Wednesday, April 21, 2010

US Credit Market Debt Analysis -- 1


In  earlier posts I suggested that the industrial world has entered a period where consistently exceeding a real GDP CAGR of about 2% will be very difficult.

The reasons for this malaise in the industrial world, I believe, are threefold:
  • The GDP growth rate has been slowing for several decades and that trend is now approaching 2% CAGR.
  • A very heavy current debt burden in almost all industrial countries which hinders future GDP growth
  • The increasing difficulty (costs) of acquiring the natural resources on which our industrial civilization depends
This post will focus on US debt.

Fig 1 below says that US citizens ended calendar 2009 owing about $52 trillion to each other and to foreigners.  What does that mean?


Figure 1 US Credit Market Debt by Sector
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US Debt

Total US "Credit Market Debt" is the total US debt published by the US Federal Reserve System in the "Flow of Funds" report.   The simplest description of this debt is that if we add up all the debt owed by every US citizen, business, household, bank, state and the US Federal government, recorded in the financial accounts of the United States at the end of 2009, it would total approximately $52 Trillion.  The "creditors" or "owners" of this debt, are Americans and foreigners.  Theoretically the "money" available to be lent out, which created these loans came from:
  1. The real money savings from individual Americans and foreigners
  2. The profits of American and foreign businesses and banks
  3. The creation of "debt money" by banks by the magic of the fractional reserve banking system.
In fact almost all of it comes from item 3.  When banks cease to lend, (essentially create debts out of thin air) for any reason at all, business immediately stops, and the world stops.  Hence the stark terror of the Secretary of the Treasury in 2008 as the banks froze and new loans (borrowing) by banks to themselves and other business came to a screeching halt.  Hence the purchasing of "junk bank loans" by the Federal Reserve to free up bank reserves to allow more bank debt creation (loans).

The drama of those days can be seen in Figure 8 (below) which records the borrowing (change in debt level) during the last two decades.


The Flow of Funds report is part of a three part accounting system which records and reconciles the financial accounts internal to the US, and internal US accounts with the financial accounts of the rest of the world.  The other two systems are the National Income and Product Accounts (NIPA) and the Balance of Payments Accounts.
At the end of 2009, US Credit Market Debt totaled approximately $52 trillion.  Figure 1 above shows the history of Total US Credit Market Debt and the debt by sector at the end of each year since 1975.

In particular Figure 1 shows:
  • The Obama FY 2011 Budget projection for GDP and Federal debt through 2015.  In 2015 the Budget projects a GDP of about 20 trillion and a Federal debt of about $14 trillion.
  • GDP (about $14 trillion at the end of 2009)
  • Total non financial sector debt including all government debt (about $35 trillion at the end of 2009)
  • Total financial sector debt (about $15 trillion at the end of 2009)
  • State and Federal debt (about $10 trillion at the end of 2009 -- included in nonfinancial sector)
  • Federal Debt only (about $8 trillion at the end of 2009 -- included in "nonfianacial sector)
  • Debt owed to foreigners ( about $2 trillion)
  • Total Debt consists of the non financial sector plus the financial sector plus the foreign sector (35+15+2 = 52)
Fig 2 is perhaps a little more enlightening -- it shows similar debt data as ratios to GDP.  Here too I have shown the projected Federal Government Debt through 2015.  I have also shown the "Household debt" and "Business debt", components of the "non financial sector" as separate items.  Note that the only debt segment to increase in 2009, as a ratio to GDP, is the "Federal Government" debt component.

Various Debt/GDP ratio charts going all the way back to the early 20th century show that the the Debt/GDP ratio has never exceeded about 260% -- it is now in excess of 350% and will certainly continue increasing in the near term.

 Figure 2:  US Credit Market Debt as ratio to GDP
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As I noted here, there is a significant and unknown amount of debt exposure in the US and the world to "off balance sheet" debt items.  I have estimated an exposure of about $5-10 trillion, for which I have no justification, but I needed to use a number.  Below is the most recent chart from the US Comptroller of the Currency (h/t Jesse Cafe Americain) showing the exposure of insured US banks to derivatives.   Some percentage of this $200 trillion will become "debt" and will have to be paid. 
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In addition to these monumental derivatives numbers, there are numerous SIV's (a la Enron) with off balance sheet potential debts for which I have no data, and neither does any one else, so I am completely ignoring them.

From this point on, unless I specifically say so, I will use debt data solely from the Flow of Funds report, recognizing (mentally) that this is not the whole story. As in the rest of this blog, I am using GDP as a proxy for consumption.
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Analyzing US Debt

 Figure 4 Debt by Major Sector
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 Figure 5 Debt by Domestic Nonfinancial Sector Component
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Figure 4 shows the relative size, actual values and % share of the three major debt sectors which comprise the Flow of Funds Credit Market Debt report.   Figure 5 does the same for the largest sector -- the non financial domestic sector.

Note:  In many future analyses I will ignore this item "Debt owed to foreigners" -- it is a small "rounding item" (less than 5% of the total debt) and will remain so.  The term "Debt owed to foreigners" is correct but misleading.  In fact the US owes much more than $2 Trillion to "foreigners" but those debts are shown in other categories -- for instance as loans to the US Government in the form of Treasuries.
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Details of US Debt


Figure 6 and Figure 7 below shows the history of US debt outstanding at the end of every year for the two major sectors in $ and in % of GDP.  Note particularly (figure 7) the rise in financial sector debt from less than 20% of GDP in the early 1980's to more than 100% in 2008 -- a rise of about a factor of four in its effect on GDP.  In the same period the nonfinancial sector debt rose from about 140% of GDP to about 240% of GDP -- less than double its effect on GDP. 


Figure 6:  Domestic Financial and Nonfinancial Debt in $
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Figure 7:  US Total Debt, Financial and Nonfinancial Debt as % of GDP.

I have shown (in Figure 8) the credit market borrowing every year (change in debt level) for the last two decades by the main sectors and components.  The chart dramatizes the major change in credit activities in 2008 and 2009.

Figure 8 also includes the budget projection for borrowing by the Federal Government through 2015, from the FY 2011 Budget.  The budget projects running about a $1.5 trillion deficit in 2010, dropping to just under a $1 trillion/year thru 2015.  This is the "deficit spending" mentioned by news commentators and economists.

Figure 8  Annual Total Credit Market borrowing and borrowing by sector and component
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Note particularly the massive decreases in the financial sector and business component borrowing and the increase in Federal Government borrowing in 2009.

These charts do not show the effect of the various Federal Reserve monetary "tricks" (eg "Quantitave Easing") used in 2008 and 2009 to save investment banks from imploding.

The effects of fiscal stimulus spending (pumping money directly into the system by more government spending and lower taxes) show up in Federal government spending, business recovery and job creation every year as they occur.  The effects of  current Federal Reserve monetary actions (very low interest rates, purchasing Treasuries, purchasing junk loans) to counter recessions, are more opaque.  They tend to show up in future Federal Government and business debt and inflation numbers.  Unlike taxes and expenditures which are controlled directly by Congress, the details of Federal Reserve activities are generally hidden from the electorate and Congress.

Sector Debt as a % of GDP

I will end this post with a chart of the history of the major debt sectors as a % of  GDP.  The next time I post on this subject I will concentrate on the Federal debt (sovereign debt) and the components of the "Financial Sector" debt we as a people have guaranteed, or likely to guarantee, but which have not yet shown up in the debt ascribed to the Federal government. 


Note that the current projected Federal Debt gets to nearly 80% of GDP in 2015.  This is hugely optimistic and misleading.  It is likely that Federal Debt, honestly calculated, is already at about !00% of GDP.

Various papers by well known economists seem to say (softly) that "Sovereign Debt" above about 80% of GDP is a danger point above which resilience to economic shocks falls off rapidly.    

Note: 
By Jay Heflin - 04/20/10 11:30 AM ET
The government so far has spent $3 trillion to stem the financial crisis, said Neil Barofsky, the Special Inspector General for the TARP.
"It's about $3 trillion -- all in, with all the various programs and support [for] the financial industry," Barofsky told lawmakers participating in a Senate Finance hearing on the bank tax.
The figure will be updated in Treasury's quarterly report due out in July and will include all payments made by all government entities.

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