Wednesday, June 5, 2013

Does Credit Drive The Economy Part II

As a follow-up to my previous post on the subject, I decided to try an alternative methodology that compares gross public spending and net private debt on an annual basis in analyzing the composition of new money creation. The graph is below. I tried to make it prettier than the previous one but I still haven't figured out how to reduce the number of decimal places on the Percentage axis (last time I did it manually…too time-consuming). It's a free program so I can't complain:

My observations…others may see more…

The peaks and valleys are more extreme, but they tend to oscillate around the 40% (average) level, just as the moving average in the original graph did.

For the years 2009 thru 2011 private debt went negative so the ratio can't be calculated. For the year 2012 private debt contributed about 5% to the new money total before taxes.

For the years that net private debt went negative (debt service exceeded new loans) private debt subtracted from total spending. What a drag!

The point that net private debt plunged drastically and went negative corresponds generally to the time the GFC hit.

Clinton's balanced budgets (or very nearly balanced) occurred in the years 1998 thru 2001. Spending declined drastically between 1992 and 1997, from $340B/year to $103B/year. These years correspond to a marked increase in debt issuance. We had headroom…we used all of that and then some.

That's about when banking policy enabled lending to borrowers that were marginal at best and uncreditworthy at worst…prudent underwriting was abandoned.


We appear to be approaching a stable balance between debt service and incomes…I don't think we're quite there yet but at least debt service isn't dragging the economy down any longer. This doesn't mean borrowing will necessarily accelerate.

Private debt (mainly households) can drive the economy…into recession.

It's all on public spending from here on out.

Sunday, June 2, 2013

Does Credit Drive the Economy?

Much of the commentary on the economy seems to assume that it is driven by credit. The statement often made in blogs and news articles is that 90% or more of the money in circulation is private debt, the rest coming through net government spending, so clearly credit (debt) must be the main driver of the system. It's obvious. A caveman could see it.

I believe this is a gross mischaracterization of how the system actually functions.

Where do these claims regarding credit domination of the system come from? Is it truth or fiction. From what I had seen it was nothing more than an article of faith, I had never come across any proof or support that this was actually the case.

Based on the claims, the "money supply" people must be alluding to is the supply of dollars in existence within the domestic non-government. This is pretty simple number to figure out…

…The total level of state money in the private economy should be equal to all public spending plus all private debt outstanding less federal taxes and net exports.

All we have to do is compare the two sources of spending over time to get a handle on their respective contributions to the "money supply" that is being alluded to.

The solution requires downloading some data from FRED and making some necessary adjustments because some datasets are annual amounts and some are accumulations or running totals. The data we need:

1. FGEXPND - Current Federal Expenditures (Annual totals, must be converted to a running total (a balance) to be compatible with TCMDO). This is equivalent to adding a balance column in your checkbook.

2. TCMDO - Total Credit Market Debt Owed. Straight from FRED, a balance.

3. FYGFDPUB - Federal Debt Held by the Public. Also straight from FRED, also a balance.

Why do we need FYGDPUB? Because TCMDO includes public debt, which we must subtract to get to the total private debt.

The first step is to prepare the data and enter it into a graphing program. Converting FGEXPND to a running total gives us a series I've called rtFGEXPND.

TCMDO minus FYGFDPUB gives us a private-debt only series I have labelled pdTCMDO.

Next, we have to sum the two series rtFGEXPND and pdTCMDO to get the Total annual spending series.

Finally I created a series that plots Private Debt as a percentage of Total Spending. Note that it is not necessary to subtract federal taxes or net exports from the series to get the ratio, they merely reduce the level of money supply not the ratio between public spending and private debt. The relationships in equation form are:

Money Supply = rtFGEXPND + pdTCMDO

pdTCMDO(%) = pdTCMDO ÷ Money Supply

The graph of the result is shown below:

Since 1970, credit has accounted for between 36% and 47.5% of the total number of dollars spent into the economy (and bad things happened at that peak), currently standing at just under 40% of the "money supply". My seat-of-the-pants observation is that a healthy credit/public spending ratio is centered at no more than about 40%.

At no time in the past 43 years has credit ever accounted for anywhere near 90% of the "money supply". It's an urban legend.