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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 3rd quarter of 2007).
This chart shows the amount that each asset/liability is above/below the exponential trend line. As a stagflationist, I was curious if anything during the stagflationary 1970s resembled what we are seeing now.
I draw your attention to the year 1973. Tangible assets, financial assets, and liabilities were all well above the trend line, just like they are now. Now would probably be a bad time to mention the price of oil, wouldn't it?
To make matters worse, tangible assets are twice as far removed from the trend line as they were then and liabilities are about three times as far removed. Financial assets aren't looking all that well either. Further, if anyone thinks tangible assets (i.e., real estate prices) have a hope in you know what of not continuing down the path they are currently on speak now or forever hold your peace.
I refer you to the cover of Time Magazine for December 9, 1974. 1974 was one of the worst recessions in American history.
Now is probably not the best time in American history to go out and embrace risk. Just a hunch.
See Also:
Flow of Funds Fun! v.7 (Musical Tribute)
Source Data:
FRB: Flow of Funds Accounts
St. Louis Fed: Population: Mid-Month
BLS: Consumer Price Index
29 comments:
Stag,
Your charts just get better and better. Everything is extended today, except inflation of course. Perhaps higher rates will bring things back towards trend lines. Everything is inflated except inflation. Preservation of capital now will allow for buying at more reasonable valuations in the future. Shorting remains attractive for those with a bent for risk.
Would making use of the famed shadow inflation rate not change the picture a bit?
Superb charts, thought provoking indeed. Keep up the good work.
Stag,
What data set did you use to adjust for inflation. Was it constant. Also, with the big slug of baby boomers, I can't help but think everything will pendlum below trend. As people age, they consume less.
Helicopters just took off from the central banks around the world. We can not have asset deflation in a fiat ponzi scheme. Like all ponzi schemes defaults lead cascading defaults,
stag mark, this is brilliant context. your commentary both here and at cr is good reading.
i have a complex question, if you'd care to respond, though i'm not sure either of us have an answer.
in comparing the current situation to the inflationary depression of 1966-82, i would agree of course that
tangible assets are twice as far removed from the trend line as they were then and liabilities are about three times as far removed
as seen here, liabilities have particularly gotten out of line (considering as well that the trend of increase continues to this day).
i would submit that, in accordance with irving fisher's theory of debt-deflation, the essential feature by which a recession becomes a debt-deflation is an initial condition of excessive debt.
as a percentage of gdp in the late 1960s, as seen on the chart, that condition simply did not exist on a scale equivalent to either 1929 or 2007. moreover, i suspect that if one could run that chart back to periods around 1814, 1836, 1865, 1892 -- years preceding the onset of deflationary periods -- one would see similar debt-to-gdp spikes waiting to be resolved.
my question, finally: why should this period be different? in a society where total credit is ~$50tn and the central-bank-supplied m1 is just $1.4tn, why should we expect the government to be able to force a sustainable total money supply?
gaius marius,
The key difference today is the lack of a gold standard. Further credit expansion is always possible and, according to Bernanke, desirable. When Bernanke was campaigning for the Fed chairmanship, he unequivicably stated he would not allow deflation. Just think of printing presses and helicopters. I have no doubt he was nominated for the chairmanship based on his expansionary credit views. All that is required for aggregate credit expansion is a willingness to borrow and lend. An accomodative fed and profligate fiscal policy are always willing and able to expand credit. This by no means assures sensible credit expansion and is why I think Stag Mark's forecast for stagflation is very plausible.
but was the gold standard really the key condition in limiting credit expansion? i actually doubt it.
i see exactly what you're saying, mab, but i think it's a bit naive to presume that the government had no power to force credit expansion while a monometallic standard was in place. currency devaluation is as old as currency.
the more subtle point you're making, i think, is that the ease with which money supply can force credit expansion has improved so as to make infinite credit expansion possible. again, i just wonder.
the fed has a balance sheet to maintain which constricts eventually its ability to engage in lending programs like we have seen announced today.
and there are moreover limits to what it can do with its monetary monopoly. in the 1970s inflationary depression, the ratio of total money-plus-credit to m1 was about 11x. today, that ratio is closer to 40x. the government also in the 1970s governed the largest creditor nation on the planet; today, it governs the largest debtor nation -- and the difference is paramount.
i think the salient quesiton is, "from that kind of ratio, can the fed print enough currency fast enough (from a policy-response viewpoint) to counteract a severe contraction in fractional reserve lending, i.e. a slowing in the velocity of money? and do so without forcing an international debt repudiation that would effectively decapitalize the american banking system by another path?"
i frankly don't think the policy response will be nearly fast enough to stave off the onset of deflation and put both borrowers and lenders into a debt-averse mindset. and even if they did, it would spark an international t-bond and agency debt repudiation that would force the american government into insolvency.
Think fiscal policy, not monetary policy.
From the discovery of America until 1974 only 1 trillion of total credit was created. The last trillion of credit was created in less than 10 months. I believe 3 trillion of government debt has been created so far under G.W. Bush. As long as other major economies are in the same boat as the U.S., its game on. If we falter in a big way relative to the rest of the world, well, that would be really bad.
Stag,
By my rough calculations, real trend population adjusted growth rates from 1960 to 2007 are:
Financial assets: 2.3%
Tangible assets: 2.8%
Liabilities: 3.3%
Asset/Debt Ratio:
1960: 8.3:1
2007: 5.6:1
In aggregate, the asset to debt ratios have decreased, but are not alarming. I think the aggregates are what fooled the fed with housing. Home equity levels are still substantial on a macro basis, over 50% in total. At the micro level though, many, many people are recently upside down. The devil is in the details.
Stag,
There is an interesting chart of the "real" dow on the itulip.com home page (top right). The chart and associated article really make you wonder about the sustainability of the above trend real growth in stocks. As I recall, its not population adjusted, but is compared to trendline real gdp.
Anonymous,
Would making use of the famed shadow inflation rate not change the picture a bit?
I'm comfortable with the CPI. I think the pain that is coming will be reflected there when all is said and done. Could be wrong of course.
"there are moreover limits to what it can do with its monetary monopoly... can the fed print enough currency fast enough (from a policy-response viewpoint) to counteract a severe contraction in fractional reserve lending"
I think you should ask an elderly German, or a middle-aged Argentine, or any Rhodesian you can find. In short they can _always_ print more money. If the demographics are favorable (IMO Japan's problem) finding people willing to take the risk trade won't be a problem.
abby normal,
Helicopters just took off from the central banks around the world. We can not have asset deflation in a fiat ponzi scheme. Like all ponzi schemes defaults lead cascading defaults,
That's certainly my take to some degree. When the right foot is in frozen ice (credit crunch) the governments will "quickly" step in to ensure the other foot is placed in molten lava (liquidity) to balance out the temperature. No worries! Too bad it wasn't the same foot though. ;)
MAB,
What data set did you use to adjust for inflation.
I adjusted all the data by the CPI-U.
gaius marius,
Thanks for your thoughts!
my question, finally: why should this period be different? in a society where total credit is ~$50tn and the central-bank-supplied m1 is just $1.4tn, why should we expect the government to be able to force a sustainable total money supply?
How much would you borrow if offered a 100-year 0% interest rate loan? I would borrow as much money as the government would loan me, and I hate debt. I'm a saver.
The situation gets extremely unintuitive as the interest rates approach zero percent. The difference between interest rates falling from 5% to 4% is nothing like the difference between 1% falling to 0%. Zero percent interest rates are the equivalent of infinite inflationary policies in my mind.
While we might get some deflation as Japan has, as judged by our CPI I would argue it won't be severe or prolonged. Even Japan's deflationary mess only had their CPI down marginally, ~1%. That's a trivial amount compared to our Great Depression.
That shouldn't provide great comfort for the housing market or the stock market though, if Japan is any indicator. The CPI isn't tied to the housing market directly (and did therefore not capture the swift rise in housing prices), and it really doesn't care how the stock market is performing.
And lastly, the only way I see our government default on the debt it owes is by taking the inflationary path. I just don't think the United States will admit it can't pay off paper debts when it has a perfectly good paper printing press.
Time will tell.
MAB,
In aggregate, the asset to debt ratios have decreased, but are not alarming. I think the aggregates are what fooled the fed with housing. Home equity levels are still substantial on a macro basis, over 50% in total. At the micro level though, many, many people are recently upside down. The devil is in the details.
Absolutely! In my opinion, the income inequality gap already snuck up on Bernanke once so far. The subprime mess doesn't make all that much sense if you look at the averages. Unfortunately, the averages are probably near useless.
If one person had all the wealth and everyone else had all the debt we'd still look okay on average. We'd also have a VERY serious problem.
I wish I could see more data based on the median American, and not the average American. Median incomes are not keeping up with inflation. We know that. What don't we know? I suspect a lot!
The amazing growth in payday loan centers in the past few years should have been a huge red flag that all is not well.
AllanF,
I'd like to ask the person from Zimbabwe how deflationary 80% unemployment has been.
"How much would you borrow if offered a 100-year 0% interest rate loan? The situation gets extremely unintuitive as the interest rates approach zero percent."
Indeed, we just saw what bankers and home buyers would do if offered 1% interest rates for seemingly 30 years. Unfortunately they failed to read the fine print and the rates on those 30 year loans turned out to be callable after 2.
As for me, I'd like to ask an elderly German if it is possible to invest fast enough to keep ahead of the Govt printing fast enough to keep ahead of a severe contraction in fractional lending.
I'm resignedly beginning to think it is not. Especially when it's not just one Govt, but all of them acting in concert.
There really is a mismatch between work and wealth. Bernanke keeps saying education is the key, but this flys in the face of the facts. On a percentage basis, more people have college degrees than ever, yet incomes are not rising at the median level. All the gains have been concentrated in the top 5% or so. Its even drastically skewed in the top 5%.
I think the "invest" rather than "save" doctrines are very much to blame. In a non-inflationary environment you know you need to work AND save. In an inflationary environment saving is difficult and the masses have never been treated fairly by the financial services community. When pension boards and insurance companies had to provide guaranteed payments to retirees, financial shenanigans were never tolerated. Also, bonds played a bigger role and these require real and regular payments which cannot be faked. Its every person for themselves now and most people just don't know enough not to trust the wall street propaganda. This is a giant failure by our country and why bubbles are soooo dangerous - they transfer and destroy so much wealth so fast.
I've never seen average weather, we live in the extremes.
Indeed, we just saw what bankers and home buyers would do if offered 1% interest rates for seemingly 30 years. Unfortunately they failed to read the fine print and the rates on those 30 year loans turned out to be callable after 2.
No kidding. It was like an illusion of illusionary prosperity. Unfortunately, two illusions don't make a reality. D'oh!
MAB,
There really is a mismatch between work and wealth. Bernanke keeps saying education is the key, but this flys in the face of the facts. On a percentage basis, more people have college degrees than ever, yet incomes are not rising at the median level. All the gains have been concentrated in the top 5% or so. Its even drastically skewed in the top 5%.
No amount of education is going to get median incomes to rise when there are billions willing to work for peanuts. All we'll end up with is a PhD glut bigger than the one we already have. Check out this TIME article from 1973.
The Ph.D. Glut
http://www.time.com/time/magazine/article/0,9171,907072,00.html
Worse, how much more dollar depreciation will be necessary in order to close the trade gap?
thanks for the reply, stag mark -- again, these are really interesting views regarding a complex subject.
The situation gets extremely unintuitive as the interest rates approach zero percent. The difference between interest rates falling from 5% to 4% is nothing like the difference between 1% falling to 0%. Zero percent interest rates are the equivalent of infinite inflationary policies in my mind.
but i state catagorically that you (or at least most people) would not borrow on nominal 0% IF real rates were still 5%. and there's the deflationary catch -- offering zero percent fed funds doesn't improve bank capital ratios when balance sheet asset prices (or, if you're private, collateral prices) are falling 5% a year thanks to the contraction of credit from ghastly levels.
the banks in japan (for example) needed balance sheet repair (ie, a way to reduce liabilities faster than assets were being written down), not balance sheet expansion (access to more cheap credit, which was more likely to further impair capital ratios in a falling asset price environment). the banks' attempt to do just that is why japan got credit contraction and deflation -- they let zero percent fund a relatively small carry income from foreign lending, which (along with incredible regulatory forebearance and periodic govenrment treasury bailouts) slowly recapitalized them once asset price declines stopped destroying capital at a rate more rapid.
the result looked in japan like near-0% interest rates all the way out the curve, monetary base growing 25% a year, but m2+CDs growing at just 11% and bank credit declining year after year for a decade. even a recapitalization of the banks by government that amounted to 12% of gdp in 1999 did not break the domestic contraction, as it was merely held as a reserve against expected future asset price declines or lent out overseas.
in the united states, current credit levels were furthermore created in part by the shadow banking system of securitization -- including many institutionals and hedgies. these holders will not have access to fed funds or (very likely) rescue, and they won't have a way to recapitalize. many will probably stop lending entirely, radically reducing the availability of credit.
in short, i suppose, nominal credit rates are not the same as credit availability. we have had a period of low nominal rates, negative real rates and incredible availability; that could well be followed by a period of zero nominal rates, high real rates and incredible inavailability.
That shouldn't provide great comfort for the housing market or the stock market though, if Japan is any indicator. The CPI isn't tied to the housing market directly (and did therefore not capture the swift rise in housing prices), and it really doesn't care how the stock market is performing.
i've read (and agree with, i think) marc faber's logic on the inflationary cycle, which reminded me of murray rothbard's in some respects -- that periods of recession mainly consist of an increase in the prices of commodities (things we need) vs the prices of assets (things we want). that was certainly what's been seen in japan, in the 1970s, and the 1930s all. so asset deflation in terms of commodity purchasing power is a lock, imo, and i expect most of your readers probably agree there.
the difficult question for a saver (like you and i both) is whether this comes in the context of a general deflation, a general inflation or monetary stability. coming off of the loosest credit conditions in american history, i suspect deflation is likely.
the only way I see our government default on the debt it owes is by taking the inflationary path. I just don't think the United States will admit it can't pay off paper debts when it has a perfectly good paper printing press.
this is of course a key question. inflation is usually the political decision in a debt-ridden fiat currency regime, given a choice. but does the united states have that choice?
mab above discussed a fiscal response to private debt liquidation -- essentially the conversion of bad private credit into government credit, a wholesale recapitalizing of the system. i don't see this as likely -- outstanding government debt is in the area of $9tn now, and replacing a 20% contraction of private credit (hardly out of the realm of possibility from these heights) would more than double real government liability and amount to a bailout on the order of 300% of gdp. such a move or anything like it would probably force foreign treasury debt repudiation (imo) and quite possibly a dollar crash -- which would force a federal book balancing and cut the united states off from most of the imports it depends on for the orderly functioning of its society.
even if the capacity exists, this isn't something i think the united states is likely to hazard, dependent as it is on international trade for basic goods.
i think instead it will have to allow significant private credit contraction to progress while moderating it with whatever narrow-money-supply inflation it can get away with internationally, combined with cuts to extant spending plans such as medicare. as a large international debtor with a manufacturing base that has moved to china, it seems to me that it has little choice.
that would seem to me to imply general deflation of a kind seen perhaps not in 1929-1933 but in longer periods like that seen from 1865-1896.
having said all that, where would you poke holes in my hypothesis?
I can try to poke holes, lol.
...that periods of recession mainly consist of an increase in the prices of commodities (things we need) vs the prices of assets (things we want). that was certainly what's been seen in japan, in the 1970s, and the 1930s all. so asset deflation in terms of commodity purchasing power is a lock, imo, and i expect most of your readers probably agree there.
Let's talk about the Great Depression pricing of commodities we need. Is the following what you are picturing?
Wheat
1929: $1.030 per bushel
1932: $0.375 per bushel
Potatoes
1929: $2.170 per cwt
1932: $0.627 per cwt
http://www.nass.usda.gov/
Let's talk about how we were the export power of the world heading into the deflationary Great Depression. The same held true for Japan. What are we now? I'd argue we are the exact opposite.
We are relying on the kindness of strangers to subsidize our lifestyles. That is not something that we were experiencing heading into our Great Depression and that is not something Japan experienced heading into their deflationary mess.
To expect severe deflation is to expect China to somehow sell toasters to us even cheaper than they already do, cheaper than we could possibly make them for ourselves. I just don't see that happening.
Is the following what you are picturing?
well, yes, kinda. :) wheat fell 64% and potatoes 75% in real terms -- but then the dow fell ~90%. it was in fact largely a period of commodity inflation relative to assets, just masked by a large rise in the value of the denominating currency.
Let's talk about how we were the export power of the world heading into the deflationary Great Depression. The same held true for Japan. What are we now? I'd argue we are the exact opposite.
so would i. the question is, i think, how does that affect the need for a credit contraction?
...it was in fact largely a period of commodity inflation relative to assets, just masked by a large rise in the value of the denominating currency.
The CPI was only down 27% from the peak in 1929 to the trough in 1932. I have a hard time thinking of "commodity inflation" during the Great Depression, since commodities did so much worse than the CPI.
However, let's assume for the moment that your reasoning is correct. If so, I would argue that the rise in the value of the currency during the Great Depression was because it was backed by gold. It wasn't the cash that was important during this "commodity inflation" you speak of but it was the gold backing the cash, since gold generally tends to be a good hedge against commodity inflation.
Now compare to the 1970s. There was a serious "commodity inflation" and gold once again outperformed. Unfortunately, cash did not.
Here we are in the 2000s. Commodity inflation is once again the norm. Gold is doing well yet again. Cash is once again suffering.
If you could point me to a fiat currency that has stood the test of time I'd be more inclined to buy into the deflation story long-term. We certainly deserve a good dose of deflation for what we've done, but I'd be extremely surprised to see the CPI drop by Great Depression standards. Japan's CPI declines have been trivial by comparison.
Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation. - Ben Bernanke, 2002
I trust him to do just that if push comes to shove. He's not going to sit idly by watching the savers of our fiat currency make a killing by burying it in their backyards. I do believe he can generate positive inflation if he so desires. If nothing else, he could suggest that we start stocking up on canned goods. I'm confident that alone would do it and falls well within his "credibly threatening to do so" criteria. In fact, it would be serious overkill.
This most certainly does not mean I think the stock market and housing markets are safe from what's coming though. Printing money will not magically create more prosperity to offset the pain that is coming.
If you could point me to a fiat currency that has stood the test of time I'd be more inclined to buy into the deflation story long-term. We certainly deserve a good dose of deflation for what we've done, but I'd be extremely surprised to see the CPI drop by Great Depression standards. Japan's CPI declines have been trivial by comparison.
i definitely agree -- i mean, i don't think we'll see or could see the degree of deflation in commodities (which i would draw broadly to include most cpi components, which are clearly not assets in the conventional sense) witnessed in the great depression. but there are a lot of other deflationary periods following credit bubble burstings which were not quite so 'great' that probably make a more reasonable expectation set. they are rather common in the historical record, even in the age of fiat currency -- including japan post-1989, the asian tigers post-1997.
i know i'm challenging a basic premise here, and i want to explicitly say thanks for tolerating my questions with magnanimity.
but i do think, as we're likely to see one or the other to resolve the current condition, it's important to delineate (if we can) what the preconditions are make deflation likely or make hyperinflation likely.
i don't have the answer, but i think the health of the banking system is critical, as it is the vehicle of velocity and rising velocity is obviously necessary to hyperinflation as declining is to deflation. with banks in america now overextended and tightening lending standards to a public that is deeply indebted, coming off a period where velocity was very high and credit standards nearly nil, it's hard for me to see inflation as the likely next step even if the government starts increasing the monetary base as a stimulant.
gaius marius,
i know i'm challenging a basic premise here, and i want to explicitly say thanks for tolerating my questions with magnanimity.
I very much appreciate the comments and I am sympathetic to your arguments. One need look no further than the upper left corner of my blog showing my short-term deflationary mood. I should probably define what short-term is at some point, lol.
I just happen to believe that this period is very similar to the period heading into 1974. That was the year building stopped (as was seen in Time Magazine).
I'm also arguing that increasing the monetary base has already happened. It won't necessarily require additional increases. There's a LOT of money just sitting on the sidelines looking for a home.
http://illusionofprosperity.blogspot.com/2007/08/money-money-money.html
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