Comstock: Liquidity Trap Means QE Will Fail As Private Sector Deleverages
Excerpts from Comstock’s latest weekly:
Debt is discussed by the pundits on financial TV also, but in almost every case the discussion revolves around government deficits relative to GDP or government debt relative to GDP. They are constantly comparing the U.S. government debt to every other country in the world (especially Portugal, Italy, Ireland, Greece, and Spain-PIIGS). We believe that the government debt should be taking a back seat to the private debt which is much larger and must eventually be deleveraged.
The private debt is about 6 times larger than our government’s public debt; about 4 times larger than our government’s gross debt (including the government debt used to fund our Social Security shortfall); and about 2.5 times the gross government debt plus the total state and local debt. Household debt alone is equal to 96% of GDP; private domestic nonfinancial debt is 183% of GDP; total credit market debt is 357% of GDP (see first chart Selected Debt Measures as a % of GDP). Please note that the only form of debt that isn’t rolling over is the government debt.
This point really bears noting. Everyone is focused on government deficits when the US debt problem is the private sector debts – households and the financial sector. As an example, total household debt is about 100% of GDP according to the Fed Flow of Funds. Financial sector debt is even higher. Meanwhile federal government debt is much lower. See A brief look at the Asset-Based Economy at economic turns for the charts. The near collapse we suffered in 2008 and 2009 was due to debts in the financial and household sectors – not the government sector. But, then came the socialization of losses that have combined with automatic stabilizers and dwindling tax revenue to run government debt up. Comstock says this will continue.
We have been predicting for over 3 years that the government debt (including public, gross, and state and local governments) will increase substantially, while the private debt (all forms) will roll over and decline substantially. In round numbers total credit market debt is $55 trillion and government debt is $15 trillion, leaving private debt at approximately $40 trillion. We have drawn debt cones (see 2nd chart-debt cones) to illustrate the concept. We believe the government debt will rise towards the $30 trillion level while the private debt will drop towards the $20 trillion level. This coincides with the Cycle of Deflation (next chart) which we authored years ago.
Comstock says this set of circumstances means the Fed is pushing on a string. We are in a liquidity trap and no amount of QE is going to get the job done.
Most bears on the stock market are fearful that the Administration and Fed are printing far too much money and this will result in potential runaway inflation. We, on the other hand, do not think the results of the Fed’s balance sheet increasing through quantitative easing (QE) will result in inflation in the next few years, although it could very well be a serious problem further down the road. We believe the private sector debt will continue to decline (deleverage) regardless of what the Fed and Administration do to attempt to jolt the economy.
As I have said, first the deflation, then the inflation.
The reason that the attempt at money printing to juice the economy will not work, in our opinion, is that the whole private sector is frozen due to the fear of losing more money. Corporations are continuing to build up cash positions and individuals are afraid of taking risk in this environment. The latest economic releases verify our opinion that the private sector is losing confidence. Corporations are afraid to take on more employees…
It seems everyone is waking up to this fact – namely that corporations are saving a lot money. I have said in the past that deficit spending to stimulate the economy will increase private sector savings purely because of the national accounting identities (the financial sectors must balance). The key here is that the government doesn’t get to decide who does the saving.
In fact, the Federal Reserve’s low interest rates discourages household sector savings and promotes the accumulation of debt. The government may expand in order to induce an increase in net private sector savings, but fiscal expansion is a blunt instrument. The government cannot (in the short-term) determine where capital account or private sector surplus is directed or held. Right now, government deficit spending is increasing business savings and not household savings.
If you want to take a statist approach, you could tax the bejesus out of these companies for not investing in America. That’s not what I would recommend but that is an idea on offer. What would be beneficial is if the household sector were the net savers so that they could deleverage. Instead corporations are net saving. And given productive overcapacity, instead of investing in more capacity they are buying back shares. At least the financial sector is deleveraging. That is what we want. But it would be nice to see the household sector deleverage or at least see economic policy geared in that direction instead of zero rates which are geared to consumption. Zero rates may be helpful to debtors, but zero rates are also a tax on savers. That means consumers are not in a position to take on more debt.
Comstock concludes:
The Fed believed that Quantitative Easing (QE) would stimulate the economy much more than it did. QE includes all of the measures the central bank takes to increase the monetary base, hoping that this translates into increased money supply. However, in the current credit crisis QE is not working as well as the Fed and Administration expected. While it has succeeded in jump-starting the monetary base it has failed to increase the money supply or velocity (the ratio of economic transactions to the money supply). Thus, while the banks now have the ability to make new loans, not enough qualified borrowers are interested in borrowing money, and banks are not willing to loan money to anyone that is not a prime borrower…
When velocity is low the nation essentially winds up in a "liquidity trap" which is a situation where monetary policy is unable to stimulate the economy either through lowering interest rates or increasing the money supply. This was the condition that Japan found itself enveloped in from 1989 to present. We expect the same problem in this country and hope (really hope) to be wrong. If we are lucky we will be able to go through the slowdown we expect (or double dip) and repair the household balance sheets enough to grow out of this mess in less time than it is taking Japan.
That’s not going to happen. What is clear is that policy makers are addicted to things like cash for clunkers, zero rates and quantitative easing because they help boost consumption and asset prices. Repairing household balance sheets is not the focus of anything I have seen coming out of Washington. Dilbert has it right about the elites’ rallying cry: "We need another economic bubble. Assemble the illuminati."
Source: Debt is Still the Major Problem and Deflation is the Painful Solution – Comstock Partners
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