Running To Stand Still

‘And what do you mean to be?’ The kind old Bishop said As he took the boy on his ample knee And patted his curly head. ‘We should all of us choose a calling To help Society’s plan; Then what do you mean to be, my boy, When you grow to be a man?’.. ..’I want to be a Consumer And live in a useful way; For that’s the thing that’s needed most, ‘I’ve heard the Economists say. There are too many people working And too many things are made. I want to be a Consumer, Sir, And help to further Trade.’

~ Patrick Barrington, Punch, April 1934

By a recent feat of statistical legerdemain, a few months back, the US savings ratio was revised up from a negative number to just in excess of 2% – still a post-Depression low. Canada has seen the savings rate plunge from a 5.6% level in 1996 which was then the lowest since 1970, to bump around either side of zero in recent quarters. Australian savings amount to a gargantuan 1.8% of disposable income, around a quarter of the level two years previously and a fraction of the respectable double digits maintained 10 years ago. The UK recently reported a level of 4.5%, the second lowest since the dark, austere days of the 50s and substantially off from the 1970-95 average of 9.2%. New Zealand’s 2.6% early last year was the lowest in the 37-year record of the series. The IMF has warned the Belgians to raise their prudential ratios, the Dutch National Bank has fretted at its citizens’ reliance on house price and equity gains in place of an actual forbearance from consumption. Remsperger at the Bundesbank has expressed concern at the fall in the German level at the end of 1998 – well before the cult of equity took hold! – to around 10% (Anglo-Celts should be so lucky!) from above 13% a few years prior, taking the cushion to its lowest relative level since the late 60s.

Though such levels on the Continent may seem high, so are the requirements. OECD estimates are that the EU – less the well-provisioned Dutch and Britons – had private pension assets scarcely in excess of 6% of GDP in 1996, despite projected annual pension running costs three times this level in 2040. This means that whereas the Americans had nearly nine years’ of assets, the UK 15 years and the Dutch over 7 years (assuming growth in lockstep with GDP), the rest of the EU could barely manage four months! And this was before the fast money, Net IPO, tulip economy began to banish such old fashioned notions as saving out of current income!

What has replaced old fashioned thrift in the Western economies? Unrealized capital gains and borrowing on their collateral, of course, all made possible by Central Bank complicity in the rapid expansion of money substitutes.

Let us take the US as the exemplar of this, not through any singular malice, but because the trends are most evident there, the statistics the most complete and the apologists the most vocal.

35 years ago, when Johnson was declaring war on both poverty and the Vietnamese (with somewhat mixed results, it would transpire) and laying the seeds for the destruction of the admittedly flawed post-WWII monetary system, US non-financial private debt stood at $584 billion – some 88% of GDP. Financial debt was barely a tenth of this at $8 billion and federal, state and local government owed future taxpayers $356 billion, or just over half of national income.

Over the intervening third of a century, current dollar GDP has risen 14-fold or at a compounded annual rate (CAR) of 7.9%. Curiously, government, big or small, supply-side or kinder and gentler, has matched it pretty much dollar for dollar so that the ratio has effectively stood still. Not so private, non-financial debt which has grown nearly 21 times or at a CAR of 9.1% to rise to 131% of GDP.

More remarkably still, negotiable CDs, the Eurodollar market, interbank lending, the ‘science’ of risk management, reduced reserve requirements, repos and derivatives, securitization and financial engineering have all served to balloon financial debt at a CAR of 15.2% or 138 times on this timescale, magnifying its proportion to GDP by a factor of ten!

Looked at another way, from 1961-1979, it took an average of $1.30 of private debt to finance the creation of an extra dollar of national income. By the end of the junk bond era of the eighties, that had doubled to $2.63. A brief respite followed as the last credit boom unwound in the period to 1994, before a rapid reacceleration as the Greenspan bubble took hold. The last two years, with its 18.6% compound rate of financial debt accumulation, have witnessed the phenomenon of $3.64 in increases in liabilities for every extra dollar generated in the real economy. And this in the age when the Chairman tells us that new technology is relieving us of otiose layers of middlemen and sclerotic inventories, thus allowing fewer resources to provide more output!

As von Mises tells us, after a credit expansion takes hold, it requires an ever quickening pace of infusion to keep enterpreneurs afloat once they have been seduced into misjudging the means available for the prosecution of their business, as well as the ultimate demand by consumers for the fruits of their labours. What we have lived through in recent years will, once the boom cracks, be seen as such an archetypal exposition of this theory that Keynes will be thought of as as much of a crank as William Jennings Bryan and George Warren.

In the meanwhile, the immediate problem is how to absorb the Y2k mainline; the 19% increase in the Fed’s balance sheet, the 24% jump in the Bank of Canada’s, the large injections by all other major central banks. Already the Bond market is in steep decline – and long-term charts as well as cold reasoning show much worse may be in store. Already, in the first few trading days of the New Year an insatiable demand for finance by overburdened but inveterate consumers, by builders caught out by the re-ignited demand for housing, and by EPS-management corporate financiers is meeting with heightened inflation fears, threats of liquidity restraint and signs of foreign repatriation. Already stocks are the richest to bonds since the 1992 recovery phase. Already, banking stocks are at their lowest since the LTCM crisis, despite still narrow credit spreads and recent strong earnings reports. Already, the almighty Dollar is looking distinctly vulnerable. Already, the weight of the $130 trillion in extant derivatives contracts the BIS estimates enumerate is beginning to crack the pillars of the temple.

The interplay of all these factors will certainly be dramatic and may be catastrophic. Feedbacks are endemic in financial markets and the smouldering could easily ignite into a wildfire starting with any of a bond crisis, a stock panic, or a dollar flight and ending by sweeping all up in the conflagration. Equity is to be avoided, Euro shorts to be unwound, Yen longs possibly essayed, perhaps Sterling or Swissy safety plays. Liquidity and credit quality should be sought, foregoing yield enhancements in lesser securities or those of longer maturity. Leverage should be cut back. This January is a time for hunkering down in the bunkers, avoiding losses, adjusting one’s mentality away from IPO mania.

Credit is not a substitute for capital, but ultimately a consumer of it. It does not create prosperity, it prejudices it. From mediaeval princes to John Law, from the German Reichsbank to the US agencies, the intoxication of easy money has always left a nasty hangover, once the frenetic whirligig spins to a halt.

Alice looked around her in great surprise.’ Why, I do believe we’ve been under this tree the whole time! Everything’s just as it was!’ ‘Of course it is,’ said the Queen. ‘What would you have it?’ ‘Well, in our country,’ said Alice, still panting a little, ‘you’d generally get to somewhere else – if you ran very fast for a long time as we’ve been doing.’ ‘ A slow sort of country!’ said the Queen. ‘ Now, here, you see, it takes all the running you can do to keep in the same place.

~ Lewis Carroll, Through the Looking Glass

Sean Corrigan writes from London on the financial markets, and edits the daily Capital Letter.