Q3 2013 FLOW OF FUNDS / PRUDENTBEAR.COM

Q3 2013 Flow of Funds

by Doug Noland

December 13, 2013


Starting to look like cracks in global markets.

Total (Non-Financial and Financial) Market Credit jumped $406bn (nominal) during Q3 to a record $58.082 TN. On a seasonally-adjusted and annualized (SAAR) basis, Total Credit expanded $1.571 TN, up from Q2’s $1.478 TN and compared to SAAR $1.155 TN in Q3 2012. As a percentage of GDP, Total Market Credit was little changed year-over-year at 344%.

Total Non-Financial Debt (NFD) jumped $377bn during the quarter to a record $41.384 TN. NFD was up $1.745 TN over the past year, or 4.4%. NFD jumped $6.860 TN in four years. In five years, NFD as a percentage of GDP has increased to 245% from 227%. So much for “deleveraging.”

On a percentage basis, Nonfinancial Debt expanded at a 3.5% pace during the quarter, up from Q2’s 3.4% and compared to Q3 2012’s 3.0%. Federal borrowings slowed to a rate of 1.5%, the weakest level since Q2 2007. Corporate borrowings expanded at a 9.2% rate, up from Q2’s 8.7% and Q3 2012’s 6.8%. Household (non-mortgage) Credit increased at a 6.0% pace, up from Q2’s 5.9%. Household Mortgage debt growth turned positive (0.9%) for the first time since Q1 2009. Total Household borrowings are on pace for the strongest annual growth since 2007. Interestingly, State & Local borrowings contracted at a 3.9% annual rate, down from Q2’s 1.1% growth.

On an annualized basis, NFD increased SAAR $1.431 TN during the quarter, up from Q2’s $1.372 TN and compared to SAAR $1.197 TN during Q3 2012. The change in the composition of Credit growth is noteworthy. Treasury borrowings slowed to SAAR $174bn during Q3, down from Q2’s $299bn and Q3 2012’s $788bn. State & Local government borrowings contracted SAAR $117bn.

Meanwhile, Corporate Credit growth is the strongest since 2007. Nonfinancial Business borrowing jumped to SAAR $981bn, up from Q2’s $934bn and Q3 2012’s $619bn. For comparison, Nonfinancial Business debt increased a record $1.317 TN in boom-time 2007, before turning negative in 2009 ($256bn). Nonfinancial Business debt increased $170bn in 2010, $543bn in 2011 and $718bn in 2012. Household debt expanded SAAR $393bn during the quarter, up from Q2’s SAAR $105bn and compared to Q3 2012’s $203bn contraction.

In 21 quarters, GDP increased 17% ($2.393TN) to $16.891 TN. Over this period, Treasury debt jumped 128% ($6.706 TN) to $11.957 TN. Federal Liabilities have increased 135% ($9.012 TN) to $15.710 TN. In 21 quarters, Federal Liabilities surged from 46% to 93% of GDP. Over this period, State & Local Liabilities jumped 76% ($2.127 TN) to $4.940 TN. Combined Federal and State & Local Liabilities have increased from 66% of GDP to 122% in 21 quarters. Over this period, Federal Reserve Assets have expanded $2.835 TN, or 298%, to $3.787 TN.

Government-Sponsored Enterprises (GSE) Agency Securities (debt and MBS) increased $52.9bn during Q3 to a four-year high $7.714 TN. Agency Securities were up $170bn y-o-y, or 2.2%. Outstanding Asset-Backed Securities (ABS), which include “private-label” MBS, declined $35bn during Q3 and fell $173bn y-o-y (to $1.629 TN). Interestingly, Home Mortgage ABS was down $150bn y-o-y, or 15.4%, to a multi-year low $819bn. Home Mortgage ABS is now about half the level compared to the end of 2009, as “private-label” MBS either default or are refinanced into lower-rate conventional mortgages.

Rest of World (ROW) holdings of U.S. assets jumped $419bn during Q3 to a record $21.996 TN, with over half of the increase explained by the increase in Equities holdings. Total ROW holdings were up $1.502 TN, or 7.3%, year-over-year. Total ROW Official (central bank) Treasury holdings jumped $1.153 TN, or 40%, between the end of 2008 to 2012 (to $4.032 TN). It is worth noting that ROW Official Treasury holdings declined $7.5bn during 2013’s first three quarters. Over the past year, Official holdings of Agency Securities declined $65bn, or 11.8%, to a multi-year low $484bn. Total ROW holdings of Agency Securities declined $145bn, or 14.1%, to a multi-year low $883bn.

Even in the face of booming equities and corporate Credit, the real economy struggles to gain momentum. National Income expanded at a 3.7% pace during the quarter (to $14.597 TN), with year-over-year growth of $635bn, or 4.5%. Compensation expanded at a 2.4% rate during Q3 (to $8.889 TN), with y-o-y growth of $298bn, or 3.5%.

Q3 federal Receipts were up 11.9% year-over-year to SAAR $2.972 TN, while Federal Spending increased just 1.3% y-o-y to SAAR $3.825 TN. Payments from the GSEs and other special items have made fiscal improvement appear better than reality. It is worth noting that Q3 State & Local receipts were up only 3.2% y-o-y, with spending rising 1.6%.

Not much notable action within the miscellaneous financials. Credit Union Assets were up 5.7% y-o-y to $1.005 TN. Finance Company Assets were down 1.7% from a year ago to $1.488 TN. Benefiting from strong securities markets, Life Insurance Assets were up 5.3% y-o-y to $5.866. The REITs were down 3.8% in four quarters to $764bn. Security Credit expanded at a 7% pace during the quarter to a near-record $1.536 TN. Securities Broker/Dealer Assets were little changed year-over-year at $2.060 TN. Funding Corp Assets were up 7.3% ($146bn) y-o-y to a two-year high $2.149 TN.

While the Corporate Balance Sheet is now expanding rapidly, the key Bubble Dynamic remains the interplay between the Fed’s Balance Sheet and the Household Balance Sheet. In one of history’s incredible “wealth” creations, a Trillion dollar expansion of Federal Reserve Liabilities – and corresponding injection of this “money” into the financial markets – saw an extraordinary one-year $7.854 TN surge in Household Net Worth.

To be sure, the Household Balance Sheet is something to behold. Household Net Worth was up another $2.122 TN (nominal!) during Q3 to a record $77.459 TN. Household Net Worth is today more than triple the level from 1994. At 459% of GDP, Household Net Worth is also not far from the year-end 2007 level (484%). In just the past two years, Household Net Worth inflated $18.631 TN, or 31.7%. It is worth noting that Household Net Worth jumped $23.807 TN during the historic four-year Bubble period 2003-2007. For further perspective, Household Net Worth increased an annual averaged $1.862 TN for the 13 years 1989 to 2002, a period notable for a historic securities bull market.

For Q3, Household Financial Assets holdings were up $1.496 TN, or 9.1% annualized, to a record $63.894 TN. Financial Asset holdings jumped $5.356 TN, or 9.1%, over the past year. Combined Equities and Mutual Fund holdings increased $917bn during the quarter to $18.299 TN, while Credit Market Instruments declined $103bn during the quarter (to $5.500 TN) and fell $41bn year-over-year. Household Deposits increased $437bn, or 4.9%, y-o-y to $9.275 TN. Since the end of 2008, combined Equities and Mutual Fund holdings were up 98% ($9.061 TN), while Credit Market Instruments increased only 6.6% ($341bn). Deposits have expanded 15.3% ($1.231 TN) since the end of 2008.

It is not only Financial Asset prices that are inflating these days. Household Real Estate holdings increased $502bn, or 9.5% annualized, during Q3 to a record $21.611 TN. Over the past year, Real Estate holdings were up $2.332 TN, or 12.1%.

The Fed’s Balance Sheet (assets) ended 1995 at $472bn, 1998 at $567bn, 2000 at $636bn, 2002 at $753bn, 2004 at $841bn, 2006 at $908bn and closed 2007 at $951bn. Fed Assets then surged to $2.271 TN in 2008 – and then ended 2009 little changed at $2.267 TN. Total Fed Assets closed 2010 at $2.453 TN, jumped to $2.947 TN in 2011 and were little changed in 2012 at $2.955 TN.

Federal Reserve Assets this week surpassed $4.0 Trillion. The vast majority of the Fed’s Assets are securities. After liquidating its T-bill portfolio, the Fed currently holds $2.178 TN of Treasury notes and other federal securities, up about $500bn over the past year. The Fed also holds about $1.70 TN of MBS, up more than $500bn from a year ago.

On the Liability side of the Fed’ s Balance Sheet, Currency in Circulation was up $72.8bn over the past year to $1.230 TN. There are a few miscellaneous Liabilities (i.e. reverse "repos" $113bn, Deposits $62bn), but the vast majority of Fed Liabilities are now “Reserve Balances with Federal Reserve Banks.” Reserves were $2.541 TN this week, an increase of over $1.0 TN from a year ago.

This additional Trillion of “Reserves” is the (electronic) “money” the Fed has injected into the securities markets over the past year. These are digital/electronic “Credit” entries in the general ledger balances between the Federal Reserve Banks and its member banks and financial institutions. These electronic IOUs are created in the process of the Fed expanding its balance sheet holdings (purchasing securities in the marketplace with newly created “money”).

There’s great confusion regarding these “Reserves.” It is a popular misconception that, since these balances sit benignly as “Excess Reserves” (surplus "cash") on bank balance sheets, this “money” is having no impact on transactions or prices. There’s discussion at the Fed to now use the interest-rate paid on these balances as a policy tool. Former Fed vice chair Alan Blinder would like the Fed to charge banks to hold these reserves, thus incentivizing the banks to lend these “reserves” rather than to do nothing with them.

I am these days reminded of when the expansion of short-term GSE liabilities (electronic IOUs) became a powerful marketplace liquidity-creation mechanism back during the nineties – yet it for years remained virtually unrecognized (was it ever recognized?). Importantly, the massive increase in the Fed’s Liability “Reserves” is a direct “money”-creation mechanism with profound effects on securities market prices (and speculative dynamics). Moreover, these “Reserves” must remain banking system Assets until the Fed sells Assets (securities) and uses the proceeds to partially extinguish its Liabilities. Said differently, Fed “Reserves” IOUs will remain in existence until the Fed extracts liquidity from the marketplace – i.e. collapses some of the liquidity it created – and reduces the quantity of its Liabilities.

To claim the Fed’s “Reserves” are large because banks are failing to lend is factually incorrect. Reserves are gigantic for only one reason: The Fed has created enormous quantities of “money” in its misguided quantitative easing program. If these $2.4 TN of “Reserves” are just sitting there innocuously, why then doesn’t the Fed commence the process of “normalizing” its balance sheet? Why is it continuing to add $85bn a month? Because once monetary inflation takes root it is extremely difficult to stop.