One of my main working assumptions has been that the credit super cycle ended in 2007. So far that theory has held me in good stead. Although in the aftermath of the credit crisis the destruction of credit was halted by aggressive government action, even with zero interest rates and aggressive quantitative easing, the resumption of credit growth has so far proved illusory.
Have a look at this chart of total credit as a percentage of GDP:
Total Credit / GDP</a> </div></p>
Credit as a percent of GDP peaked in 2007 and turned violently lower during the crisis.
After years of piling on debt, the economy finally failed to respond to the typical government action of lowering the price of credit. This is what led many to proclaim the end of the grand credit super cycle.
What is this credit super cycle anyway? Since the end of the Great Depression of the 1930s credit has been on a steady uptrend. There has been some hiccups, but each slowdown has been met with increasingly easier monetary policies which has fuelled this grand credit bubble.
But during the 2007 crisis, the economy finally hit a point where no matter how low credit was priced, there was no corresponding increase in credit growth. The Fed and other major Central Banks entered into an era where their policies were “pushing on a string.” They could not force feed any more credit into the system. And at this point, it was easy to proclaim the grand credit super cycle of the past decades finally dead.
Since 2007, the private sector economy has refused to expand credit (even though it is priced near zero). In fact, for a long time, the private sector actually destroyed credit through the paying back of their large indebtedness. How then did the total credit as a percentage of GDP stabilize? If the private sector was paying back debts, shouldn’t total credit have fallen?
The answer is that the Federal Government took up the slack. Have a look at this chart of the various sectors of credit:
The blue line represents household credit. It headed lower during the crisis, and has so far refused to uptick. The purple line is financial sector corporate credit, and it too has fallen and refused to get up.
The orange line represents the Federal Government’s total credit. In 2007 it started a large upswing and has only continued to explode higher. For a while it was the only sector of credit that was expanding. The Federal Government’s expansion slowed down the accelerating credit destruction vicious circle. They stopped the bursting of the grand credit super cycle bubble.
Recently the non-financial corporate sector credit (red line) has also joined the Federal Government in their expansion of credit. This is the result of the many corporate borrowings that are being used for buybacks, takeovers and other corporate re-leverings.
I have been assuming that the grand credit super cycle was finished. I did not expect total credit to ever surpass the levels seen in 2007.
But lately I have been re-thinking this assumption.
So far the financial and household sectors have refused to lever back up. Although I do not expect them to ever make the same sort of aggressive choices that were too common in the 2000s, what if they just resume normal credit growth?
Over the last 7 years America has suffered from a lack of confidence. The 2007/8 credit crisis was a demoralizing blow to the psyche of the American people. The US was supposed to be the economic power house of the world. Credit crisis were what happened to other countries. The fact that the US was the epicentre of the crisis shook Americans’ beliefs down to its core.
This is why American finance professionals are so busy predicting housing crashes throughout the rest of the world. If it happened to them, the masters of the global financial system, it can happen to anyone (or everyone).
There is a great TED talk by Peter Atwater about America’s lack of confidence. In the talk the author highlights some of the reasons for American’s new found skepticism.
I have come to the realization that this lack of confidence is the main reason for the constant falling velocity of money. Americans do not expect things to ever get better, so there is little reason to invest in the future.
The constant battles in Washington have only made this indecision all the worse. There is no leadership. No one is stepping up and saying, “here is the way – follow me.” Instead everyone is blaming everyone else.
As the memory of 2007 slowly fades without another crisis jumping back to the forefront, what if confidence returns to America?
What if the assumption that the grand credit super cycle is finished is wrong? What if this lack of confidence means that we have just applied all the more fuel to try to kickstart the economy, and that when it finally gets lit, the results are all the more violent?
I know that this sort of optimism about America seems unimaginable. But markets often do what you least expect.
Do not get me wrong, I think that eventually this whole debt bubble comes crashing down in what will most likely be an inflationary reset. However in the mean time I think there is a better chance than most realize that America’s love affair with debt is rekindled.
When this does happen, the explosion of all sorts of prices will be surprising. I will expand on these ideas in the coming days…
Weird correlation of the day
I am hesitant to give weird correlations too much credence, but they are often interesting nonetheless.
Have a look at the Platinum/Gold ratio versus US 10 year yields:
Platinum/Gold Ratio (yellow line) vs US 10 Year Yield (white line)</a> </div>
I guess it makes sense that if platinum (more of an industrial metal) is outperforming gold (more of a financial metal) that the economy is doing well, which should send yields higher. But the relationship seems tenuous to me.
However, there can be no denying that the relationship has been fairly consistent. For the sake of my bond shorts, go platinum go!