Category Archives: Debt

Credit Impulse

The credit impulse isn’t the sudden urge to borrow – it is the additional income and concomitant spending that results from an increase in aggregate debt. Spending capacity = net income + credit impulse. Credit impulse (annual) = current debt amount – year ago debt amount. Not complicated.

The credit impulse is how easy money creates economic expansion as economic entities – households, corporations, governments, etc. are able to spend more than they earn.

The downside is that, sooner or later, the entities reach the limit of their ability to borrow. The credit impulse disappears and the economy shrivels. Incomes diminish and defaults begin as entities can no longer service their debt. Credit becomes very difficult to obtain, lenders fail as capital losses mount and the economy accelerates downhill as the credit impulse goes negative as borrowers are unable to roll over their debt.

Credit Impulse

US household debt ended the year at $13.15 billion, a y-o-y increase of $402 billion and a record. This means that about 2% of GDP came from the increase in household debt alone. It is likely that when corporate and government debt increases are taken into account that the economy is operating at a substantial loss.

Fed Minutes

Another day, more blather from the Fed. Risk is “on” with a vengeance as the Fed continues to demonstrate its unwillingness to “take away the punch bowl” as Fed Chairman Martin put it.  Apparently there is no such thing, in their minds, as too much stimulus. We’ll see about that. In my view, a financial catastrophe is almost inevitable at this point. Overpriced stocks and the fear of inflation have always been a toxic mixture. Add in the overhang of aggregate debt somewhere in the neighborhood of 350-400% of GDP and you have a recipe for a protracted decline to well below fair value, unlike 1987’s brief shock.

 

Universal Basic Income

The left continues to be fascinated with the idea of re-distribution. It believes that the whole notion of some people being paid more than others is fundamentally unfair, that they must have had some advantage – skin color, parents, brains, whatever – which was just a matter of luck. “You didn’t build that,” as Obama famously said.

So the latest brainchild of this idea is the notion of a monthly check from the government that is sufficient to provide a comfortable lifestyle regardless of whether or not the recipient chooses to work.

A single program that replaced the myriad of transfer payment programs, from welfare through Social Security, would save an enormous amount of administration costs at all levels of government and help to pay for the program. The “poverty trap” would be eliminated as the payment could be “universal” that is, not means tested. Minimum wage laws would need to be abolished, of course, since the “living wage” would be redundant. Might not work, but there seems to be some potential anyway.

But that is not what is proposed. In general, it seems that this would be yet another program which would be funded by even more government borrowing. This, it is claimed, would “grow the economy by $2 trillion.” Please.

There are only two ways to grow the economy. One of these is to increase labor utilization, the number of hours worked in a given period. The other is to increase the productivity of that labor, that is the amount of output produced for each hour of labor. That’s it.

Existing programs already provide a major disincentive for work – the “poverty trap.” This would add another. Productivity is improved by investment – in technology, skills, infrastructure, etc. More spending on consumption would not help this, but would certainly provide more inflation, which would act to deter investment. If you want to see the outcome of this kinf of program, just check the news from Venezuela.

 

 

Government Shutdown?

Many voices are being raised to warn of the danger of a government “shutdown” should Congress fail to raise the debt limit.

Why, one might ask, is this so dangerous? It is simply the fact that U.S. Federal deficit is still running about 3% of GDP. Cut Federal spending back to match its income and recession will certainly ensue.

Of course, the steady accumulation of debt is even more dangerous, but less immediate. So the voices hope.

A “shutdown” would not need to be anything more than a modest 15% reduction in run rate. Inconceivable.

Unexpected Outcome

People seem to be surprised that the Fed’s rate hikes have resulted in rates declining. Really? It seems pretty clear that the Fed’s outlook is at odds with reality, and that rates are responding to the real outlook, which is that Fed rate hikes are a negative for an economy that is already tanking.

The Future Is Now

Debt pulls demand forward in time. Borrowers use debt to pay for consumption today and commit future income to service the debt.

The amount available for consumption today represents the present value of that committed income, discounted by the prevailing interest rates.

The further that borrowers reach into the future, the more that discount lessens the amount available today. The Fed wants consumption today, so it attempts to induce inflation in order that borrowers are more confident of their future nominal incomes, while holding interest rates low so that the discounting of that income is minimized.

This strategy has sustained consumption in the short term, at the expense of reducing future income available for consumption.

The problem is that the future is now.

As consumption slows, so does production and inflationary pressure. Defaults rise – just look at the subprime auto loans. Yes, defaults eliminate debt – but only at the expense of the creditor who takes an immediate hit to income, charged against net worth or equity capital. Lenders are forced to reduce their assets.  Borrowers find that debt service takes more of their income than they had expected. Purchasing power erodes and deflation sets in. Spending capacity falls even more rapidly and the economy slides into recession and depression.

The larger the accumulation of debt, the longer it takes to purge the financial system and restore it to stability. Debt – credit – is a necessary and healthy part of the economic system. But the economy cannot depend on consumption funded by the continuous growth of debt. Debt must revolve, expanding and contracting within limits proportional to the size of the economy.

A Bit Of Math

Simon Mikhailovich of Tocqueville Bullion Reserve reminds us of the deadly numbers with a sobering tweet:

A bit of math. With the global debt / GDP ratio at 320% and the cost of average debt service at 2%, it takes 6.4% growth per annum just to service the debt. Not happening.

Same Old

Per Bloomberg, house flippers have pushed the share of sales that are flips, or properties sold twice in 12 months, to its highest level since 2006.

Home flippers, who buy homes as a speculative bet on short-term price appreciation, accounted for 6.1 percent of U.S. home sales in 2016, according to Trulia, which defines a flip as a property sold twice in a 12-month period in arm’s-length transactions. That’s the highest share since 2006, when flips accounted for 7.3 percent of sales.

House prices are, of course, now above the last bubble peak. This is not likely to end any differently than the last time. Thanks, Janet.

Malls Hit The Wall

According to Forbes in 2015, the US leads the world in retail space per capita, with about 25 square feet (roughly 50 square feet, if small shopping centers and independent retailers are added). In contrast, Europe has about 2.5 square feet per capita. Number two is the UK, with about one-sixth the retail space per capita of the US. Now that online shopping is replacing store visits, shopping malls are becoming white elephants.

More mall landlords are choosing to walk away from struggling properties, leaving creditors in the lurch and posing a threat to the values of nearby real estate.

As competition from online shopping batters retailers, some of the largest U.S. landlords are calculating it is more advantageous to hand over ownership to lenders than to attempt to restructure debts on properties with darkening outlooks.

Obviously this is a looming bust for commercial real estate – and of course a wave of defaults on the associated debt.