A popular analyst recently wrote in his weekly outlook that the underlying theme of today’s environment should be known as “It’s the Deleveraging, Stupid!”
Deleveraging is technically accurate if the argument is centered on the contracting credit activities of the private sector of the US economy.
But focusing on deleveraging isn’t correct, it’s misleading. That’s because the private sector isn’t the only part of the US economy.
On the contrary, since the crisis surfaced, US government’s share of the US economy has exploded.
From CFR.org
One must realize that even prior to the crisis that the trend of the US government’s contribution to the economy has already been expanding, albeit gradually.
The crisis only hastened the process.
Well even in the labor market, government employment has now surpassed the private sector.
In short, it would be a terrible mistake to fixate on the private sector when government’s role in the economy has been capturing a fairly substantial share of the economic pie.
Laissez faire, anyone?
So is the US government also experiencing a "deleveraging"?
Based on the overall credit picture of the US, the answer is clearly NO.
Total credit has surpassed 350% of the GDP of which the US Government’s leverage has virtually topped the private sector. And that was in 2008, at the height of the crisis! It should be more today.
Obviously, a bigger government translates to bigger spending.
This means that spending has to be financed by higher taxes, by borrowing or by printing money.
Since higher taxes won’t be politically appealing considering the frail state of the economy, then the palpable recourse is to borrow or let the printing press rip!
Yet speaking of government, until this point we have not seen signs of deleveraging.
But we are obviously seeing debt building up…leveraging by deficit spending and not deleveraging.
Of course, like many deflation proponents Japan’s lost decade has been made as a popular example of what the US outcome might be.
While everyone in the investing community seem to know that Japanese internal savings financed its debt burdens, what everyone don't seem to realize is that Japan’s policy priorities had been far different from the US.
Forget about Japan’s bubble bust as being “isolated”, the important difference is that Japan policies didn’t have to bother with much of the world.
The US, on the other hand, being the world’s primary foreign currency reserve, has had to deal not only with its own economy but importantly work to uphold its status as the world’s monopoly provider of the medium of exchange for international payment and settlement.
In short, the global banking system and its attendant liquidity required for most of its transactions, greatly depends on the US dollar (Federal Reserve), which has equally been dependent on its own banking system to facilitate this transmission.
Therefore, US authorities have had to face two competing priorities, particularly the banking system (its global seignorage status) or its economy.
They made a choice and it was to rescue the banking system-so it can provide liquidity to the world and retain the privilege of being the world's monetary hegemon.
Of course, US authorities has repeatedly justified that its banking system is a vital part of the US economy, if not THE economy.
And that’s the reason why the Fed lent, spent and guaranteed some $11.6 trillion (as of September 2009), to the sector.
This implies that resources had to be redirected to the banking system which have been drained from the real economy.
This massive act of redistribution epitomizes not deleveraging, but inflationism.
And as we said above, bigger spending requires financing from debt or the printing press, if taxes is the least available option.
But considering that its banking sector’s balance sheet had been stuffed with rubbish but labeled as 'AAA' assets during the days of delusion, a solution has to be made.
Hence Bernanke like a good student of the Great Depression resorted to what he deemed as the most effective strategy to deal with this problem. His solution is to use the magic wand, the nuclear or the Helicopter option.
So by the waving of his magic wand, this would now allow him to “hit two birds with a single stone”….
The quantitative easing program or what the Cleveland Fed euphemistically calls as the “Fed credit easing policy tools” is simply the printing press!
By buying assets of the banking system, the banks get a reprieve, aside from buying time to build up capital. By manipulating the mortgage and treasury markets (even possibly the stockmarkets) the banks earn from spreads. By pushing up asset prices the animal spirits are reanimated. People go out and borrow and spend again, hurray!
Central bankers once ridiculed Zimbabwe’s Dr. Gideon Gono but apparently his formula seem so chic these days, such that Dr. Gono must have felt exonerated.
So does this signify as “deleveraging”?
Again the answer is NO.
Credit Bubble Bulletin’s Doug Noland who recently dissected on the Federal Reserve’s 3rd Quarter Flow of Funds has this to say, (bold emphasis mine)
``Once again, system Credit expansion was almost completely dominated by federal borrowings. For the quarter, federal government debt expanded at 20.6% annualized, down from Q2’s 28.2%, Q1’s 22.6%, and Q4 2008’s 37.0% SAAR. Domestic financial sector Credit contracted 9.3% SAAR, an improvement from Q2’s 12.5% contraction. Foreign sector U.S. borrowings expanded at a 14.9% rate, the strongest since Q1 2008….
``Over the past year, Treasury debt expanded $1.743 TN, or 30.2%, to $7.521 TN. Treasury borrowings were up $2.270 TN, or 43%, in just five quarters. And despite the contraction in overall mortgage borrowings, outstanding GSE MBS expanded $408bn, or 8.3%, over the past year to $5.30 TN. In the past eight quarters, GSE MBS expanded $1.057 TN, or 25%. For the quarter, GSE MBS expanded $481bn SAAR. In just five quarters, combined Treasury and GSE MBS expanded an unprecedented $2.810 TN. “Flow of funds” data continue to confirm the Government Finance Bubble thesis."
But NO, the government isn’t.
Instead what Doug Noland calls as “Government Finance Bubble thesis” alternatively means inflationism...again.
Bottom line: I hate to say this, but I’ll simply borrow or paraphrase the sarcasm imbued in the title used by the popular analyst, ``It’s not deleveraging, but inflationism, stupid!”
