Doug Noland: The Financial Accounts of the United States

Market Peak Percentages Compared to GDP

2000:  Total Debt & Equity (359%), Equity (202%), Debt (157%) – Tech Bubble

2007:  Total Debt & Equity (379%), Equity (181%), Debt (198%) – Housing Bubble

2017:  Total Debt & Equity (435%), Equity (219%), Debt (216%) – Everything QE Bubble

Note:  Equities were at 50% of GDP in 1975 and ended the eighties at 67%.


I would add that bull markets create their own liquidity. And so long as “risk on” is fueled by self-reinforcing speculative leveraging, the marketplace would easily accommodate small portfolio sales from the Federal Reserve. It’s an altogether different story, however, when “Risk Off” materializes. De-risking/de-leveraging dynamics would rather abruptly emerge from hiding. That’s when the markets will sorely miss – and beckon for more – QE.



Q2 2017 Z.1 Report


I found the Fed’s latest (Q2) Z.1 report particularly interesting. It brought back memories. In general, debt growth was steady and rather uninteresting. As such, it would be reasonable to equate the seemingly placid Credit backdrop with an extraordinarily long period of low securities market volatility. Yet there’s another dynamic to contemplate (and carefully monitor). Below the surface the financial sector is turning increasingly unstable. Latent financial instability has begun to surface. And, sure enough, acute monetary disorder ensured that securities markets succumbed to speculative blow-off dynamics.

Q2 2017 Non-Financial Debt (NFD) expanded at a 3.8% rate, up from Q1’s 1.7% and Q4’s 3.1%. Household Debt growth increased from a 3.4% rate to 3.7%. Home Mortgage Debt expanded at a 2.8% rate, down from Q1’s 3.4%. Consumer Credit slowed to 4.6% from 5.2%. Total Business Debt growth slowed to 5.3% from Q1’s 6.1%. After contracting at a 2.6% rate during Q1, Q2 saw Federal borrowings increase at a 3.6% rate.

With system debt having inflated for decades now, today’s percentage changes don’t do justice. Plus, with interest rates so low, interest compounds much less than in the past – thus working to restrain overall debt expansion. But let’s examine nominal data. On a seasonally-adjusted and annualized (SAAR) basis, Non-Financial Debt expanded at a $1.813 TN pace during Q2 (up from Q1’s $794bn). This compares to annual growth of $2.095 TN in 2016, $1.958 TN in 2015, $1.792 TN in 2014 and $1.547 TN in 2013.

Total Household borrowings increased SAAR $542 billion during Q2. For comparison, Household borrowings expanded $510 billion in 2016, $403 billion in ‘15, $400 billion in ‘14, $241 billion in ’13 and $265 billion in ‘12. Household borrowings contracted in 2011 ($51bn) and 2010 ($60bn).

Total Business borrowings slowed to SAAR $724 billion, down from Q1’s $817 billion. Borrowings nonetheless remain robust, tracking above 2016 annual borrowings of $711 billion and not far below 2015’s $820 billion (strongest since 2007).

On a year-on-year basis, Federal government borrowings have shown the largest slowdown. This won’t last. Federal Government Liabilities ended Q2 at a record $18.651 TN, up from $8.056 TN to end 2007. Over this period as a percentage of GDP, Federal Liabilities have increased from 55% to 97%. Outstanding Treasury securities ended Q2 at $15.798 TN, up 160% from 2007’s $6.051 TN. Somehow there is still talk of “deleveraging” in the face of one of the great bouts of government indebtedness.

Meanwhile, outstanding Agency- and GSE-Backed Securities ended Q2 at a record $8.667 TN. One of these decades there may even be GSE “reform.” GSE Securities increased $95 billion during the quarter, $343 billion over the past year and $888 billion over three years. Amazingly, with Fannie and Freddie remitting (accounting) profits back to the Treasury, the government sponsored enterprises these days have no meaningful capital base (Z.1 has GSE assets less liabilities at a paltry $6.0bn).

Complacency may come easy to those viewing relatively modest annual percentage growth in household, corporate and federal debt. Indeed, most at this point completely dismiss the Credit Bubble hypothesis. Yet there is plenty of support for The Bubble Thesis buried throughout the Fed’s Z.1 report.

Let’s start with the Fed’s “Financial Sector” category. Total Financial Assets expanded nominal $1.411 TN during the quarter to $93.61 TN, this following Q1’s gain of $1.997 TN (strongest since Q1 2012). Financial Sector growth is on pace for the largest gain since 2007. Notable expansions included the SAAR $797 billion gain in “Federal Funds and Security Repos,” SAAR $899 billion rise in “Loans”, and SAAR $1.573 TN jump in Financial Sector “Miscellaneous Assets.”

The Security Broker/Dealers expanded Financial Assets SAAR $567 billion during Q1. The quarter saw the strongest growth since Q1 2010. “Security Repurchase Agreements” jumped SAAR $263 billion, with Debt Securities up SAAR $154 billion. On the Liability side, Security Repurchase Agreements surged SAAR $329 billion and Corporate Debt Securities rose SAAR $144 billion.

The explosive growth of the ETF complex runs unabated, as detailed in Fed data. ETF assets surged a nominal $170 billion during the quarter (24% annualized) to a record $2.944 TN. Total assets were up $715 billion y-o-y, or 32%. Interestingly, when ranked by “investment objective,” World Equities led the way during Q2. World Equities assets expanded $77 billion (53% annualized) during Q2 and were up $195 billion, or 42%, y-o-y. U.S. Equities gained $55.6 billion during Q2 and were up $429 billion, or 33% y-o-y. Taxable Bond funds attracted $34 billion during the quarter, with assets up $95 billion y-o-y.

Further indications of “Hot Money” On the Move: Bank “Holding Companies” saw Financial Assets jump SAAR $903 billion during the quarter. Financial Assets of “Funding Corporations” dropped SAAR $492 billion during Q2. Net Interbank Assets dropped SAAR $663 billion during Q2, after surging SAAR $1.582 TN during Q1 and declining SAAR $649 billion in Q4 2016. While Financial Sector Debt Securities holdings were relatively flat (up SAAR $31bn), a “risk on” dynamic was apparent with a SAAR $403 billion decline in Treasuries largely offset by a SAAR $308 billion increase in Corporate & Foreign Bonds. On the Liability side, “Federal Funds & Repo” jumped SAAR $698 billion and “Miscellaneous Liabilities” rose SAAR $662 billion.

Speaking of “hot money”… Rest of World (ROW) saw “Net Acquisition of (U.S.) Financial Assets” surge SAAR $1.916 TN, this following Q1’s gain of SAAR $1.515 TN. In nominal dollars, ROW holdings of U.S. Financial Assets surged $1.336 TN during the first-half to a record $25.559 TN. At this pace, the growth in ROW holdings will easily surpass 2006’s record $2.143 TN. By category during Q2, ROW Debt Securities holdings jumped SAAR $1.214 TN, with U.S. Corporate bonds up SAAR $584 billion. Foreign Direct Investment increased SAAR $299 billion, a significant slowdown from the 2015/2016 pace.

September 17 – Reuters (Saikat Chatterjee): “Global debt may be under-reported by around $13 trillion because traditional accounting practices exclude foreign exchange derivatives used to hedge international trade and foreign currency bonds, the BIS said… Bank for International Settlements researchers said it was hard to assess the risk this ‘missing’ debt poses, but that the main worry was a liquidity crunch like the one that seized FX swap and forwards markets during the financial crisis. The $13 trillion unaccounted-for exposure exceeds the on-balance-sheet debt of $10.7 trillion that data shows was owed by firms and governments outside the United States at end-March. The fact these FX derivatives do not appear on financial and non-financial institutions’ balance sheets under current accounting rules means little is known about where the debt lies. ‘The debt remains obscured from view,’ Claudio Borio, head of the BIS’s monetary and economic department…”

I hold the view that nontransparent derivative trading and associated leverage have been integral to the global government finance Bubble. QE and currency devaluation strategies created extraordinary opportunities for “carry trade” leveraged speculation. I believe enormous amounts of finance have been created in the process of shorting select currencies, most notably near-zero rate euro and yen securities. A large chunk of “money” flowed to “king dollar” U.S. securities markets, easily offsetting the (late-2014) termination of Federal Reserve QE. It is likely that huge flows are not being captured in Fed data – the Rest of World Z.1 data in particular. It was helpful to see the BIS put a $13 TN estimate on debt/leverage associated with unaccounted for foreign-exchange derivatives.

Recall that 10-year Treasury yields traded as low as 1.36% in July 2016, only to reverse sharply to as high as 2.60% near year-end. I believe fear of a disorderly unwind of leveraged holdings was behind the Fed’s decision to back away from rate “normalization.” When the Fed then signaled that rate hikes had largely run their course, the veritable speculation floodgates were pushed wide open.

The value of U.S. Equities jumped a nominal $1.50 TN during Q2 to a record $42.23 TN. Over the past four quarters U.S. Equities have jumped $6.182 TN, or 17.1%. For perspective, Equities rose about $3.9 TN in 1999 and $3.5 TN in 2006. The Q2 value of Equities was 67% higher than at the close of 2007. Equities ended Q2 2017 at a record 219% of GDP. Equities had cycle peaks of 181% of GDP during Q3 2007 and 202% to end Q1 2000. Equities were at 50% of GDP in 1975 and ended the eighties at 67%.

Total Debt Securities ended Q2 at a record $41.502 TN, up $85 billion for the quarter and $977 billion y-o-y. Debt Securities-to-GDP slipped a basis point to 216% (began the ‘90s at 130% and ended the decade at 157%). This puts Total (Debt & Equities) Securities at $83.733 TN, or a record 435% of GDP. Previous cycle peaks were 379% in Q3 2007 and 359% during Q1 2000.

Policy-induced asset inflation has profoundly impacted Household Net Worth – or what I would refer to as “perceived wealth.” Indeed, the bloated Household balance sheet remains a primary Bubble manifestation. Household (& Nonprofits) assets ended Q2 at a record $111.4 TN, up $1.844 TN for the quarter and $8.660 TN (8.4%) over four quarters. Liabilities increased $146 billion during the quarter and $467 billion y-o-y – to $15.219 TN. Fundamental to the ongoing Bubble, Household Net Worth (assets less liabilities) jumped $1.698 TN during Q2 to a record $96.196 TN. Net Worth surged a staggering $8.193 TN over the past year (now 42% higher than the 2007 peak). For perspective, Net Worth jumped $4.894 TN during 1999 and dropped $10.240 TN during 2008. As a percentage of GDP, Household Net Worth reached 500% for the first time during Q2, up from cycle peaks of 473% in 2007 and 435% in 1999.

I’ll have more comments about the Fed meeting next week. It was interesting to see chair Yellen refer to an inflation “mystery.” There was nothing too surprising with the Fed’s plan to reduce its balance sheet holdings. For good reason, the markets assume the Federal Reserve won’t get too far into balance sheet “normalization” before it suffers a change of heart. Recall that our central bank more than doubled holdings after scrapping its 2011 “exit strategy” before it even got started.

I would add that bull markets create their own liquidity. And so long as “risk on” is fueled by self-reinforcing speculative leveraging, the marketplace would easily accommodate small portfolio sales from the Federal Reserve. It’s an altogether different story, however, when “Risk Off” materializes. De-risking/de-leveraging dynamics would rather abruptly emerge from hiding. That’s when the markets will sorely miss – and beckon for more – QE.


Original Post 23 September 2017


Categories: Doug Noland, Perspectives