Friday, August 12, 2011

Deleveraging: Four Years in and Still no Sign of It

A primary argument of the deflationists since 2007 has been that aggregate de-leveraging of the US economy is putting downward pressure on prices.  It follows that despite how much money is printed in the form of quantitative easing, this de-leveraging process will hold inflation and interest rates low.

The argument makes sense when looking at private (consumer and corporate) balance sheets.  Within these two sectors there has been (modest) de-leveraging.  However, on an aggregate level, taking the government into account, there has been no deleveraging since the financial crisis.  The US Government has merely filled the void of private sector de-leveraging by increasing the pace of its own debt accumulation.

I think this idea is generally pretty well understood: the US Government has declared a Keynesian war against deleveraging and is attempting to not just mitigate the effects of the deleveraging process, but actually perpetuate aggregate credit growth.  Still, unless you're paying close attention, I think it's easy to overlook the extent to which Uncle Sam has actually succeeded in this (arguably futile and even dangerous) goal.  Below are some exhibits to highlight that the American Government can do anything it sets its mind to--even if it doesn't always make a whole lot of sense.

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The above chart shows unequivocally that total non-financial sector debt has continued to grow even as the private sector de-levers (somewhat).

The chart below shows that the rate of accumulation of new debt has hardly even slowed at an aggregate level. As shown below, over the past 3 years, the aggregate amount of credit outstanding in the US has increased at about a 5% rate, which is not drastically different from other three year periods.

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The implications of aggregate credit growth to a deflationist argument are important.  Even if one believes that de-leveraging still will occur eventually, it clearly hasn't yet.

Perhaps even more important though are the implications to the inflationist's argument that de-leveraging is occurring via inflation.  A 5% growth rate in aggregate debt is high enough that de-leveraging has hardly taken place relative to GDP.  That casts doubts on the "back door de-leveraging through inflation" argument.  Sadly, all that has occurred in the last 3 years is a continued coil of the aggregate leverage spring.

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