Flow of Funds Report: Credit Market Shrinks for Every Sector Except Government

The Flow of Funds report covering the second quarter of 2009 (through June) was released Thursday by the Federal Reserve and it revealed yet another retreat in total credit despite the heroic levels of state and federal government borrowing.

One of the better windows we have into the macro credit and borrowing universe is a quarterly report put out by the Federal Reserve called the "Flow of Funds" report. While it is a bit dated already (the report covers through the end of June) it is a great snapshot of the big trends and can tell us much about the general direction in which we are headed. This report was released on September 17th at 12:00 p.m.

Here are a few of the fascinating findings…

While total credit market debt was down by -$122 billion from Q1 to Q2, or slightly less than a quarter of one percent overall, there was quite a bit of variability across all the sectors.

A quick explanation: the Flow of Funds report has two main sectors; "non-financial" and "financial."

• In the non-financial sector (about 2/3rds of the total) we have households, non-financial businesses, and government (state and federal).
• In the financial sector (the remaining 1/3rd) we have banks, holding companies, insurance companies, and the like.

Interestingly, the financial sector recorded an amazing -$493 billion dollar drop (or 2.9%) in the total amount of credit from the first quarter to the second.

The non-financial sector, naturally, made up the difference and had a $316 billion dollar increase.

However, there's a wrinkle to the story about this increase.

It's a tale of two parts. The government part (state and federal combined) increased by +$390 billion while the household and business parts fell by -$74 billion. Summed together we get the $316 billion increase.

As I wrote a while back in one of the more important reports I wrote this year entitled "It's Not Over - The Collapse in Household Credit Says So," the most important determinant of recovery will be whether or not consumer credit will expand.

After all, since our money is debt, then increasing the amount of debt is an essential component of the very basis of our financial markets. After all, if everybody is expecting a few percent return on their bonds and equities, but the money supply is contracting, then quite a bit of disappointment is in store for whomever is expecting positive returns.

For now, the government and the Federal Reserve, like nearly all of their major foreign counterparts, are busy stimulating and bailing and borrowing to fill the void left by the dearly departed corporate and public borrowers.

These next two figures showing the year over year change in household vs. government borrowing tell nearly the entire tale.

That's the big story right there, in bold green and red lines.

Households have reversed their previously uninterrupted, decades-long accumulation of ever more debt and government borrowing has countered this by a nearly ten to one margin.

This is really just a continuation of my last post about the cost of the recovery (The Recovery Was Too Expensive), but I've been anxiously awaiting this report so that I could show it to you in pictures.

Conclusion

The Flow of Funds report for 2Q 2009 reveals that credit market borrowing has been shrinking for nearly every sector but government.

While it is certainly possible for the government to apply such Keynesian heroics for a while, it is also true that it cannot do so forever. Sooner or later the sputtering consumer portion of the economic engine is going to have to catch to life or the government's efforts will prove to be an expensive and possibly dangerous miscalculation.

Every report that you will soon read about a recovery in GDP must be assessed against the charts above. Can we really call an enormous increase in government borrowing the same thing as legitimate economic growth?

If the answer is "yes" then why do we even bother with working for pay when the answer is that nobody needs to work and we can all live off of fat government contracts? Obviously that is a fantastically out-of-kilter world-view but if we are to count the next few positive GDP readings as real, then it means that we accept this view as legitimate.

Since it is not possible for the government to become the perpetual source of all new borrowing, for the old economic paradigm to work it is imperative that consumers and businesses pick up the borrowing baton and race off with it.

However, as many outside of the main economic echo chambers have already divined, it may simply be that there is a "new normal" out there that does not include a return to the former trajectory of borrowing. If so, then the government attempts to "plug the gap," while crossing their fingers and waiting for everyone to get back in the race, will fail.

I have resolved myself to a new normal, a much lower normal, and my main concern centers on whether the government will arrive at the same conclusion before the dollar is ruined, or after.

Disclosure: No Positions

Comments

[untrusting investor]

Great article and comments. Thanks for posting it. It certainly does appear that the US government intends to devalue the dollar virtually indefinitely. One wonders where the government thinks they will ever be able to generate sufficient tax revenues to even service the massive debt, let alone ever begin repaying it?

2009 Sep 22 11:53 PM

[johngonole]

Great article. Basically the consumer has reached the point where those who can't help them selves can no longer borrow. The rest of us who are responsible either don't want to borrow OR are waiting for a more clear picture.

Government spending is our leaders ways of saying, "We know better than you, therefore we are going to FORCE you to borrow". The author is correct when he says they can't do it forever. The bigger problem is that while our economy is trying to resize for REAL sustainable demand our government is messing the process up by forcefully spending. In the end we will arrive at the same place before the economy in REAL terms will begin to grow. All this is doing is weaking our country.

2009 Sep 23 12:19 AM