Outside the Box

US Private-Sector Deleveraging: Where Are We?

February 1, 2013

I was just in Greece with Christian Menegatti, and we had a good conversation about the piece he has sent along as today’s OTB. The case Christian and his coauthor David Nowakowski lay out regarding an incipient turnaround in US deleveraging (and therefore in economic growth prospects) is in some ways truly outside the box – I certainly wouldn’t call it the consensus view at this point. But they make the argument about as strongly as it can be made; so, if nothing else, they give us a solid piece of work off of which we can bounce counterarguments.

For new readers: I often feature pieces in Outside the Box that make us think and that don’t reflect my personal bias or opinion. The point is that, if you only read what you agree with, you will miss the important changes and associated opportunities when they happen. And note that this piece is from Christian, who is head of research at Roubini Global Economics – not exactly a hotbed of bullishness. (By the way, Nouriel will be at my conference this year, more on which in a few weeks.)

The authors point out that deleveraging in the US household sector is nearing completion, with consumer credit starting to releverage and home prices creeping upward. They admit that mortgage flows are still bad news – they remain in the negative territory they have occupied since 2008. Offsetting that, the authors see a promising surge in housing starts, which they project could grow by 30% this year. (But will the buyers be there, ready to load up on the debt it takes to buy a home?) Oh, and then there are those skyrocketing student-loan defaults, but they amount to “a mere $1 trillion,” say the authors, “and so [are] unlikely to trigger a systemic financial explosion” – though they do exceed both auto loans and credit-card debt.

Meanwhile, the financial sector is still deleveraging strongly, offset by nonfinancial corporations and small businesses that are leveraging up. “Unfortunately,” the authors admit, “this borrowing seems to be mainly for refinancing, cash hoarding and equity buybacks, along with some investment in capital stock, but little hiring.”

All in all, it seems to me that we are poised at a potential tipping point. Things could go as Christian and David foresee and we could find ourselves back in the territory of 2.5-3.0% GDP growth; or, as I’ve been pointing out for several months now, we could fail as a society to really turn the corner this year on our national debt and fiscal-deficit problems and find ourselves in a much deeper hole by 2015, at which point the bond market – bloodied in Europe and Japan – could lose patience with our political antics. This all points to 2013 being a very important, make-or-break year, as I have been predicting for several years.

Life on the Road

I wrap up this intro at 30,000 feet, flying back to Dallas from a whirlwind trip to Toronto, NYC, and DC. (Wifi on airplanes is truly an upgrade to civilization!) The conversations have been stimulating and enlightening. Some people wonder at my schedule, and it can be tiring at times if I am not careful, but see if you wouldn’t have wanted to come along on this trip:

David Rosenberg on Sunday evening, then the next day a lot of media, but especially an in-depth conversation with Rick Rule, who now is with Sprott Asset Management. Rick and I go back (ahem) decades. I remember writing in the ‘90s that he was my favorite analyst and investor in the natural resource arena. He still is. Eric Sprott demonstrated a great deal of sagacity and his usual business shrewdness in buying Rick’s company. (Rick would self-deprecatingly say that Eric was reckless.) The resources world has been beaten up badly the last few years, which piques my interest. Only the committed want to hang around there now – which is of course why you should start paying attention again. At least if you share my contrarian views.

New York was fun, as always. I really love the city – one of my favorite places in the world, at least for a few days a month. Drinks with Rich Yamarone, chief economist at Bloomberg, who nailed the GDP number that came out the next day, shocking everyone but him. Dinner? A small affair with Barry Ritholtz (the Big Picture guy), Christian Menegatti, investment legend Jack Rivkin (he just drips savvy thoughts), and Danielle DiMartino (who works for the Dallas Fed and is wicked brilliant). Dinner went too long, as we just kept at it. I struggled the next morning, but Tom Keene at Bloomberg tends to get your juices flowing. I need to figure out where he gets his energy.

Then it was down to DC, where I met with Newt Gingrich, business partner Olivier Garret (we’re planning yet more offerings from Mauldin Economics), and then with Zach Mallove, chief of staff for Senator Patty Murray (D-WA), who is chair of the Senate Budget Committee. And the cream in the coffee? I got to spend a long lunch with Andy Marshall. Andy is 91 and runs the Office of Net Assessment for the Department of Defense (their future-scenarios think tank). He was appointed by Nixon and has been reappointed by every president since. He is an institution and a legend to anyone who has a futurist bent. Dear gods, what an honor. (Thanks to his associate and my good friend Dr. Andy May, who sets these things up.) Andy Marshall and I shared notes and thoughts, of course, but I learn more from his questions than I do from the entirety of most conversations. I mean, if Andy is interested in something, I need to pay attention and give it more research time myself.

The travel? Lately, the only real annoyances have been TSA and small, no-leg-room taxis with irrational drivers. My personal experience is that customer service has seen a major improvement almost everywhere in the last five years. Someone obviously sent that memo to the Trump hotels in Toronto and NYC (my first time to stay in a Trump facility, and not my last). How the heck does the general manager in Toronto greet me by name when I get off the elevator? And not just him. It was almost spooky the way I was recognized. Someone teaches name-memory courses there. And the taxi ride from La Guardia must have left me visibly shaken, because the staff caused a procession of drinks and food to magically appear in my room in short order, without my requesting it. You might not like the Donald’s hair or politics, but he does know from creating a service-oriented experience.

The personnel at the Hyatt in Crystal City also went out of their way. The shuttle service to the airport left a little early, and I missed it. The young attendant standing nearby stopped me from hailing a taxi, ran to get the keys to a car, and drove me to the airport. I asked him if he knew I was Hyatt Platinum, and he did not; he just saw a chance to make a customer happy.

That type of extraordinary service helps make the life of a road warrior pleasurable. And Teresa, here on this American Airlines flight, is a delight. I actually enjoy flying American. For me, 6B is just another office chair. American’s service level has also jumped in the last few years.

I mean, really. I can stay at home and sit in front of my computer and have a week with more hassles than that. I am looking forward to being at home with my kids and friends and to sleeping in my own bed, but I find trips like this one energizing and massively intellectually stimulating. Not to mention the times with readers and friends. There was a time when life on the road was lonely and not at all fun, but those memories have long faded. Now if I can just schedule more gym time when I’m on the move.

Your just finding life fascinating analyst,

John Mauldin, Editor
Outside the Box

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U.S. Private-Sector Deleveraging: Where Are We?

By Christian Menegatti and David Nowakowski

Roubini Global Economics

• Question: Are U.S. households done deleveraging? Answer: Getting there; thanks to consumer credit rebounding, household debt increased in Q2 2012, for the first time since 2008, although it dipped again in Q3. Consumer credit held up with a significant acceleration in the pace of releveraging in 2012. Mortgage debt is still shrinking, as homeowners…

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Feb. 3, 2013, 5:12 p.m.

One cannot take the conclusion in this presentation seriously as the authors have conflated inflation data.  “However, in the early 1980s and 1990s, inflation (and nominal GDP) was running at over 10% and 6%, respectively—that has not been the case during this deleveraging episode.”  If one is to compare inflation data from the 80’s and 90’s to today, then one must use the same equation.  We all know the government has modified the calculation of today’s inflation to understate it dramatically.  Thankfully, John Williams provides charts on his website using the same equation used in the 80’s and it clearly shows inflation today is equivalent to the 80’s, hovering around 10%(http://www.shadowstats.com/alternate_data/inflation-charts).  Because the authors are using an inflation rate well below reality, all of their real income and real GDP growth numbers are way overstated, and, therefore, their conclusions are likely incorrect.

Dallas Kennedy

Feb. 1, 2013, 10:37 p.m.

I keep hearing about this releveraging, but I find the whole argument about reacceleration of growth very dubious. There’s little evidence for it.

Growth slowed down all last year and amounted to about 1.6%, if you take the official inflation numbers (less if you use a higher and more realistic number). Earnings are in a recession. Much or most of the household releveraging is just the explosion of student debt. Maybe that allows someone in the household to buy an iPhone or Galaxy. It doesn’t matter in the end, because it just speeds up the next episode of debt crisis that’s coming. Watch Japan for the next act.

Wayne Materi

Feb. 1, 2013, 6:30 p.m.

Several things really stood out in my mind from this article:
1) Although consumption rebounded rapidly in 2008-9, home equity did not, leading to a breakdown in the previous correlation between the two.  At the same time student loans and other consumer credit ballooned, while unemployment remained high, suggesting that people turned away from asset collection to lifestyle financing through increased personal debt. If unemployment does not reverse soon, this could seriously impair future growth through an even more-rapid increase in the number of delinquent student loans (at over $1T this is anything but insubstantial).
2)The household debt-service ratio is being held artificially low by historically low interest rates set by the Fed. This ratio is obviously sensitive to an inevitable increase in interest rates and could become altered rapidly when the Fed (or the rest of the world) decides that interest rates do not reflect loan risks accurately.
3)Household net wealth has been rebuilt but mostly on the back of financial investments (presumably in the Fed-assisted equities and bond markets).  Thus net-wealth is now subject to high variability and rapid evaporation as these markets are not known for being kind to the small investor.

Thus, although things seem to have gotten better over the past few years and seem to be slowly improving overall (absent any noticeable improvement in unemployment), the improvements seem to be sensitive to current Fed policy and predicated on a return to the “old normal.” Japan is obviously interpreting their different experience as being due to insufficient Quantitative Easing and has pledged to correct this over the coming year.  Whether having at least three of the world’s largest economies (the US, EU and Japan) all racing to print great sums of their currency at the same time can occur without having some overall severe impact on factors that these statistics are sensitive to, remains to be seen.