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Totally Addicted to Credit

Josh Abrahams – working under the pseudonym Puretone – released a monster hit single in the Fall of 1998 entitled Totally Addicted to Bass.  Fifteen years, a currency crisis, a tech bubble popping, a housing boom and bust and the largest global financial crisis since the Great Depression we have revisited the thematics of this song that suggest a total lack of control.

Here are the lyrics that most remind me of what the economy would sing – if it could – about the current NEED for “stimulus”

There’s nothing I can do to be cool
I don’t sleep till I’ve had my fuel
It frustrates if I’m deprived
A hunger that grates from deep inside
Feel like I’m doing time
Imprisoned by dependence on a rhythm sublime
In my mind I must overcome the need to define
Solitary silence of a faceless crime

Unfortunately the crime isn’t faceless.  This victims – mostly savers – are now looking at the start of the second half of what will most certainly turn out to be a lost decade.  The good news is that addicts can recover.  This takes all kinds of will power and fortitude.  But continuing to do the same thing over and over; well – that’s the definition of insanity.

Much ink has been spilled in the Post-Fed-Head-Fake weeks over whether we will ever be able to end our addiction to the zero or lower bound current construction of interest rates.  As we noted last week it is currently very difficult to disaggregate the space between what a modestly raising rate environment and the potential for a government shut down produced.

That said, a few things seem certain:

  • The simple specter of higher rates – spikes and then contracts – various kinds of economic activity
  • Housing, durable goods (ex the lumpy stuff) and auto are clearly the most effected
  • Markets seem to be unworried about a rise in credit expansion without the concurrent improvement in the underlying employment fundamentals

This week, after a review of the market’s stratospheric exploits, we will take a look at three interesting credit charts from the Federal Reserve.  What we are noticing is a concurringly high correlation in credit expansion and a potentially even more disturbing construction of who owns the debt related to that growth.

Credit growth would be a good thing if we though it was coming in useful parts of the market.  In particular those, which were directly tied to populations that had both, paid down their high levels of pre-crisis debt AND were nearly squared away in secure full-time employment.  The numbers suggest that such a constellation of the world at this time is highly unlikely.

Unfortunately this sets up all kinds of weakness in the system; one that seems all too ripe for an exogenous shock that would put the Fed and the US economy back to square one.  A taper here or there is ultimately necessary to recalibrate a still awkwardly balanced economy; one that is far too dependent on Federal Reserve activity and one that could be lost in the Japanese model for decades if we continue to rely on the current constellation of economic factors.

Markets

I think the nomenclature these days is that stocks “killed it” in the month of October.  Not only were they helped by an end to the three-ring circus otherwise known as the government shut down but they continued to drive YTD performance north of the long-term average by close to 40%.

What’s Japanese for excess?

Funnily enough we continue to note that the true tenor of underlying global economic activity is there for all to see month after month.  The commodity complex simply refuses to suggest that there is anything other than massive deflationary forces at work.  Whether this is a savings glut or a labor glut – we will leave for Dan Alpert and Martin Wolf to decide but suffice for now that until you get sustained wage floors the commodity markets will continue to, as Joan Didion put it, “slouch toward oblivion.”

Revolver

What’s interesting about the Beatles 1966 release, Revolver is that the average length of the tracks is under 3 minutes.  This seems to be the equivalent to US consumer’s ability to worry about their very bloated revolving credit balance sheets. 

 Most punters would have you focus on the chart above to make some kind of half hearted argument about consumers having taken the lessons of the financial crisis to heart.  While we wouldn’t advocate a total return to the pre-innovation world of the 1980s we do think a more moderate trend line in credit growth would suggest a more sustainable path.

Here is the same chart again with a simple trend line inserted.  Such a graph suggests that there continues to be way too much credit (most likely non-performing) in the system.  A move to a lower trend line looks like a decrease of close to 20% of the outstanding balance.

 Now that we’ve painted what we think the trend might be in a more useful universe let’s actually look at the REAL growth in credit that has exploded in the last twelve months.

 The growth of TCC has gone parabolic.  The Pink Floyd-like “Momentary Lapse of Reason” seems to be very much in consumer’s rearview mirrors.  Nowhere do we actually see signs of consumers recalibrating savings rates or consumptive behavior.   In fact, most of the recent conversation around how consumers are better “balanced” has to do with home price appreciation that is also the ghost of false gains from prices rises that have more to do with a total dearth of inventory than any real price appreciation.

And to drive this point home one has to remember what sustains real price gains.

Any one? Buller?

Wages!!!!  and wages seem to be trailing both credit growth and home prices by some margin.  How can credit growth explode when the employment situation continues to warrant exceptionally low levels?  One side of the equation better be terribly is wrong or credit growth better be entirely skewed to the wealthy.  Lest we hear “Uh, Houston, we have a problem.”

Duck Duck Goose

 

The final part of the issue suggests a look at who is currently holding the bag should we not see and improvement and experience some kind of shock.  Oh look!  Just like the general expansion of the Fed’s balance sheet with purchases from Treasury we see they are also holding the bag on consumer loans too!

No wonder they can’t let rates rise…

Final thoughts

For years I have been quite strongly supportive of policies which limit government intervention in the lives of its constitutents while concurrently understanding that communities and countires alike benefit when we agree that there is a base line of acceptable living that we should all be afforded.  Whether that base line comes in the form of direct intervention or the opening up of opportunities is for another post.

My concluding thought here is a caution to people on both ends of the spectrum.

The only person who agrees with you 100% of the time, is most likely you.

It is only when the 100%ers realize this is not a way forward in government we we ssee long term sustainable politics return to the US.  Until then be ready for the extremes to wreak havoc on average once a year.

 

-Lincoln S. Ellis

 

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