Wednesday, June 1, 2016

Fear of debt

Not investment advice.

At Bloomberg, Risky Reprise of Debt Binge Stars U.S. Companies Not Consumers by Rich Miller, 31 May 2016:

Among the warning signs: rising debt, lagging profits and mounting defaults...

“Companies have been adding to their debt and their debt has been growing more rapidly than their profits,” said John Lonski, chief economist of Moody’s Capital Markets Research Group in New York.

The similarities between the pre-recession debt binge by consumers and today’s burst of borrowing by companies are striking.

Rich Miller's focus is on debt in dollars. Debt in dollars is going up. Ergo problemo, says Miller. But debt in dollars is always going up -- except when there's a problem. Apart from 2008-2010, debt was always going up:

Graph #1: Debt in dollars is always going up -- except when there's a problem.
This graph shows total credit market debt, public and private.
Rich Miller sees debt going up, and takes it as a warning sign. He seems to assume that a high level of debt (in dollars) is the cause of the problem. It looks to me that the lesson Rich Miller took from the crisis and recession was

    1. Debt was high in the years after 2000.
    2. We had a recession in 2008.
    3. Debt is going high again now.
    4. So we will have another recession.

Miller's concluding paragraph confirms this four-step summary. He writes

Lonski of Moody’s said it’s premature to predict that the U.S. is heading into a recession because the labor market is still strong. But the squeeze on companies is “a risk factor that’s worth watching.”
We're going to have a recession, he says, because debt is going up. But debt in dollars is always going up, except when there's a problem. The problem occurs when debt stops going up. Keep that in mind when you look at debt.

Miller's focus is debt in dollars. Did he miss the Fed's response to the crisis and recession? Did he miss all the quantitative easing??

No. More likely, Miller doesn't know what purpose QE served. A lot of people thought QE was the wrong response to the problem. Hey, I guess I did, too. But that's what we got, we got QE. And QE changed the numbers. You have to work those numbers into the mix to see the situation today.

I'm thinking Rich Miller hasn't looked at the changed numbers. Hasn't looked at debt in the context of those changed numbers. That's what I want to look at now.

I want to point out first that quantitative easing was the solution chosen by people who know a lot about this sort of thing. They know more than most of us. Just because everybody hates the government doesn't mean the smart guys at the Fed were wrong. And anyway, QE is the solution we got. Might better have a look at those numbers.

If we take base money -- the money that increase directly as a result of QE -- it goes up. I'll show it in red on a graph, along with the same debt we looked at above:

Graph #2: Total Debt (blue)(Same as on Graph #1) and Base Money (red)
Yeah... (Tongue in cheek.) Base money really went up.

You've heard of stretching a dollar, right? The red line shows the number of dollars of money created by the government. The blue line shows how far those dollars were stretched by the banking system.

The vertical gray bar at the right, just before 2010, that's the 2008 recession. During that recession is when the quantitative easing started. You can see the red line go up. That was QE.

Now let me take that debt and that base money, and divide the one by the other:

Graph #3: Total Debt relative to Base Money
This graph shows how many dollars of total debt there are for each dollar of base. You can see the number peaked at over sixty dollars of debt for each dollar of base money, when the 2008 recession was starting. By the end of the recession the number had fallen by half. Since then it has fallen intermittently, and now there's about $15 in total credit market debt for each dollar of base.

That decline from $60 to $15 was due mostly to quantitative easing. So yes, base money really did go up. I was funnin' you before when I suggested it didn't.

Now let me take the data from Graph #3 and plug it into Excel.

The blue line on Graph #4 is the same "debt relative to base money" data that we saw on #3. I showed the last part of it red, the part since the last quarter of 2008. Then I had Excel put a trend line on that part of it, in black, and extended that trend line out to 2020.

Graph #4
The trend line bottoms out in the first quarter of 2016 -- just a few months ago. The trend shows increase since that time.

Like Rich Miller said, it's going up. Yeah -- but my graph shows it just starting to go up now, after a very big drop. Miller looked at debt in dollars. I'm looking at debt in context -- and the context is the quantity of money that was adjusted by some pretty smart guys.

This trend line turning upward -- this is a big deal. If you read economic history in terms of debt relative to base, you know that when the trend bottoms out and starts to go up, economic growth gets vigorous.

This is the part nobody believes -- that our economy is going to be very good for the next few years. But it's right there on the graph.

Actually, it's there on the graph twice. Once, the black line, which shows the economy getting good right now. And before that, the blue line bottoms out in late 1993 and starts to go up again. By 1995 we had what they call "the new economy". The vigor lasted several years. Attribute those good years to technology or what you will. The fact is, we didn't get those good years until after the debt-to-base ratio bottomed out and started climbing.

And before that, though it didn't make the graph, the ratio bottomed out in 1946, then started increasing. You can see most of that increase on the graph in the 1950s and the '60s and the early '70s. Those years are considered a "golden age".

And before that, the ratio bottomed out in 1920, then trended upward for a decade. We call that one "the Roaring Twenties".

So look: 1920, and 1946, and 1993... and 2016. Four bottoms, each followed by some years of a healthy and vigorous economy. Something to think about, surely.

// See also mine of 3 March, 25 April, and 4 May.

// Download the Excel file for Graph #4

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