their opinions and watch the debate come to a conclusion before I added my 2 cents worth.

The waiting aside, I see the problem with Nate's position is that he thinks the outside, credit leveraged money will come back the the US and the in-rush of currency will cause hyperinflation. I see it similiar to what you just posted. When credit leveraged money goes bang it is just gone and there is nothing to come back (if it is still accepted it might have a very short-term halflife where it will be hyper-inflationary but it will be short lived). When the credit/money crackup comes, all those leveraged dollars will just go away and no printing will offset it.

I think that is where Vox is headed if he ever gets around to posting on it again but I was waiting to see. Might be awhile.

Doesn't really matter who is right in this as both recognize the root problem and the likely results to society. They are just arguing over the schematics of it, end result is the same either way, we are SCREWED!



Anonymous Stilicho June 10, 2013 10:54 PM  

Allyn, I think one of the curious effects of the coming deflation will be that gold performs very well contra the expectations of many inflationista gold bugs who can be monomanically focused on the late 70's experience. The reason is that gold is beginning to resume its role not just as money, but as the money against which all other monies are measured. Real money does well during deflation.

Anonymous Joe Doakes June 11, 2013 10:27 AM  

Stilicho, would you mind picking up where Nate and Vox left off, dumbing this down for me?

Zn diverges from Z1, mostly because of government borrowing. So easy money is rushing to government, as it once rushed to tech stocks, then to real estate, now to student loans, all of which caused bubbles of malinvestment that eventually popped causing a crash in those sectors.

Is Vox saying we're looking at a government bubble? That it's going to pop like tech stocks and real estate did?

Is that even possible?
.

Blogger James Dixon June 11, 2013 11:19 AM  

> Zn diverges from Z1, mostly because of government borrowing.

Not quite. It's diverging because we're tapped out. Individuals and companies have quit borrowing at their former rate.

The government is trying to fill the gap by borrowing as much as possible.

Anonymous joe doakes June 11, 2013 1:53 PM  

Thanks, James, I stand corrected. But I still don't understand why that matters.

The credit demand gap means the bank has money to lend but nobody wants to borrow it. We're driving our cars longer while we pay off our credit cards.

So why is that the government's problem? Why does it need to borrow the money to fill the gap? Just to make the GDP numbers look better? Let the gap exist, who cares?

Blogger James Dixon June 12, 2013 11:36 AM  

> So why is that the government's problem? Why does it need to borrow the money to fill the gap? Just to make the GDP numbers look better? Let the gap exist, who cares?

To prevent deflation.

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