Credit & Money Supply in the USA and China

As explained before, inflation and deflation within a certain territory are defined as increase and decrease of the total volume of money plus credit in that territory.

Total Credit Volume

Probably the best approximation on the development of total credit outstanding in the US is the Federal Reserve’s so called Flow of Funds report’s data series “Total Credit Market Debt Owed“.

The long term series shows us the historical relevance of 2008’s credit event:


As I predicted before, I believe that the US has reached peak credit in 2009 and is now on a long term path of credit contraction. I would consider the 2010 bump an anomaly, one that was brought about and fueled by massive and unprecedented government stimulus and bailout programs, and a general yet tentative mood of things potentially looking up again.

As I also predicted, it will be those stimulus and bailout programs that will be aggravating the agony and sluggishness, and prolonging the duration of this necessary correction:

Neither is there any need to be surprised about the fact that all countermeasures taken by the government will turn out to be utter failures that will accomplish nothing but aggravate the crisis. For if the cause of the problem has been too much government intervention, then more government intervention will only add to it.

Zooming in, we can see that as of Q2 2011 (the latest quarter available in the data series) it looks like all these countermeasures have run out of steam and total credit has begun contracting again, from around $52,650 billion to around $52,550 billion, a contraction of roughly $100 billion:


Money Supply

I have recently come to realize, mostly based upon this article that the Treasury’s Supplementary Financing Program really seems to be nothing but another sort of checking account that the federal government holds at the Fed, in particular it is actual spendable money, not just a reserve balance that would still need to be loaned out in order to become spendable money. And as you can see, the Treasury does spend the money, since it obviously regularly draws upon that account, to the point where now the balance on there is zero again. Thus I will from now on include it when adding up the different components to come up with theTrue Money Supply.

Based on that we can see that the true money supply is currently at $2,592 billion, and that so far its been able to maintain its growth through 2010 and 2011 for the most part:


The growth rate is currently at around 6.19% and has been recovering from a low 1.28% around April:


During the period from Q1 to Q2 2011, which is the one we observed credit growth for above it has risen from $2,417 to $2,458, so by about $41 billion, which is less than the volume of credit contraction. And since then through now the money supply has roughly risen by another $140 billion (we’ll have to wait for the Q3 Flow of Funds report to see by how much this may or may not have been counteracted via credit contraction).

Overall it seems as though it is still a pretty close call between inflation and deflation, with inflation having certainly been the dominating force during 2010 and maybe also 2011, but slowly coming to a halt as credit expansion seems to have come to an end at this point.

We’ll have to wait and see what the next few months bring.

Money Supply in China

M1 in in China has most recently begun to fall:


The growth rate has now slowed to around 10%, coming closer to that in the US:


Money supply in China is slowing most likely as a result of contracting credit as a correction from prior government stimulus malinvestments.

As I said before, the Chinese housing bust is underway, the Chinese economy is headed for a severe recession, and that’s what the slowdown in the money supply growth rate may very well be indicating at this point.

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S&P 500 Now vs. Nikkei in 1989; How Low Can We Go From Here?

I have often compared the current situation in the US to Japan in the 90s. Indeed, a lot of the characteristics of the current contraction match what went on in Japan back then.

Since 1989, the Nikkei index has dropped from just below 40000 to now around 9000. It is conceivable that US stocks will see similar declines over the next decades, along with spectacular counter trend rallies from time to time.

Below I put together a chart that shows how the Nikkei has fared since the bust of the Japanese credit bubble in 89 vs. the development of equities in the US (S&P 500) since the bust of the US credit bubble in 2007:


As you can see, since the crash, both charts have behaved rather similar. Immediately after the crash, the Nikkei, too, staged a phenomenal 35% rally from around 20000 to around 27000. If US equities continue mimic the events two decades ago in Japan, it is indeed conceivable that we may see an S&P 500 in the 200s or 300s in ten years or so.

Along with that would come several periods of renewed optimism and spectacular rallies. Just as an example, look at the Nikkei’s rally from 1998 through 2001, a 140% increase!

All this would be consistent with my long term outlook for the US economy:

From 1989 on, the Japanese government has launched one stimulus after another to no avail, leaving Japanese taxpayers with the largest public debt per capita of all industrialized nations.

A burden that the US government seems to be more than willing to have its taxpayers shoulder over the years to come unless someone picks up a history book and tries not to feverishly repeat mistakes others made in the past.

Thus the long term outlook for the US economy is the fate Japan took: A long lasting correction supercycle with one failing “stimulus” program after another, and with on and off periods where the economy slips out of and back into recessions from time to time.

Just for fun, I attempted an Elliot Wave count of the indexes above because I think that the EWave formation really screams at you in this case:


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US Repeating Japan’s Mistakes

Moneymorning writes U.S. Making Same Mistakes that Led to Japan’s Lost Decade, Say Analysts:

Experts on the Japanese financial crisis, which culminated in 10 years of stagnation known as the “Lost Decade,” are fearful that the United States is making similar mistakes with its recent bailout efforts.

The two meltdowns started in much the same way – with busted stock-and-real-estate bubbles. With both the United States and Japan, whose market manias ignited by laughably loose credit policies, smoldered under a lack of oversight from government regulators, market analysts or such private-sector sentinels as credit-rating agencies, and were finally fanned into a frenzied financial conflagration by the promise of easy profits.

The real estate bubble popped and Japan paid the price then, as the United States is paying now. Banks were left holding trillions of yen in loans that were virtually worthless.

By early 2004, houses were selling at 1/10th their peak value, and commercial real estate was selling for less than 1/100th of its peak-market value.

The Nikkei 225 stock index had dropped by almost three-quarters from its heights. All told, an estimated $20 trillion in stock market and real-estate wealth vaporized (although one could easily argue that the peak values weren’t real to start with).

Over the course of a decade, a succession of government policymakers waded through the crisis and routinely fell short of solving it. The Japanese lowered interest rates, increased government spending, pumped cash directly into banks and even tapped private capital to help buy some of the bad assets from banks.

All of these measures failed. Japanese taxpayers are estimated to have recouped less than half of what it cost the government to bailout the nation’s banking sector.

Yet, the U.S. government has employed many of the exact same tactics.

The benchmark Federal Funds rate stands a range of 0.0% to 0.25%. More than $350 billion has been poured into financial institutions in an effort to shore up their balance sheets and spur lending. And last week, newly appointed Treasury Secretary Timothy Geithner outlined his proposal for a Public-Private Investment Fund, which will buy up many of the toxic assets that have bogged down banks’ balance sheets.

“I thought America had studied Japan’s failures,” Hirofumi Gomi, a top official at the Japanese Financial Services Agency, told the International Herald Tribune. “Why is it making the same mistakes?”

Indeed, many analysts believe the largest U.S. banks to be insolvent, with more liabilities on their balance sheets than assets. These analysts believe the only thing left for U.S. officials to do is the same thing Japan ended up doing: Force major banks to declare their bad debts, and then weed out the weakest and recapitalize the survivors.

Japan’s delay in aggressively seizing control of the banking sector cost the economy trillions of dollars and years growth.

The historical record shows that you have to do it eventually,” Adam S. Posen, a senior fellow at the Peterson Institute for International Economics, told the New York Times. “Putting it off only brings more troubles and higher costs in the long run.”

Nouriel Roubini, a professor of economics at the Stern School of Business at New York University, estimates that total losses on loans by U.S. financial firms and the fall in the market value of the assets they hold will reach $3.6 trillion, with half of that risk falling squarely on the shoulders of banks.

“The United States banking system is effectively insolvent,” Roubini said.

However, the government is hoping that over time, the economy will start to recover and some of the bad debt that banks are currently holding will start to regain its value.

“If [financial institutions] had to sell these securities today, the losses would be far beyond their capital at this point,” Raghuram Rajan, a professor of finance and economist at the University of Chicago told the Times. “But if the prices of these assets will recover over the next year or so, if they don’t have to sell at distress prices, the banks could have a new lease on life by giving them some time.”

The strategy has worked before, notably during the Latin America debt crisis of the 1980s. The total risk to the nine money-center banks in New York was estimated at more than three times their capital, the Times reported. But regulators did not force those banks to value the loans at the hugely depreciated value of the market and averted a catastrophe.

Marking assets to market is the only way to allow for the correction of this business cycle. The longer we wait for it, the longer it will take. If we wait 10 years it will take 10 years, if we wait longer it will take longer.

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