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The Balance Sheet Recession Continues



June 10, 2011 – Comments (5)

Excellent post by TPC. He points out that consumers are still deleveraging, and I think that is exactly what needs to happen. He does clarify that in addendum 1 at the end.

I am not posting this to advocate any particular policy response, but to point out a trend. If the US government were to follow an austerity path then this contraction in consumer debt would continue (probably mostly by defaults instead of paying down of debt), but the economy (which is still heavily driven by the consumer) would collapse at the same rate if not faster. This has absolutely nothing to do with QE. Consumers are deleveraging and will continue to do so whatever the Fed thinks the 'appropriate' monetary policty will be. What will affect the rate of consumer deleveraging is fiscal policy targeted at Main Street, not Wall Street. That is what should be paid attention to here.

As investors who pay attention to the macroeconomy, this is bears watching closely.


10 June 2011 by Cullen Roche

This may very well be the most important data point that we are currently receiving every quarter.  Yesterday’s Z1 released by the Federal Reserve showed a continuing decline in household credit.   The latest reading showed a -2% decline in total household debt growth versus last year.  The Fed summarized the data:

    “Household debt declined at an annual rate of 2 percent in the first quarter; it has contracted in each quarter since the first quarter of 2008.  Home mortgage debt fell at an annual rate of 3½ percent in the first quarter, ¾ percentage point more than the decline posted last year.  Consumer credit rose 2½ percent at an annual rate in the first quarter, the second consecutive quarterly increase.”

Total household debt continues to decline

Frustratingly, I’ve been discussing this dynamic for well over 2 years now.  In early 2009 I wrote about why this wasn’t the banking crisis that Ben Bernanke thought it was, why the aid package would likely fail to help Main Street (it focused too much on Wall St) and why we were remarkably similar to Japan:

    “Unfortunately, our leaders have misdiagnosed our problem as a banking crisis and not a Main Street crisis.  We have ignored the real root cause of the problem which lies not with the bank balance sheets, but with the household balance sheets.  As I have long maintained, we are looking more and more like Japan and the balance sheet recession they suffered.  While we ignore Main Street in favor of Wall Street it’s likely that the recession on Main Street will endure….”

Being a consumer driven economy this decline in debt remains the most important component of our economic plight.  As I’ve previously explained, the collapse in consumer debt has been the primary cause of weak economic growth.  Consumers took on excessive debt levels during the housing boom and when housing prices collapsed their balance sheets were turned upside down.  Consumers were left with excessive debt, collapsing aggregate incomes and a subsequent balance sheet recession.  The overall result is that consumers are still working to pay down this debt and remain in saving mode as opposed to debt accumulation and spending mode.

This is a highly unusual event that has only been seen on rare occasion in developed economies over the last 100 years.  As this process occurs there is only one entity that can help to stabilize the economy – the US Federal government.  As we know from the sectoral balances, when the private sector is in saving mode and not spending mode (due to debt reduction) and the current account remains in deficit, there is only one sector that can offset this weakness in an attempt to create economic growth.  That is the public sector.  Thus far, we’ve managed to fend off the austerity chatter, however, the risks appear to be on the rise as government officials become convinced that the United States is bankrupt (something that is fundamentally impossible).

This is the exact situation we have seen in Japan for the last 20 years and it is currently occurring in much of Europe.  If the United States implements a policy of austerity there is little doubt that the economy would continue to contract again, unemployment would increase and the economic malaise would worsen.  By my estimates, this situation is likely to persist well into 2012 and perhaps longer depending on how the economic environment progresses.


* Addendum 1 - It’s important to note that the consumer debt reduction process is a good development.  It is necessary to help build the foundation for a sustainable recovery.  Consumer debt accumulation in moderate levels should been seen as a good thing.  Unfortunately, it was the excessive debt binge that caused our current predicament.  As this process heals over the years we should embrace it and accept it as a necessary part of the natural economic progression following a debt bubble.  That requires a unique policy response and a particularly important need to focus on Main Street’s woes and not Wall Street’s woes.

** Addendum 2 – Because monetary policy works largely to increase the debt levels and by helping the banking sector, it can actually be detrimental to this natural healing process during a balance sheet recession.  This is why we should reject further Fed intervention in the markets and encourage Congress to look into potential aid packages such as a reduction in taxes.

*** Addendum 3 – Scott Fullwiler wrote a spectacular piece on sectoral balances here.  This should really help clarify what is going on today.  Scott Fullwiler for Treasury Secretary?  :-)

5 Comments – Post Your Own

#1) On June 10, 2011 at 11:54 AM, amassafortune (29.15) wrote:

My bank, through my "personal banker", called me last week to see if I needed any loans. We own our cars and home and have no home equity line of credit. He seemed disappointed that I did not want to add a line of credit. Would I consider restructuring the one, small loan we have with the bank for a recreational property? No thanks. In fact, I plan to pay it off earlier than expected. His audible disappointment may have been part of the sales strategy, or it may have been genuine after a string of similar calls. 

The Roche article documents my financial actions since 2008, though I've always leaned against personal debt that could not be covered by at least two methods - income, savings, or other investments. 

I am a boomer. I do not believe I will see my real estate holdings appreciate anywhere close to the levels of the past two decades. According to Money Magazine a couple months ago, workers in my age range saw a loss of 500K jobs while jobs recovered over the past 10 months.

If any proposal like Paul Ryan's passes, I'll get a health care stipend in lieu of Medicare, and my expected Social Security will be cut by at least $2K per year. $2K lost income, $3K extra to pay for a private health policy, and I now need at least $7K more before taxes per year in each year of retirement. Throw in future taxes for all this Bernanke debt and every boomer is looking at maybe $10K of annual income needed for saving irresponsible banks that Shiela Baer should have been allowed to dimantle three years ago.

And as much as we all love Reagan, us boomers and our employers have been paying the hefty SS tax increase for most of our careers. The security that tax increase provided for the WWII generation was an honorable commitment for boomers, but "pay as you go" is a catchphrase that masks the ponzi character of Social Security. Like a giant Tetris game with life-altering ramifications, the top layer of Social Security, Medicare, and debt that now exceeds that of all previous presidents combined, is speeding up and topping out. 

Not to be confused with weinergate, but the goal of most taxpayers, and especially boomers, has got to be to store as many long, straight ones to clear out the coming threats. 

This is what Cullen Roche has documented, and explains why Bernanke's live dissertation experiment is not gaining traction, and will not gain traction. Nice find, binve.  

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#2) On June 10, 2011 at 12:27 PM, binve (< 20) wrote:

Hey amass,

Excellent comment, and I very much agree.

>>This is what Cullen Roche has documented, and explains why Bernanke's live dissertation experiment is not gaining traction, and will not gain traction.


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#3) On June 10, 2011 at 12:43 PM, IIcx (< 20) wrote:

Exactly, if the stimulus was simply distributed over US households instead of the banks then household debt would have been erased, the housing crisis over, and the remainder would have been spent resulting in a stimulated economy.

Instead, they spent it on jackass ideas like Green Tech that kills jobs and increases household costs.

Not the brightest lights in Washington during the 111th Congress. Let's hope the 112th does better! 

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#4) On June 10, 2011 at 1:18 PM, binve (< 20) wrote:


Yep. Take the current temporary payroll tax cut and turn it into a payroll tax holiday for both employers and employees. Since most employees pay more in payroll taxes than they do in income taxes this would directly help employees. And since the largest employers in the economy are small business owners, it would help them too.

This would be super easy to implement (just stop the withholding, it could start next week) and directly help those who need it the most.

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#5) On June 10, 2011 at 2:20 PM, IIcx (< 20) wrote:

exactly binve,

This is what they should have done long ago but they need to make it a permanent change not a short term fix. They also need to kill capital gains taxation and the tax on interest.

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