Quote of the Day: Real Deleveraging

No stock market commentary for today.

Here is a brilliant objective analysis of the current bubble conditions from Doug Noland of the Credit Bubble Bulletin at the PrudentBear.com (bold emphasis mine)

Our economic structure certainly enjoys unmatched capacity to absorb Credit excess without engendering traditional consumer price inflation.  Yet there is indeed a huge problem that no one seems to want to recognize:  Our system also has an unprecedented capacity to expand Credit that is backed by little in the way of wealth-creating capacity.  Our government literally injects Trillions into the economy – Credit that inflates incomes and sustains consumption and elevates asset prices.  The downside of this economic miracle is that, at the end of the day, there’s little left to show for the whole exercise except for an ever-expanding mountain of suspect financial claims.  Moreover, market values of these claims are sustained only by the unrelenting expansion of additional claims/Credit concurrent with increasingly radical monetary management.  This is Minsky’s “Ponzi Finance” at a systemic level.

A real deleveraging would see the economy and financial markets weaned off of rampant Credit growth.  Non-financial Credit growth averaged about $700bn annually during the nineties.  This inflated to about $2.4 TN at the Mortgage Finance Bubble pinnacle in 2007.  As I noted above, we’re currently running at an annualized Credit growth rate of nearly $2.0 TN.  This is posing great unappreciated risk to system stability.

A real deleveraging would see price levels (and market-based incentives) adjust throughout the economy in a manner that would spur business investment – in the process incentivizing sound investment-based lending and resulting job growth.  Real deleveraging would see a shift in the economic structure from Credit-fueled consumption to savings and productive investment.  Real deleveraging would give rise to our endemic trade deficits shifting to surplus.  Real deleveraging would see a meaningful reduction in non-productive debt.  Real deleveraging would see market prices dictated by fundamentals rather than governmental intervention, manipulation and inflationism.

The “raging” debate is whether recent elevated unemployment is a “cyclical” or “structural” phenomenon.  Academic “white papers” not required.  After all, find a system that doubles mortgage Credit in about six years and then proceeds to double federal debt in four - and you'll no doubt locate a deeply maladjusted economic structure.  Such gross financial imbalance ensures economic imbalance.  And, importantly, the longer such imbalances are accommodated/incentivized by loose fiscal and monetary policies the deeper the structural impairment.  Throw massive fiscal stimulus and monetize Trillions and such a structure will surely demonstrate historic deficiencies and fragilities.

Deleveraging – the process of unwinding the economic damage wrought from years of excess - will be a quite arduous economic process; one that will commence at some unknown date in the future.  Oh, I guess I failed to mention that total (financial and non-financial) Credit ended Q2 at a record $55.031 TN, or 353% of GDP.  And Rest of World holdings of our financial assets ended the quarter at a record $19.100 TN, a $3.860 TN increase from the end of 2008.

Deleveraging, which has been the mainstream tautology, has been promoted by cherry-picking evidences in support of this view.

Yet while it may be true that some sectors have been enduring salutary deleveraging, the big picture reveals that systemic debt has been intensifying not only in the US but on a global scale most of which has been borne by the governments.

And much like austerity, deleveraging has been a maligned and distorted term and uttered like an incantation which has been used to justify more government interventions. 

All these only adds up to have a compounding effect on systemic fragility.