Q4 2013 "FLOW OF FUNDS" AND GEOPOLITICAL / PRUDENTBEAR.COM

Q4 2013 "Flow of Funds" and Geopolitical

by Doug Noland

March 7, 2014


Ominous geopolitical meets exuberant markets. During Q4 2013, Total System Credit increased (nominal) $840bn to a record $58.991 TN, or 345% of GDP. On a percentage basis, total Credit expanded at a 5.8% rate during the quarter, up from Q3’s 3.8% but still below Q4 2012’s 6.2% pace. For all of 2013, system Credit expanded $2.139 TN, compared to 2012's $1.613 TN increase. Total Corporate debt expanded $915bn, or 7.2%, to $13.622 TN. Non-financial Corporate debt expanded $783bn, or 9.0%, second only to 2007’s $856bn.

Total Non-Financial Debt (NFD) expanded nominal $629bn during Q4, a 6.1% pace, to a record $42.021 TN. NFD expanded $1.734 TN for all of 2013, down slightly from 2012’s $1.882 TN increase. For comparison, NFD expanded $1.070 TN in ’09, $1.472 TN in ’10, and $1.376 TN in ’11. During the past five years of so-called “deleveraging,” NFD increased $7.296 TN, or 21%.

On a seasonally-adjusted and annualized (SAAR) basis, total system Credit expanded $2.246 TN during Q4, the strongest pace since Q4 2012. At SAAR $1.394 TN, Federal borrowings were at the highest level in seven quarters and accounted for 62% of total system Credit growth. Total Corporate borrowings increased SAAR $948bn during Q4. Total Household debt expanded SAAR $49bn (0.4% rate), with non-mortgage consumer debt expanding SAAR $166bn, largely offset by a SAAR $93bn contraction in mortgage borrowings. A notable market tightening of muni finance saw State & Local borrowings contract SAAR $145bn, or 4.9%. This was the steepest quarterly decline in municipal debt in years.

Interestingly, Financial Sector market borrowings expanded SAAR $612bn during the quarter, or 4.4% annualized, to $14.081 TN. This was the strongest growth since 2008. By category, “Agency- and GSE-Backed Securities” expanded SAAR $374bn during the quarter to $7.793 TN (high since ’09). From their yearend 2008 high of $8.167 TN, GSE Liabilities have declined only 5%. For the quarter, GSE debt expanded SAAR $206bn and GSE-backed MBS increased SAAR $144bn. For 2013, total GSE Securities expanded $239bn, the first annual growth since 2008, in part financing large payments to the federal government (counted as “receipts”).

Federal Receipts expanded a notable $375bn, or 14.1%, during 2013 to a record $3.038 TN. And with Expenditures up only 0.5% to $3.792 TN, the federal "deficit" registered a significant decline (to a still huge $755bn). I would not extrapolate either the surge in receipts or the rapid slowdown in spending growth. The GSEs and Fed remitted huge sums to the Treasury, while the Fed’s Trillion plus injection of liquidity into the markets created capital gains, corporate profits and a general boost to cash-flow throughout the economy. It is as well worth noting that 2013 federal spending was still almost a third higher compared to the 2007 level.

The banking system continues to show a mild pulse. Bank (“Private Depository Institutions”) Assets expanded at a 4.9% rate during the quarter to a record $15.779 TN. Strong Q4 expansion put 2013 Bank Loan growth at $185bn, or 8.0%. Total Bank Assets were up $956bn for the year, or 6.4%. Yet Reserves (at the Fed) were by far the most rapidly growing bank asset. Reserves jumped $758bn, or 51%, year-over-year to $2.249 TN.

There continues to be little indication of a more broad-based Credit expansion. Finance Company assets declined 1.3% in 2013 to $1.474 TN. REIT liabilities were down 4.4% year-over year (to $761bn). Credit Union assets increased 4.5% in 2013 to $1.005 TN. Broker/Dealer assets expanded about 1% y-o-y to $2.087 TN. Funding Corps gained 2.3% to $2.137 TN, while Fed Funds & Repo contracted 2.9% to $1.919 TN. Asset-Backed Securities contracted 8.7% last year to $1.616 TN, likely partially explained by “private-label” mortgages continuing to be refinanced into lower-cost agency-backed mortgages. Then, as a GSE MBS, they can make their way onto the Fed’s balance sheet.

For “flow of funds” purposes, the Fed’s balance sheet is not included in “financial sector” aggregates. For 2013, Fed holdings increased $1.119 TN, just shy of the $1.319 TN crisis year 2008 surge. Last year, Treasury holdings jumped $543bn and MBS holdings rose $564bn. Total Federal Reserve Assets ended 2013 at an unprecedented $4.074 TN. Fed Assets have inflated 328% during six years of the greatest central bank experiment in history.

As I’ve highlighted over recent “flow of funds” analyses, the Household balance sheet remains fundamental to the Fed’s reflationary policymaking. For the quarter, Household Assets increased another $2.403 TN to a record $94.419 TN. And with Household Liabilities up $127bn, Household Net Worth jumped $2.276 TN (13% of GDP!) during Q4.

Household Net Worth inflated a staggering $8.184 TN in 2013, or 11.8%, to a record $80.664 TN. For comparison, Household Net Worth jumped $7.089 TN during 2006 and $6.023 TN in 2007. Over the past five years, Household Net Worth inflated $23.484 TN, or 41%. In five years, Household holdings of financial assets surged 43.5% to end 2013 at a record $66.949 TN, or a record 399% of GDP. For comparison, Household holdings of financial assets ended 1995 at about 300% of GDP before peaking at 385% of GDP to end 2007.

In piecing together recent “flow of funds” analyses, I have not given the Rest of World (ROW) segment the attention it deserves. ROW ended 2013 with holdings of U.S. Financial Assets at a record $21.940 TN. Holdings were up $1.296 TN, or 6.3%, year-over-year. ROW holdings of Treasuries ended Q4 at $5.842 TN, up from $2.376 TN to end 2007. ROW ended 2013 with $862bn of Agency/GSE securities, $822bn of Securities “Repos,” about $1.35 TN of bank deposits and net interbank assets, $2.730 TN of Corporate Bonds, $4.656 TN of Corporate Equities, $1.043 TN of Mutual Fund Shares, and $3.823 TN of Miscellaneous Assets (chiefly foreign directed investment).

ROW holdings of U.S. Financial Assets ended 1995 at $3.653 TN, before closing the nineties at $6.209 TN. Unprecedented Current Account Deficits were largely behind the explosion of U.S. financial claims that inundated the world. ROW holdings ended 2007 at $16.199 TN. And in the past five years, ROW holdings of U.S. Financial Assets have surged another $6.554 TN, or 42.6%, to reach almost $22 TN.

I often refer to global central bank international reserve holdings as a good proxy for the dollar liquidity that has destabilized the global financial “system” over recent years. The incredible growth in foreign holdings of U.S. debt and other financial claims similarly reflects this process that has been ongoing for at least the past two decades.

We’re now fully five years into the “global government finance Bubble.” I have argued that the emerging markets (EM) have been a major recipient of post-mortgage finance Bubble reflationary monetary stimulus. I have posited that EM is this global Bubble’s “subprime.” Moreover, it is my view that the EM Bubble is in the initial phase of deflating.

I stick pretty close to home in my Credit and Bubble analysis. At the same time, it’s fundamental to my money, Credit and Bubble analytical thesis that unchecked monetary inflations and attendant Bubbles have profoundly deleterious effects on financial systems, economies and societies.

I have for some time fretted the geopolitical ramifications of a runaway global financial Bubble and its eventual bursting. From a global perspective, the crazy growth in Fed “money” printing isn’t unrelated to Draghi’s “do whatever it takes” that is not unrelated to “Abenomics” and crazy printing by the Bank of Japan that’s not unrelated to crazy Credit excess in China and throughout EM. All the craziness is symptomatic of deep structural maladjustments in finance and economies on a global basis. And with my view of faltering Bubbles and mounting stress in the emerging markets, I have been on guard for heightened geopolitical instability.

After dropping to $368bn in early 2009, Russian international reserve holdings jumped to almost $500bn by mid-2011. Russian reserves ended 2013 at $470bn, little changed over two years. After expanding at about a 5% pace throughout 2010 and 2011, the Russian economy has since largely stagnated. The Russian ruble has declined 15.8% over the past year, with Russian stocks (RTS Index) down 24% and bond yields up almost 200 bps.

March 7 – Financial Times (Catherine Belton): “An ally of Vladimir Putin has accused the US and a ‘global financial oligarchy’ of organising the violent overthrow of power in Ukraine to ‘destroy’ Russia as a geopolitical opponent. Vladimir Yakunin, a former senior diplomat who now heads Russian Railways, the state railways monopoly, claimed the US had for decades been intent on separating Ukraine from Russia and bringing it into the west’s fold. ‘We are witnessing a huge geopolitical game in which the aim is the destruction of Russia as a geopolitical opponent of the US or of this global financial oligarchy,’ Mr Yakunin said…”

I’ll suggest that the Ukraine crisis potentially marks a critical juncture in global geopolitics. Having been mismanaged and pilfered for years, the Ukraine economy is a basket case and social tinderbox. Meanwhile, the Russian leadership may have calculated that losing the Ukraine to the West at this point would entail unacceptable economic and political costs. The Russians may have decided these costs outweigh the waning benefits associated with the current global financial and economic landscape. Russia and other countries may no longer believe they are benefitting from the forces of global monetary inflation. They may these days see themselves increasingly as losers.

I fear that the unfolding Ukrainian crisis and rising tensions between China and Japan are no mere coincidence. I have no reason to believe that Russian and Chinese officials are coordinating their geopolitical thinking, maneuvers or strategies. I do, however, sense that the changing global financial and economic backdrop is altering incentives, disincentives and the calculus of cooperation, coordination and confrontation.

The world is indeed changing, but certainly not in the manner those seduced by inflating securities prices behold. Sure, central bank liquidity is still expanding and the global debt mountain just keeps rising to the stars, increasingly unhinged from real economic wealth. Yet the global economic pie has begun to decay. I fully expect mounting domestic economic and global political pressures to increasingly dictate a much more aggressive stance with respect to “geopolitics.”

I’ll further add that I don’t believe the ongoing melt-up in U.S. stocks and the rapidly deteriorating geopolitical backdrop are coincidental. Again, from my analytical framework, both are creatures of historic monetary inflation. Serious (faltering Bubble) stress at the “periphery” now dictates erratic behavior many would view (from the old world view) as irrational. Meanwhile, liquidity flooding into the “core” feeds a historic speculative Bubble. The Russians might very well see it in their relative best interest to dig uncompromisingly in for the long hall, believing the West actually has more to lose. The backdrop would seem to ensure we’re entering a period of extraordinary uncertainty, although over-liquefied securities markets remain priced for extraordinarily low risk.