Thursday, December 10, 2009

Deadlock! Total Borrowing Has Stabilized at a Mild Contraction Rate as Private Debt Reduction Stops Increasing and Government Borrowing Stays Steady

The latest Federal Reserve Flow of Funds report shows a rough continuation in Q3 2009 of the Q2 trends in borrowing. However, the big news is that it has become clearer that the private sector's negative rate of borrowing has stopped increasing and has stabilized at a level roughly opposite to the government's positive rate of borrowing.

(click on graph for a larger version)

The above chart shows the borrowing rate as a percentage of GDP for government (federal, state and local), the private sector, and the total of the two from 2003 to Q3 2009. Last quarter it was unclear whether the rate of private sector debt reduction would keep increasing or stabilize, and for now it has stabilized (actually a slight decrease, with the trend unclear). The result is that the rate of total borrowing has stayed between -1% and -3% of GDP for the first three quarters of 2009. Some thoughts on the details:
  • Steve Keen often discusses the "debt contribution to demand", i.e., borrowing adds to total demand and reducing debt subtracts from it. This stabilization in the rate of total borrowing (and its associated spending) since Q1 likely is one of the larger factors in the stabilization of GDP in Q2 and Q3 from a state of freefall (see graph on right). But see the following caveat on how this conclusion could be flawed.
  • This data is a somewhat crude proxy for debt's contribution to demand in the sense that some government borrowing (e.g., TARP) goes to propping up balance sheets rather than supporting spending on goods and services and thus incomes. Similarly, private debt contraction is still dominated by the financial sector, the debt of which likely has a less direct correlation to GDP-related spending than does household credit, for example. Perhaps I will try separating these in a later post, but it may not be feasible to do well.
  • One of the reasons why treasuries have no trouble finding buyers (more details in posts here and here) is that in a balance sheet recession, public debt simply fills the "hole" left by disappearing private sector debt.
Will this deadlock hold in future quarters? There are several possible scenarios that I still plan to cover in a separate post. A negative one of non-trivial probability is "double dip" recession with re-accelerating private debt reduction unaccompanied by sufficient public sector borrowing to offset the falling demand and therefore GDP. In another scenario, if the current "deadlock" were to continue as is, there would no longer be the ongoing annual increases in debt that have added to aggregate demand over recent decades (a point often emphasized by Steve Keen). This would imply a much lower level of annual growth in GDP than most expect, and is closer to the Japan outcome than the Great Depression outcome.

Evaluation of these debt trends is complicated by the huge size of both financial sector and Federal government changes in borrowing relative to other sectors:
(click on graph for a larger version)

Mortgage debt and consumer credit are being reduced (these are typically cited symptoms of attempted deleveraging) but they are dwarfed in absolute terms by the debt reduction of the financial sector, at least so far. In relative terms (debt reduction relative to stock of existing debt of that type) the rates are slightly closer: as of Q3 around -9% for the financial sector, -4% for home mortgage debt, and -3% for consumer credit. This chart shows the annualized rates by sector:
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And here is the first chart of borrowing by sector on a longer time line, 1974 to Q3 2009:

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UPDATE: Replaced corporate debt with business debt (a broader category) in two charts.

Thursday, December 3, 2009

Dividends Are Still Trending Worse Than The Great Depression

With S&P 500 earnings reporting mostly (98%) complete for Q3 2009, it's time for an update to the charts from Dividends, Earnings, and Stock Price Trends have Tracked the Great Depression.

The following chart compares the decline in twelve month trailing earnings and dividends since the stock market peaked in October 2007 to the same measures following the stock market peak in September 1929:

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Earnings have dropped more rapidly than during the Great Depression (dramatically so if you count reported rather than operating earnings), but they appear to have begun a recovery much sooner than occurred back then. Trailing 12-month dividends are still falling slightly faster than during the Great Depression, which is particularly remarkable given how much more severe deflation was then compared to now. These trends underscore that contrary to some claims, this is no crisis of confidence!

Since dividend changes tend to lag earnings changes, rising earnings could mean dividends will level out and start increasing soon (and in fact the quarterly fall in dividends from Q2 to Q3 was small). However, if earnings are being over-reported thanks to factors such as relaxed accounting rules or optimistic loan loss assumptions, dividends should ultimately reveal the truth about underlying cash flows.

And while we should all hope that this recovery can be sustained, there is a significant probability (details of which I hope to discuss in a separate post) that this is a temporary upturn in a longer term depression. A renewed fall in GDP, persistent unemployment, and intensifying deflationary pressures would not be good news for any fledgling recovery in earnings and dividends.

Here is a chart comparing the dividend yield today with the Great Depression trend. Yields are much lower today and are trending down again despite the significant upward yield trend back then. So is this a genuine early economic recovery, or a sign that the modern stock market tends to be a capital-gain seeking momentum machine with little regard for underlying fundamentals? Yes, interest rates are low, but they were back then too, and David Rosenberg suggests most current corporate bond yields are a lot more attractive than yields of the same companies' stocks.

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The next chart compares price/earnings ratios earnings during the Great Depression with today using reported earnings. There is no comparison.

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It is clear that the market has accepted Wall Street's encouragement to ignore reported earnings when valuing stocks, so here is the same price/earnings chart using operating earnings (for the recent trend — the measure had not been invented back then):

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The P/E ratio based on operating earnings has soared above 25 just as it did at a later stage during the Great Depression. I just wish I had more confidence that this was the start of an earlier sustainable recovery rather than a sign of the irrationality of markets and reckless myopia.

Note: All of these charts use Robert Shiller's monthly stock data (with a single representative stock price for each month), not daily prices.

Thursday, November 19, 2009

Deflation Watch (October 2009): Price Level Trends Relative to Past Debt Crises

This is another update (with October's data) to the series of posts on US price level trends that started with Price Deflation Today versus the Great Depression and Post-1990 Japan — Comparative Charts (which had data through July). The original post contains the most in depth discussion of the comparisons between the three episodes, so please look at that if you have not already.

I'm posting updated charts as the data is released each month, but for now since time is scarce I will keep the commentary minimal... I will have more to say if and when the current price level trends change more significantly.

October shows a minor increase in price level for many components of the CPI. According to the BLS much of this is energy and auto related, but while disinflation is still apparent when looking at 2009's trend, strong deflation has yet to reappear in any CPI components. The big question is if and when this will change. While I expect it will, time will tell.

These are my definition related comments from a previous post:
As noted previously, "deflation" is often discussed in broader terms than simply price level:
  • Contraction of money and credit (broad money supply)
  • Deflation in asset prices
  • Deflation in a representative "basket" of consumer and producer prices
  • Deflation in wages
The various measures are often somewhat correlated but they only track to each other loosely. In the Great Depression prices fell faster than wages, yet wages (along with asset prices) still fell enough to propagate the adverse feedback loop of debt deflation in which income falls but debt obligations remain at the same nominal level, increasing the burden of the debt. Deflation in asset prices (triggered by the bursting of debt-financed asset bubbles) generally precedes the other deflationary trends.
Some Relevant Current Articles
  • Apartment Rents "Plunge" in the West — The BLS rent measure still seems to lag reality.
  • More on Falling Rents — The rental vacancy rate is at record levels, pressuring rents and ultimately home prices lower.
  • Bill Gross: Fed on hold through 2010Pimco's Bill Gross apparently expects that unless we can sustain 5-6% nominal GDP growth over the coming years (a rate the economy is geared for) then debt deflation is likely to take hold. Unless I am misinterpreting these remarks, this is ominous, as true debt deflation dynamics would likely lead to an economy no one could deny was in depression.
  • What Stinkin' Inflation? PPI Edition — Breaks down the PPI changes in a useful graph. Food and energy increases dominated in October.
As I've alluded to in past posts, commodity prices have seemed far ahead of fundamentals. What's unclear is whether they will keep rising anyway, plunge again like in 2008, grind lower more slowly, or stagnate for years until fundamentals catch up. A crash or decline could feed through violently to CPI changes as in 2008, potentially amplifying other deflationary forces. A sampling of opinions include:
  • Nouriel Roubini, One on One: More Doom and Gloom"Well in commodities, I look at oil prices. They fell from $145 last summer, came down to $30 earlier this year and now they’re back close to $80. But if I look at the fundamentals of demand and supply, demand is down to 2005 levels, supply and inventories are at all-time highs. In my view, the movement in oil prices is not fully justified by the fundamentals."
  • Pig Farmers are Making Brent Nervous — on "pervasive" hoarding of metals by private speculators throughout China.
  • Goldman’s Global Oil Scam Passes the 50 Madoff Mark — On the ability of financial speculation in futures to drive commodity prices (the focus here was on oil).
  • Commodity inflation — James Hamilton asks "Why are the prices of so many commodities rising in an economy that seems to remain quite weak?"

Price Level Charts for October

CPI-U 12 Month Changes, 1999 to Present (US) (source: BLS)

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BLS Summary Comments:
"On a seasonally adjusted basis, the Consumer Price Index for All Urban Consumers (CPI-U) rose 0.3 percent in October, the U.S. Bureau of Labor Statistics reported today. The index has decreased 0.2 percent over the last 12 months on a not seasonally adjusted basis.

The seasonally adjusted all items increase largely reflected advances in the indexes for energy and for new and used motor vehicles. The energy index rose for the fifth time in the last six months, advancing 1.5 percent as the indexes for gasoline, fuel oil, natural gas, and electricity all increased. The index for all items less food and energy rose 0.2 percent in October, the same increase as in September. The indexes for used cars and trucks and for new vehicles both rose sharply and together they accounted for over 90 percent of the increase in the index for all items less food and energy. The indexes for airline fares and medical care also increased, while the shelter index was unchanged and the indexes for apparel and recreation declined.

The food index also increased in October, rising 0.1 percent after declining in two of the previous three months. The index for food away from home increased slightly, while the food at home index was unchanged. Within the food at home group, the index for dairy and related products rose significantly, while the fruits and vegetables index declined for the fourth straight month."
16% Trimmed CPI

This chart of 16% trimmed mean CPI (generated from the Cleveland Fed site) removes the most extreme monthly price changes:

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Consumer Price Index Trends: Great Depression versus Today through October 2009 (US)
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Components of US Consumer Price Index (May 1927 - Dec 1937, Great Depression)

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Components of US Consumer Price Index (Jan 2006 - Oct 2009)
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Annualized 3-Month Rate of Change for Components of US Consumer Price Index (Apr 2006 - Oct 2009)
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The above chart shows the rate of change (over a sliding three month period) of the components whose absolute price levels are shown in the previous chart. I also added the magenta line for shelter (even though it is contained within the yellow housing measure) to better show the effect of declining rents and owners' equivalent rents separated from other housing components such as energy.

Price Index Changes: Great Depression CPI versus Current PPI through October 2009 (US)
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I added "Finished goods less food and energy" starting this month. It shows marked disinflation (and deflation for October, but that could be a blip for now).

Consumer Price Index Trends: 1990s Japan versus US Today (through October 2009) and US Great Depression
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CPI in Japan (Jan 1980 - Jul 2009)

The peak of Japan's CPI occurred in October 1998, almost eight years after the stock market peaked, and Japan's notorious mild deflation has been in effect since then. A multi-year disinflation (of core CPI) leading to sustained mild deflation is one possible outcome for the US.
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Factors Contributing to Deflation

The measures I've been showing here recently haven't changed significantly this month, so I'm going to skip updating them this time. I'll bring them back when there are noteworthy directional changes.

Saturday, November 7, 2009

Global Price Level Trends Show Varied Inflation/Deflation Across Housing Bubble Countries

While looking at US consumer price level trends in prior posts (starting in September), I have pondered the differences between the Great Depression experience in the US of severe deflation and Japan's post-1990 slower-onset milder deflation to assess today's risks. Factors that could in some combination explain this historical difference in severity include:
  1. A greater amount of government stimulus applied by Japan to maintain aggregate demand.
  2. Japan's post-asset-bubble balance sheet recession occurring in the context of a booming global economy, which would support demand for Japan's output via strong exports to the rest of the world, as well as put a floor under commodity prices.
  3. Consumer prices in modern economies potentially much "stickier" than was the case in the 1930s, due to a larger share of complex goods in our typical consumption "basket", plus a large services sector, neither of which seem likely to be dragged down rapidly by falling commodity prices. (Labor prices are are generally not renegotiated daily like commodity prices). If accurate, this could suggest modern economies are less likely to enter the vicious spiral of self-reinforcing deflation.
  4. Larger upward inflationary momentum at the time of the asset bubble burst. In the US, when the stock market and credit bubbles started bursting in 1929, three out of four CPI components were already in mild to moderate deflation. Japan had roughly 3% inflation at the time of the stock market bubble peak and it was almost eight years before the consumer price level peaked.
In gauging the accuracy of the above potential factors and their relevancy to today's crisis, it may be helpful to look at the price level trends of various modern economies that have experienced asset prices bubbles leading up to the 2007-2009 global financial crisis. This post will include graphs for the following countries:
  • the US (for obvious reasons)
  • the UK, Ireland, and Spain (as the three most bubbly major European economies, at least with respect to housing prices)
  • Japan (the world's second largest economy, and of interest to see what happens decades after asset bubbles burst)
  • Australia (as a major commodity exporter that also has a housing bubble, and apparently the only major economy to so far escape a technical recession)
  • the Euro 27 area (the largest aggregation of Euro countries offered by eurostat)
  • Iceland (a bit of an outlier in part due to massive externally denominated debts and different crisis dynamics to date, but of interest for comparison purposes)
I initially attempted to include China's data, but only year over year changes are provided for each month, so there is insufficient data to reverse-engineer back to the raw price level data.

Here is a chart of consumer price level trends for these countries, with all price levels normalized to 100% at July 2008 (which was the peak of the non-seasonally-adjusted US price level):
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Some observations:
  • The US CPI has been the most volatile — the fastest rate of increase leading up to summer 2008 (excepting Iceland), and the most rapid deflation in the second half of 2008. Perhaps this reflects a greater CPI weighting to energy than the other countries.
  • Iceland's price level inflation has been so dramatic relative to other countries that rather than show the full climb (from 87% to 118%), I zoomed in the chart to make the differences between other countries more visible. I'm not sure to what extent this inflation was driven by falling currency exchange rate versus other factors.
  • Spain and Ireland (but especially Ireland) appear to be in the strongest deflationary trend among European countries included here.
  • Spain and Japan have tracked closely to Ireland since mid 2008, but are in 2009 showing a little more price level stabilization than Ireland.
  • The UK and Australia each paused in their price level ascent in the second half of 2008, but their prices have marched higher again in 2009. Probably not coincidentally, both countries have seen housing prices rebound and set new highs (I have read this but not confirmed the data).
The next two charts show the annualized trailing three month inflation rate for each country. The charts are identical other than the Y-axis scale — the second shows the data in full, while the first is zoomed in, excluding most of Iceland's data points, to better see differences in the other inflation rates. Note these are probably extra volatile because many of the data series are not seasonally adjusted.

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Some observations:
  • All the countries except Iceland experienced a dramatic decline in inflation at the end of 2008. Even the least affected, Australia, still had a negative three month annualized inflation rate lasting three months. This is very likely the result of global commodity price declines in the second half of 2008, underscoring that some price level influences truly are global.
  • Iceland's inflation rate soared in early 2008 and has been declining ever since. It is still the highest rate of the countries I've shown, at 8% (July-September 2009, annualized), but has been dis-inflating rapidly from a peak three month annualized rate of around 30%. I have wondered whether at some point Iceland could fall into deflation, since at least a couple years ago its domestic credit levels looked quite high relative to GDP. I don't know what the domestic debt dynamics are currently and perhaps the dynamics of a huge external debt level contribute more substantially to macroeconomic developments.
  • Only Australia has had a three month annualized inflation rate that has climbed consistently through 2009 (September is the latest data). The UK diverges from Australia with its three month inflation rate declining since April 2009 (but it did increase faster at the start of 2009).
  • Excluding Iceland, the most recent data point, September 2009, shows a range from around 4% inflation (three month annualized) in Australia down to around -4% inflation (i.e., deflation) in Ireland.
Concluding Thoughts

This was a very rough high-level look at relative price level trends and short term inflation rates over a sampling of housing bubble countries and other countries of interest (Japan, Iceland). More insights would be likely with additional analysis such as adjusting for exchange rate trends, comparing rates of government deficit spending, comparing changes in private debt levels, etc.

The price level trends across countries show some correlation at times (e.g., late 2008), suggesting global macroeconomic factors matter to some degree, but also diverge significantly at other times (e.g., the current -4% to 8% range of 3-month annualized inflation across countries), suggesting domestic country-specific dynamics are the dominant factors in price level trends, even at times of global recession/crisis.

There are at least three key domestic dynamics that could be most heavily influencing price levels. One is the degree of government stimulus relative to the contraction in private spending. A second is whether private debt bubbles have actually popped or are still growing. A third would be the relative size of these debt bubbles (total debt-to-GDP) and their recent rate of growth (since added debt contributes to annual aggregate demand).

I have not included enough data in this post to evaluate these factors for each country. But at the risk of being wrong, my current assumption is that size of government response is the number one differentiating factor, and some countries are maintaining a stronger private-sector bubble mentality than others (e.g., with respect to Australia's housing prices). If government stimulus proves politically unsustainable, or private sector debt bubbles collapse and prove to be overpowering, it could be that countries like Australia will simply lag countries like Ireland with respect to consumer price deflation. Ireland may be the country to watch — I've seen suggested that it may have begun a full scale debt deflation.

Endnotes

Note that different countries construct their CPI measures differently, so some trend differences likely reflect what each country considers a representative "basket" of goods and services. Also the US, UK, Ireland, Spain, Iceland, and Euro 27 price levels are not seasonally adjusted. I think the data I found for Japan's and Australia's are seasonally adjusted, but I am not certain.

The reason I like looking at absolute price level trends right now rather than just rate of change (typically year-over-year) is that when price levels are not moving in a single direction (until the recent deflationary trends, the direction of CPI indexes was primarily up), then the year over year change only incorporates two data points at a time, and is therefore especially volatile and doesn't reveal the big picture as well.

Tuesday, October 20, 2009

Deflation Watch (September): Price Level Trends Relative to Past Debt Crises

This post updates the charts from Price Deflation Today versus the Great Depression and Post-1990 Japan — Comparative Charts (which had data through July) and the August data update with the data for September. The original post contains the most in depth discussion of the comparisons between the three episodes, so please look at that if you have not already. My current plan is to update this post each month after PPI and CPI data is released as long as the comparisons remain interesting.

These are my definition related comments from the previous post:
As noted previously, "deflation" is often discussed in broader terms than simply price level:
  • Contraction of money and credit (broad money supply)
  • Deflation in asset prices
  • Deflation in a representative "basket" of consumer and producer prices
  • Deflation in wages
The various measures are often somewhat correlated but they only track to each other loosely. In the Great Depression prices fell faster than wages, yet wages (along with asset prices) still fell enough to propagate the adverse feedback loop of debt deflation in which income falls but debt obligations remain at the same nominal level, increasing the burden of the debt. Deflation in asset prices (triggered by the bursting of debt-financed asset bubbles) generally precedes the other deflationary trends.
Some Relevant Current Articles

In BLS Owner's Equivalent Rent Numbers From Twilight Zone, Mish looks at the surprisingly small decline so far in rent and owners-equivalent-rent measures:
"With home prices crashing year-over-year and both housing rents and apartment rents dropping as well one might think that falling rents would be reflected in the CPI."
Mish subsequently looks at the September CPI data in Year-Over-Year CPI Negative 7th Consecutive Month; Rents Decline First Time In 17 Years.

While many have expected falling rents and their eventual impact on reported CPI, Calculated Risk has been bringing the topic up more recently, for example, here:
"Anyone analyzing the tax credit should call the economists at the BLS and ask about how falling rents will impact owners' equivalent rent and CPI. Then call the economists at the Federal Reserve and ask how CPI deflation will impact consumer behavior and monetary policy. Welcome to the Fed's nightmare."
The BLS methodology for calculating owners' equivalent rent (weighted at 23.8% of the entire CPI!) is to survey homeowner households. Given people's likely lack of close knowledge of the current rental market, lack of objective perspective of their own home's rental value, and lag effects of changing home prices, rents and perceptions, it is no wonder that the BLS measure has not fallen at the rate anecdotal experience suggests it should have. The BLS says on its guide to Consumer Price Indexes for Rent and Rental Equivalence:
"However, the expenditure weight in the CPI for rental equivalence is obtained by directly asking sampled owner households the following question: If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?"
In China’s September data suggest that the long-term overcapacity problem is only intensifying, China expert Michael Pettis discusses (among other topics) the level of China's commodity imports. He quotes someone else regarding China: "the recent pace of commodity import growth has been much faster than justified by the rise in current demand." Pettis then says:
"It seems that there may be another explanation, and that is stockpiling by private investors. From what I am being told, it seems that a number of wealthy Chinese investors have been speculating directly in commodities, and so some of this inventory buildup is occurring not at the company level but at the investor level."
The potential for a sharp drop in commodity imports by China (if this inventory build is accurate and if it turns out to not be sustainable and if real demand doesn't catch up quickly) is one of the reasons, even if the odds could be small, that I believe there could at some point be another commodity price "crash" similar to the second half of 2008. Those are a lot of "if"s, and they are not the only factors involved. But if commodity prices crashed in the context of other CPI components already in mild decline (food and shelter in particular have moved in this direction recently), then unlike in 2008 in which inflation in many CPI components was still high, the conditions would be more similar to the starting conditions of the self-reinforcing deflationary spiral during the Great Depression. To recap the 1930s experience, look at the Great Depression CPI Components chart later in this post (and past posts) — in 1929, before CPI started dropping rapidly, only food prices were in a rising trend — everything else was already declining.

In The September CPI with all the trimmings, Macroblog at the Federal Reserve Bank of Atlanta discusses whether the recent CPI changes really show "broad based" increases, and concludes:
"An interpretation of these data is that the September CPI increase was anything but broad-based. Moreover, the data seem consistent with the idea that prices overall are on a path of disinflation."
I'll start including a trimmed CPI chart with the others (below).

Price Level Charts for September

CPI-U 12 Month Changes, 1999 to Present (US) (source)

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BLS Summary Comments:
"On a seasonally adjusted basis, the Consumer Price Index for All Urban Consumers (CPI-U) rose 0.2 percent in September, the Bureau of Labor Statistics reported today. The increase was less than the 0.4 percent rise in August. The index has decreased 1.3 percent over the last 12 months on a not seasonally adjusted basis.

The seasonally adjusted increase in the all items index was broad based, although tempered by a decline in the food index. The all items less food and energy index increased 0.2 percent in September after increasing 0.1 percent in each of the previous two months. Contributing to this increase were advances in the indexes for lodging away from home, medical care, new vehicles, used cars and trucks, and public transportation. The increase occurred despite declines in the indexes for rent and owners’ equivalent rent, the first decreases in those indexes since 1992. The energy index also increased in September, as increases in the indexes for gasoline, fuel oil and electricity more than offset a decline in the index for natural gas.

In contrast to these increases, the food index declined, falling for the sixth time in the last eight months. The index for food away from home increased, but the food at home index declined as the indexes for fruits and vegetables and for meats, poultry, fish and eggs fell sharply. Both the food and energy indexes have declined over the past 12 months. The decline in the food index is the first 12-month decrease in that index in over 40 years."
16% Trimmed CPI

This chart of 16% trimmed mean CPI (generated from the Cleveland Fed site) removes the most extreme monthly price changes, and it shows a rapid disinflation in progress (with the year over year rate of increase down to 1% so far, versus 1.5% for the core CPI), though the rate has recently slowed:

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Consumer Price Index Trends: Great Depression versus Today through September 2009 (US)
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Components of US Consumer Price Index (May 1927 - Dec 1937, Great Depression)

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Components of US Consumer Price Index (Jan 2006 - Sep 2009)
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Annualized 3-Month Rate of Change for Components of US Consumer Price Index (Apr 2006 - Sep 2009)
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The annualized 3-month rate of change chart is new for this month. Despite being cluttered with too many lines (sorry), it does give a better sense for the rate of change of the components whose absolute price levels are shown in the previous chart. Most components are flat or down as of the three month last period. I also added the magenta line for shelter (even though it is contained within the yellow housing measure) to better show the effect of declining rents and owners' equivalent rents separated from other housing components such as energy. Shelter has been in a remarkably consistent disinflation and has just turned negative.

Price Index Changes: Great Depression CPI versus Current PPI through September 2009 (US)
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Consumer Price Index Trends: 1990s Japan versus US Today (through September 2009) and US Great Depression
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CPI in Japan (Jan 1980 - Jul 2009)

The peak of Japan's CPI occurred in October 1998, almost eight years after the stock market peaked, and Japan's notorious mild deflation has been in effect since then. A multi-year disinflation (of core CPI) leading to sustained mild deflation is one possible outcome for the US.
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Factors Contributing to Deflation

This is a partial selection of measurable forces that contribute toward price deflation, though the core cause is the bursting of debt-financed asset price bubbles. Not all of these measures are in an outright deflationary trend, but most are suggesting at least disinflation. This data is US-specific, but US price levels will also be affected by global trends in the months and years ahead, for example with respect to whether China and other emerging economies falter meaningfully in their growth. I have kept the same set of charts even though same data updates are quarterly not monthly and as such some charts are the same as last time. No commentary on these for now — perhaps in the future.

Capacity Utilization (through Sep 2009)
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Inventory to Sales Ratio (through Aug 2009)
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Gross Domestic Purchases (through Q2 2009)
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Total Consumer Credit (through Aug 2009)
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Total Bank Credit (through Oct 7th 2009)
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Total Borrowing (All Debt Markets) (through Q2 2009)
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(source)

Broad Money Supply (through Oct 5th 2009)
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Disposable Personal Income (through Aug 2009)
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Employment Cost Index (through Q2 2009)
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(source)

Unemployment (through Aug 2009)
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(source)

Household Debt Service (through Q2 2009)
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Household Financial Obligations (through Q2 2009)
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Household Wealth (through Q2 2009)
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Source: Calculated Risk

Personal Savings Rate (through Aug 2009)
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Tuesday, September 22, 2009

The Mystery of Japan's Private Debt Levels (Solved?)

For the last couple years there has been a lot of discussion of how the macroeconomic situation in the US compares to past historical episodes. Unfortunately the discussion of debt levels has relied mostly on anecdotal data, other than the one well covered comparison of the US today with the US at the time of the Great Depression (see for example Steve Keen's charts here). I'm among those who view post-1990 Japan as a highly relevant additional example. A few months ago I finally found what I hope is reliable debt data for Japan. I'll present charts of the data first but please read the sourcing methodology further down as it's possible this method of measuring of Japanese debt may not be an apples-to-apples comparison with the US Federal Reserve's debt data (please give feedback if you have it, and I will update the post).

Japan's Private Sector Debt From 1980 to 2007

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The above chart shows the total debt in yen for Japan's household, corporate, financial, and government sectors from 1980 to 2007 (the latest available). Private sector debt actually kept rising (much more slowly) after 1990, peaking around 1997! Government debt also rose significantly during this time period. This large expansion of total debt likely contributed to the continued growth in GDP until 1997, seen here:

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The next chart shows the debt-to-GDP ratios since 1980 — i.e., factoring in the impact of economic growth (as measured by GDP) reducing the debt burden relative to incomes. By this measure, total private debt-to-GDP did peak around 1990 when stock and real estate bubbles were bursting.

(click on chart for a larger version in a new window)

This suggests that in the context of a booming global export market and by continuing to increase its debt, Japan was able to keep growing for years after its asset bubbles burst. Interestingly the 1997-1998 time-frame is also when Japan's consumer price levels peaked (see chart here). Confirming anecdotal experience, the corporate sector was highly leveraged (much more so than the household sector), and did work on reducing debt but most notably so after 1997.

But the most striking insight this data yields is that Japan's economy from 1990 until 2005 did not deleverage on aggregate, due to the government increasing debt faster than the private sector was reducing debt, and that the private sector has only reduced debt from 386% of GDP (1990) to 328% of GDP (2007)! This government borrowing most likely explains why Japan did not experience a depression (and is somewhat consistent with the views of Richard Koo, who I have discussed before). But it reinforces the question of what the end-game is for Japan and whether it will ever be able to grow out of or pay down its massive total debt.

Note that I have seen and used in the past a couple other charts of Japan's debt-to-GDP ratios that disagreed with each other and with this data, for example this one: [UPDATE Jan 18 2010: I now believe the below chart is WRONG, see the end of this post]

I played with the Japanese Cabinet Office data I obtained for this post by excluding loan-based debt, excluding non-loan debt, excluding financial sector debt, etc and no matter what combination I tried I was unable to generate a chart that looked like this one. So one of the charts is probably wrong and it could be mine.

This article by Andy Xie, What We Can Learn as Japan's Economy Sinks, is very worthwhile reading on Japan's crisis and more (though there are a few things I'm not sure I agree with). The debt levels he cites for Japan differ a bit from what I derived, for example, he says "total indebtedness of Japan's non-financial sector is 443 percent -- probably the highest in the world, and far higher than the 240 percent in the United States."

Comparison with the US debt-to-GDP ratios around 2007

The following chart shows the rise in US debt-to-GDP levels by sector that many people have seen before:

(click on chart for a larger version in a new window)

It is color coded to match the colors of the Japanese debt chart's sectors for easier comparison. In the US, households carry substantially higher debt than they did in Japan. Here is a comparison of the debt-to-GDP ratios by sector at the start of each crisis (Japan around 1990, the US around 2007, plus also the US around 1929 at the onset of the Great Depression):

(click on chart for a larger version in a new window)

Household debt was much higher in the US in 2007 than past episodes, but Japan had much higher corporate debt and somewhat higher financial sector debt. Government debt was fairly comparable. The chart's debt-to-GDP numbers are in this table.













US 2007US 1929Japan 1990
Household98%37%62%
Corporate75%98%149%
Financial115%22%169%
Private Sector Total288%157%386%
Government52%29%62%
Foreign14%

Total355%185%447%
Total Excluding Financials240%163%278%

In one respect this is a mildly optimistic outcome in relative terms — contrary to past claims (by me included), Japan's debt crisis is not dwarfed by the current US debt crisis. Depending on the US's political willingness to provide ongoing fiscal stimulus as Japan did, my opinion is this makes the Japanese style stagnation and mild deflation relatively more likely in the US, as opposed to a deep depression — though employment and GDP have already fallen more than they ever did in Japan (at least until this global crisis hit). Of course, total debt-to-GDP is not the only macroeconomic determinant that matters, so other factors could drive the US today to a different outcome.
  • Substantially higher household debt, especially with non-recourse mortgages standard in the US, could be a much more negative factor relative to Japan. There are far more distressed household balance sheets than corporate ones given the relative number of entities in each sector, so this could increase the system's susceptibility to full-blown debt deflation, especially given that households have less incentive to "extend and pretend" by faking solvency through relaxed accounting rules than corporations do.
  • The global context today is that most nations in the world have been involved in this crisis, many of them with high debt levels of their own. This probably explains in part why the current crisis has been deeper than Japan's post-1990, but the question remains whether this crisis is winding down or whether deflation will intensify and cause even deeper economic pain in the years ahead. With deleveraging barely having begun, there is strong reason to believe that we have years of adjustment still ahead.
  • Other differences in financial markets today such as the huge global derivatives market and associated counterparty risks could be relevant.
Many people summarize the options for removing excessive debt as inflate or default. While the long term result is uncertain, Japan has been carving a third option for nearly the last two decades — reduce nominal interest rates to very low levels to reduce the debt servicing burden while leaving the debt in place in an attempt to grow out of it, even if doing so is accompanied by economic stagnation. Note that this approach does not seem to cure insolvency, except perhaps through the long and slow process of using earnings for balance sheet repair. No doubt demographics are different in Japan compared to other countries and this has some impact, but the US and Europe are also increasingly facing aging populations.

Methodology for Obtaining Japan's Debt Data

I derived the data from selected balance sheet liabilities within the aggregate national accounts stock data provided by the "Economic and Social Research Institute (ESRI), Cabinet Office, Government of Japan." See "Part 2 Stock" under the heading "Accounts classified by Institutional Sectors". The super-set of liabilities listed across households, non-financial corporations, financial corporations, and general government are (the bolded ones are what I used):
  • Currency and deposits
  • Loans
  • Securities other than shares
  • Shares and other equities
  • --> Of which shares
  • Financial derivatives
  • Insurance and pension reserves
  • Other liabilities
Loans are clearly one kind of debt. It seems likely that securities other than shares are a good proxy for all other debt (e.g., bonds). Is this incorrect? This OECD definition of "securities other than shares" is:
"Securities other than shares consist of bills, bonds, certificates of deposit, commercial paper, debentures, and similar instruments normally traded in the financial markets."
The Federal Reserve Flow of Funds guide defines debt as follows:
"Credit market borrowing or lending is defined here as the transfer of funds through certain financial instruments: open market paper, Treasury and agency securities, municipal securities, corporate and foreign bonds, bank loans not elsewhere classified, other loans and advances (such as loans made under various federal programs), mortgages, and consumer credit. Excluded from the definition are a number of other items that are also sources and uses of funds for the sectors — official reserves, special drawing rights certificates, Treasury currency, deposits and interbank items, security repurchase agreements, corporate equities, mutual fund and money market mutual fund shares, trade credit, security credit, life insurance and pension fund reserves, business taxes payable, investment in bank personal trusts, proprietors’ equity in noncorporate business, and miscellaneous items; a sector’s credit market borrowing is thus not the same as the increase in its total liabilities."
It seems quite possible, especially for the financial sector, that the "securities other than shares" contain types of debt that are excluded from the US debt measures (for example, perhaps certificates of deposit). PLEASE TELL ME IF YOU KNOW WHETHER THESE MEASURES ARE COMPARABLE.

I did compare this data to a few individual data points I was able to find on Japan's sector-specific debt levels around 1990, and this data appears to be in line with those data points. The main unconfirmed data is Japan's financial sector for which I have found no other data points to compare.

Another Pre-Crisis Comparison: Sweden

The Swedish government's response to their early 1990s crisis has often been held up as a model for what the US should do, so it would be valuable to have an idea of the relative size of their crisis as well. As I summarized in an earlier post, the data points I've found for Sweden around 1990 so far are:
  • 170% total debt-to-GDP
  • 127% private sector debt-to-GDP (source)
  • 43% government debt-to-GDP (source)
It's not clear whether the private sector measure includes the financial sector, but if it does, Sweden's debt levels were much smaller than Japan's in 1990 or the US in 2007. However, they were more comparable to the US at the start of the Great Depression. Yet like Japan, Sweden was able to grow exports to a booming global economy in the 1990s. So while the absolute debt-to-GDP measure is central, I don't believe it is the only important macroeconomic determinant.

UPDATE 10/14/2009: I added a foreign debt row to the table of debt-to-GDP numbers (a commenter pointed out the numbers do not sum otherwise, so I probably shouldn't have skipped it in the first place).

UPDATE 10/14/2009: After originally posting, I did seek input on the derivation of this Japan debt data from a highly financially-savvy blogger, and he replied that "yes" it was comparable to the US data (though I can't guarantee he looked at it in detail).

UPDATE 1/18/2010: McKinsey has released a study on deleveraging that seems to validate my findings here. The only difference is that their numbers for Japan's financial sector are consistently around 50% of GDP less than what I found (perhaps reflecting exclusion of some specific bank liability such as certificates of deposit?). But the overall shape of the trends do match, most notably that public debt expansion has exceeded private debt reduction. Here is one of their charts: