Q42012 FLOW OF FUNDS / PRUDENTBEAR.COM

Q4 2012 Flow of Funds

by Doug Noland

March 08, 2013



For years, I would anxiously await the opportunity to sift through each new voluminous quarterly Z.1 “flow of funds” report. On a quarterly basis, the Federal Reserve’s Credit data illuminated the evolving U.S. Bubble – with each report reliably offering additional clues and Credit insight. The past few years analyses have been somewhat boring to write and, surely, painful to read. More recently, however, the data have again turned more interesting. As you read through this analysis, please keep in mind the Fed’s decision to increase quantitative easing to $85bn monthly beginning this past January.


For Q4 2012, Total Non-Financial Credit expanded at a 6.4% rate, the strongest expansion since Q3 2008 (7.0%). Total Household Borrowings expanded 2.4% annualized, the briskest pace going back to Q1 2008 (3.6%). Household Mortgage Credit contracted 0.8% annualized, the smallest pace of decline since Q1 2009 (positive 0.2%). Corporate borrowings grew at a blistering 10.7% pace, the quickest since Q4 2007 (11.5%). Federal debt expanded at an 11.2% rate during the quarter. In nominal dollar terms - seasonally-adjusted and annualized (SAAR) - Q4 Total Non-Financial Credit expanded $2.536 TN. Looking at the main categories, Total Household debt increased SAAR $312bn, Total Business SAAR $1.076 TN, and Federal Government SAAR $1.259 TN. Credit expansion has become increasingly broad-based.


For full-year 2012, Total Non-Financial Debt (NFD) expanded $1.848 TN, up from 2011’s $1.351 TN to the strongest pace since 2008. For comparison, NFD increased $1.457 TN in 2010, $1.078 TN in ‘09, $1.907 TN in ’08, $2.552 TN in ‘07, $2.387 TN in ‘06, and $2.343 TN in ’05 (nineties avg. $715bn). For the year, Household debt growth turned positive for the first time since 2007, with the strongest (non-mortgage) Consumer Credit growth ($154bn) since 2000 just offsetting the continued contraction in Mortgage borrowings. Total Business Credit expanded $687bn, up from 2011’s $546bn for the strongest expansion since 2007’s booming $1.316 TN (business Credit expanded $163bn in 2010, after contracting $245bn in ’09). The growth in Federal government market debt increased to $1.140 TN, up from 2011’s $1.068 TN – for the fifth straight year of Trillion-plus deficits.


I’ll briefly interrupt Q4 2012 “flow of funds” analysis in order to update data for the deleveraging vs. leveraging “debate.” The fourth quarter’s $655bn expansion pushed Total Non-Financial Debt (NFD) above $40 TN ($40.099 TN) for the first time. In the past four years, NFD has increased $5.620 TN, or 16.3%. As a percentage of GDP, NFD ended 2012 at a record 253%, up from 232% to end 2007 and 240% to conclude 2008. It is worth noting that Household liabilities contracted $663bn over the past four years, while Federal debt expanded $5.580 TN.


Total (non-financial and financial) system Credit ended 2012 at a record $56.281 TN (355% of GDP). Total system debt growth has been somewhat restrained by the four-year $3.261 TN drop in Financial Sector debt obligations to $13.852 TN (low since 2006). As I have tried to explain in previous CBBs, the contraction in U.S. Financial Sector Credit market borrowings has been chiefly due to the shift of assets onto the Fed’s balance sheet coupled with the significantly reduced intermediation requirements for government debt when compared to mortgage Credit (no need for the financial sector to securitize/intermediate Treasury bills, notes and bonds!). Especially after 2012’s strong Credit expansion, the deleveraging thesis has become even more flimsy.


Much of “deleveraging” analyses focuses on the decline in household debt. In aggregate, total Household Liabilities contracted $663bn, or 4.7% during the past four years to $13.453 TN (worth noting liabilities ended 2000 at $7.353TN). Meanwhile, fueled by a remarkable accumulation and price inflation in financial asset holdings, Total Household Assets surged $11.764 TN, or 17.4%, in four years to a record $79.525 TN (up 57% since 2000). Over four years, Household Net Worth (assets minus liabilities) jumped $12.428 TN, or 23.2%. Notably, Household Net Worth surged $5.464 TN, or 9.0%, during 2012, surely helping to explain the ongoing vigor in household consumption. As a percentage of GDP, Household Net Worth jumped to 421%, down from the 2006’s real estate Bubble spike to 490% but still significantly above the 385% average for the period 1985-2003.


Along with quite strong inflation in Net Worth, the aggregate Household Sector continues to enjoy respectable income gains. Fourth quarter Compensation was up 3.9% y-o-y (strongest gain in 6 quarters) to a record $8.662 TN. Total National Income was up 3.3% y-o-y for the quarter to a record $13.995 TN. Compensation increased 3.3% in 2012, somewhat less than 2011’s 4.1% increase. Total National income increased 3.6% in 2012, down from 2011’s 4.3%. National Income has risen 14.0% over the past three years, with Compensation gaining 9.8%.
 

Most of the ongoing inflation in asset prices and incomes is either directly or indirectly related to Washington’s extraordinary policymaking. Since mid-2008 (18 quarters), publicly held Treasury market debt has increased 120% to $11.569 TN. Federal debt (includes some other obligations) doubled to $13.469 TN, increasing over this period from 46% of GDP to 85%. State & Local debt increased 33% in 18 quarters to a record $3.732 TN.
 

Federal Expenditures were flat during 2012 at $3.758 TN, or 24% of GDP. Recall that federal spending jumped almost 28% in the three years ended 2010. In the process, federal spending as a percentage of GDP jumped from about 20% of GDP in 2007 (1995-2007 avg. 20.3%) to 25.5% in 2010. Federal Receipts were up 5.9% in 2012 to $2.669 TN, fueled by accelerating non-federal Credit growth. Since 2007 (five years), annual receipts have increased $14bn, or 0.5%, while federal expenditures have surged $858bn, or a whopping 29.6%.


The Fed’s balance sheet expanded $117bn during Q4, the strongest expansion since Q2 2011. Federal Reserve Assets were little changed for the year, while being up $502bn, or 20.5% over two years. Fed holdings are up $2.1 TN, or 210%, since Q2 2008. In ten years, Federal Reserves have inflated an historic 292%.


Huge federal expenditures and deficits coupled with the Fed-induced collapse in borrowing cost have lavished inflated earnings and cash-flows upon corporate America. Despite these inflated earnings, ultra-loose financial conditions have nonetheless incited a mini boom in corporate borrowings. Corporate bonds increased SAAR $719bn during Q4 to a record $12.511 TN. For the year, Corporate bonds jumped $527bn, or 4.4%.


Bank Credit has quietly been showing a pulse. Bank Assets jumped $226bn during Q4, or 6.1% annualized, to $14.992 TN. Bank Assets were up 2.4% y-o-y and 10.7% over two years. During Q4, commercial loans increased $75bn, with a 2012 gain of $195bn, or 9.5%, to $2.252 TN. Mortgage loans increased $55bn during the quarter, although they were down $47bn for the year. The banking system continues to accumulate government securities, with this asset class jumping $140bn, or 6.7%, during 2012 to $2.245 TN. It is worth noting that Total Bank Deposits rose $714bn, or 7.0%, in 2012 to a record $10.948 TN.


For the first time since Q2 2008, Total (home and commercial) Mortgage Debt (TMD) actually posted a quarterly increase ($17bn). Overall, TMD declined $259bn (1.9%) in 2012, down from contractions of $328bn in ‘11, $621bn in ’10 and $292bn in ‘09. Total Mortgage Credit declined $1.567 TN, or 10.7%, from its Q2 ’08 high, having now dropped back to 2006 levels. For perspective, TMD is today double the level where it ended the 90’s. If the current backdrop holds, I would expect positive mortgage Credit growth in 2013.
  

While we’re on the subject of Mortgage Credit, GSE Assets declined $35bn during Q4 and $211bn for all of 2012, to $6.269 TN. But we have to temper our enthusiasm for the so-called “winding down” of Fannie and Freddie. Agency-backed MBS increased $32bn in Q4 and $135bn (10.4%) in 2012, to $1.440 TN. Overall, outstanding Agency Securities (debt and MBS) declined only $33bn (0.4%) during 2012 to $7.544 TN.
 

In the miscellaneous financial sector categories, Credit Union Assets expanded 6.0% in 2012 to $904bn. Securities Broker/Dealer Assets increased 6.1% to $2.068 TN, the first annual growth since 2007. REIT Liabilities were up a notable 22.9% to $778bn, with a two-year gain of 55%. For the year, total Securities Credit jumped a notable $200bn, or 15.2%, to the highest level since 2007. Securities Credit has increased 40% in three years.
 

Rest of World (ROW) holdings of U.S. assets increased $583bn in 2012 to a record $19.384 TN. ROW Treasury holdings jumped $474bn last year to $5.546 TN, with Official Treasury holdings up $339bn to $3.992 TN. Over three years, total ROW holdings jumped $3.578 TN, or 22.6%. During this period, Treasury holdings jumped 50%, or $1.848 TN, with Official holdings up $1.121 TN, or 39%.


Granted, the fourth quarter was an odd one. There were clearly impacts from fiscal cliff uncertainties and looming tax increases. Still, the quarter was noteworthy for the big jump in Credit growth and the even wider divergence between strong Credit/financial markets and weak economic performance. A jump in (non-financial) Credit expansion to a 6.2% pace equated with a barely positive (0.1%) real GDP reading. It would be easier to dismiss this as an anomaly if it wasn’t such a prominent global dynamic (i.e. China, India, Brazil, etc.). As for the maladjusted U.S. economy, we’ve reached the phase were it requires exceptionally strong Credit expansion (and overheated markets!) to attain what most economists would view as “normal” growth.
 

A few years back I opined that it would take roughly $2 TN of annual system Credit growth to more fully reflate the deeply maladjusted economy. After four years of outrageous fiscal and monetary stimulus, our Credit system is poised to possibly reach this milestone in 2013. The good news is that jobs are growing at a decent clip (as one would expect with ultra-loose financial conditions and strong corporate borrowings). The bad news is that this reflation has required a doubling of federal debt coupled with incredible Bubble-inducing monetary measures.
  

The government finance Bubble has significantly inflated household incomes and corporate earnings, a Bubble dynamic that has worked to incite speculation and inflation throughout equities and corporate debt markets. The reflation in securities and, increasingly, real estate markets has again inflated Household Net Worth. Perceived gains in wealth and ongoing (government policy-induced) income growth have spurred boom-time spending levels, in the process sustaining the consumption and services-based U.S. economy. Ignore the underlying Credit dynamics and things almost look OK.
 

Importantly, the government finance Bubble has succeeded in sustaining the U.S. “Bubble Economy” structure that evolved over the prolonged Credit Bubble period. This has ensured unending Current Account Deficits and endless dollar liquidity; historic global financial and economic imbalances; and attendant myriad Bubbles around the world. Desperate global central bankers, meanwhile, are content to disregard precarious Bubble excess throughout global risk markets - fixated instead on acute economic and financial fragilities. Flawed economic doctrine, analytical frameworks and policies over years fostered deep economic maladjustment and market Bubbles. Resulting fragilities these days ensure even more aggressively “activist” policy measures viewed as necessary to bolster an acutely vulnerable global “system.”
 

Two of the savviest “macro” analysts of this era – Stan Druckenmiller and Marc Faber – this week separately warned that this central banker-induced boom will end badly. Mr. Faber went so far as to predict unpleasant happenings for 2013. I don’t know if this historic Bubble will burst this year. But I am convinced the longer the current backdrop continues the greater the eventual economic and financial turmoil. The Q4 2012 “flow of funds” provides added confirmation that policymakers have painted themselves into a corner. It’s hard to believe the Fed will stick with $85bn monthly QE in the face of mounting Credit and market excess. On the other hand, the liquidity backdrop has created such unsettled global markets that central bankers will look for any excuse to avoid watering down the punch.