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This chart shows the tangible assets, financial assets, and liabilities adjusted for inflation per person in the United States as seen in B.100 Balance Sheet of Households and Nonprofit Organizations within the Flow of Funds Accounts reports (through the 2nd quarter of 2007).
We're well above the long-term exponential growth trend in each and every one of these (which is rather unprecedented). What would happen if we revert to the mean?
- Tangible asset prices (adjusted for inflation) would fall. We're starting to see that in the housing market. It does not mean inflation would necessarily fall, just that housing prices relative to reported inflation would fall (since housing makes up the vast majority of tangible asset prices).
- Financial asset prices (adjusted for inflation) would fall. We're starting to see that in the stock market. Although returns are doing well in the bond market this year thanks to falling interest rates, those same falling interest rates may make it more difficult to earn interest in the future (once again, when adjusted for inflation).
- Liabilities (adjusted for inflation) would fall. We're starting to see that in the credit markets. Delinquencies are rising. Lending standards have risen. The "b" (bankruptcy) word is becoming more popular. Bankruptcy has been a notoriously easy way to see credit fall. The debt simply vanishes with the stroke of a pen.
This is not an inflation vs. deflation argument though, since this analysis is based on inflation adjusted numbers. In other words, if you believe we will revert to the mean you do not have to choose between inflation and deflation. We'll get there either way.
I continue to believe that real yields are dying and that it will be very difficult to make money on real estate, stocks, and bonds. It will also be very difficult for those in debt to borrow ever increasing sums of money. It's a lose, lose, lose, lose situation in my opinion. This will be in sharp contrast to the last few years which saw a win (real estate), win (stocks), win (bonds), win (cheap debt) situation.
Am I pessimistic? I don't think so. Am I bearish? Absolutely. I'd like to think I'm being realistic more than anything though. I'm not shorting stocks. I'm not selling my house. I'm not hoping for this outcome. I'm simply waiting on the sidelines as best I can for a much better time to be bullish. That's all. I could be wrong of course and since I have nothing to gain if I am right, I'd be perfectly okay with that.
See Also:
Flow of Funds Fun! v.5
The Death of Real Yields v.4
Source Data:
FRB: Flow of Funds Accounts
St. Louis Fed: Population: Mid-Month
BLS: Consumer Price Index
8 comments:
Why are you not shorting? Fear that inflation will make it a losing prop?
"What would happen if we revert to the mean?" The nature of means is such that some of the time you have to be below them.
Mark, you are doing some very substantial and thoughtful work with your blog. Net, The Fed is harmful to the average U.S. citizen, but is believed otherwise. To the owners of assets, The Fed is an advocate and benefactor. However, the coming train wreck is beyond any monetary solution. Massive fiscal stimulus is required. Democrats and Republicans will oblige. By the way, The Fed does do a reasonalbly good job of data collection and reporting. For the initiated, this data is far more useful than the SELL, SELL, SELL nonsense spewed from Wall Street.
anonymous,
Why are you not shorting? Fear that inflation will make it a losing prop?
Yeah, I look at the 1970s and see a flat stock market that paid dividends. I don't think those who shorted the market during that period did any better than those who were long the market (in general).
dearieme,
The nature of means is such that some of the time you have to be below them.
That does pose a problem going forward, doesn't it? I'm reminded of a permabull who told me a few years ago that the record unemployment was a reason to be bullish. I replied that I'd rather buy stocks when unemployment was at a record high and that good news could therefore appear.
The stock in question was Capital One Financial. It is now well below the price it was when I turned bearish in late August, 2004.
mab,
Net, The Fed is harmful to the average U.S. citizen, but is believed otherwise. To the owners of assets, The Fed is an advocate and benefactor. However, the coming train wreck is beyond any monetary solution. Massive fiscal stimulus is required.
I'd like to think of The Fed as a quasi-governmental agency placed on Titanic-like ships in order to make sure the bankers make it to the lifeboats. That's not necessarily something the average U.S. citizen (especially the women and children, who would presumably be seated first) would care to see should the ship hit an iceberg.
Just wanted to say great posts. I've read many of your comments on CR and just started checking out your site. It's now one of my daily reads. Keep up the good work.
Best Wishes,
PDX
Thanks PDX!
I appreciate the kind words.
I'm not sure I deserve the kind words, based on how much I enjoy posting sarcasm though. ;)
I'm not even sure what my point of posting really is. If everyone was as defensive as I was, the entire economy would no doubt collapse. I certainly don't want that.
On the other hand, I do think somebody needs to say something to offset the apparent illusion that all has been well and will be well going forward.
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