Thursday, September 17, 2009

Total Borrowing Continues Contracting in Q2

The Q2 2009 Federal Reserve Flow of Funds (Z.1) report shows a continuation of the Q1 trend — total borrowing in all US debt markets is contracting at an annualized rate equivalent to 2.1% of GDP. Government borrowing is falling slightly short of offsetting private sector deleveraging in Q2:
  • Government adding debt at a $2082 billion annualized rate
  • Private sector reducing debt at a $2515 billion annualized rate (household sector: -$233 billion, corporate sector: -$203 billion, financial sector: -$2079 billion)
  • Foreign sector adding debt at a $192 billion annualized rate
As I've stated before, I think this is the number one reason (among other reasons) why the huge supply of government debt is able to find buyers. Treasuries are simply filling a "hole" left by disappearing private sector debt! (i.e., on aggregate, previous holders of those debt assets will look for replacements, and treasuries are what is available.)

US Total Borrowing by Sector (Quarterly 2003 - 2009/Q2) Relative to GDP

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

The rate of private sector deleveraging (yellow line) is still increasing as of Q2. The rate of government borrowing (red line) has been mostly flat since Q3 2008, with a dip in Q1 2009. If these two trends continue, total borrowing may begin to contract more significantly, with potentially more noticeable macroeconomic impacts (for example, deflation).

US Change in Debt By Sector (Quarterly 2003 - 2009/Q2)

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

This chart shows the quarterly change in debt for each sector, i.e., borrowing relative to existing debt for that sector rather than relative to GDP. Since government debt is much smaller than private debt, it clearly is growing at a much larger rate in these terms. Also of note is that the private sector is deleveraging at a 6.6% annualized rate, which leaves a lot of room for further private sector debt reduction.

US Total Borrowing By Sector (1974 - 2009/Q2) Relative to GDP

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This chart shows the same data on a longer time-line — annual data since 1974.

US Borrowing by Sector Excluding Bank Credit (1974 - 2009/Q2) Relative to GDP

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

This chart again shows the longer term borrowing trend but with changes in bank credit (TOTBKCR) subtracted from total borrowing and private sector borrowing. In other words, it captures the borrowing enabled by non-bank lending (such as bond issuance). While the data isn't very useful for most of the years shown (since expanding bank lending increases the money supply and amplifies the non-bank lending that can occur), the point of this chart is to show that the recent contraction in total borrowing is not about contraction in bank loans alone.

UPDATE: I have focused on total debt including the financial sector in part as context for addressing the eternally asked question of why government debt finds enough buyers, however total non-financial borrowing may have more relevance to the health of the economy due to a higher correlation (maybe?) with consumption markets rather than asset markets. By this measure, we are not deleveraging in aggregate because of current government spending, as the Z1 report makes clear:
"Debt of the domestic nonfinancial sectors is estimated to have expanded at a seasonally adjusted annual rate of 5 percent in the second quarter of 2009, about ¾ percentage point faster than in the previous quarter. Private debt contracted in the second quarter while government debt expanded."


  1. Regarding Treasuries... I remember reading a report from the Heritage Foundation that argued that boomers selling their assets wouldn't cause a decline in the equity markets. Of course, if the reasoning in the report is correct, then their arguments can be used to support lower interest rates for years as it doesn't seem likely that the boomers would sell their fixed income assets. I do not buy the thesis of higher interest rates caused by a dollar collpase. I do not think the US will turn out like Mexico in the mid 90s with 18% short-term tesobonos.

    What do you think the "fair-value" is on stocks now? My own assumptions include low real interest rates (bullish), low inflation (if at all) (bullish), demographic decline i.e aging population and little immigration (bearish), and stagnant wages and employment (bearish-neutral), no earnings growth (bearish). The current can only be justified if wages and unemployment remain relatively stagnant. The S&P 500 index is not overvalued as lower interest rates can justify higher multples, but I do expect the index to have a "positive carry" compared to the 10 year bond. I do expect dividend yields to be higher than the 10 year Treasury.

    Do you have the capital structure of the aggregrate S&P 500 (excluding financials)? What is their debt to equity ratio?

    But, I am not uber bearish on equities anymore unless one gets a very pronounced wage/price spiral (in reverse) ... I do like the risk/reward on long dollar though instead of short equities.

  2. While that report on boomers likely raises some valid points, I see flaws too (I only skimmed an overview). Demographics do matter, and a balance sheet recession overturns a lot of tradition notions about what people do and don't do.

    I have no idea what fair value on stocks is as I'm mostly interested in the macroeconomics angle on things and don't analyze markets closely. David Rosenberg suggests the 850-ish range and his reasoning is usually strong. But the market doesn't always care about fundamentals! I still see little potential for big upside in the medium term of several years (i.e., either flat or down) for many of the reasons you give. Also dividend yield on S&P500 is around 2% (and could keep falling) versus 3.5% for 10 year treasuries! Stocks have a lot of growth priced in...