Brilliant analysis.

I would like to point you all to an article in 2005 which exactly predicted such a situation. Note that consumers are being hit with 30% rates on credit cards and much higher interest rates by banks than they earn from their deposits. There is no way for them to service their debt any more.

Quote:

HOW DEBT MONEY GOES BROKE
by Steven Lachance
December 12, 2005


Most know debt is a byproduct of the finance-centered US economic model. Few, however, are familiar with how much debt the US credit system creates, let alone the implications. The upshot is financial decision making based on mainstream herding and hesitancy to take essential steps to preserve personal wealth.

How much debt?

According to the most recent Flow of Funds report from the Federal Reserve, total credit market debt (TCMD) expanded by $799 billion in the third quarter of 2005. At this rate, debt growth for a single year is $3 trillion, or 50% greater than total US industrial production. Since 1987, the year Alan Greenspan became chairman of the Federal Reserve Board, TCMD has more than tripled, from $13 trillion to $40 trillion, and now accounts for well over 300% of GDP. This debt growth is without precedent by any relative or absolute measure, evidence that the US has experienced a debt bubble.

Where does it come from?

Traditionally, savings finance debt. As the US savings rate has been anemic for years, many establishment economists, Ben Benanke among them, have claimed that US debt growth is supported by the inflow of surplus savings from abroad-the global savings glut thesis. Net purchases of US debt by foreign interests, though, are less than $1 trillion per year, far short of annual debt growth of $3 trillion. Some commentators are quick to point a finger at the Fed; it's printing money they say. This too misses the mark. As of 9 December, Fed credit was up just 3.8% YoY and the combined balance sheet of the 12 Federal Reserve Banks is barely $1 trillion.

The pump for the epic American debt bubble is neither foreign savings nor the Fed. For the $27 trillion of debt created during his tenure, Alan Greenspan can thank the private sector and the government-sponsored enterprises (GSEs). The Fed may be negligent for loosing control of the credit system, but it is not directly responsible for what has occurred since. The GSE's combined book of business, for instance, dwarfs the Fed balance sheet at nearly $3 trillion. Anchored by the money center banks, a vast constellation of financial entities, including mortgage lenders, consumer credit firms, and the financial arms of industrial enterprises, has blossomed to do with a vengeance what the Fed itself would not; create a seemingly unlimited quantity of debt out of thin air through loan origination.

Where does it go?

Debt is self-liquidating when used to generate future income, from which interest is serviced and principal repaid. Used for any other purpose, it is non-self-liquidating and results in payment obligations with no countervailing source of income. Of the $3 trillion in debt created this year, households used about 50% for mortgages and consumer loans, governments 25%, and companies 25%. Only companies incur self-liquidating debt, so at least 75%, or $2.25 trillion, of the debt has produced a future burden rather than an income stream. Companies, though, are no white knights. They have mostly used their $750 billion of the debt pie for purposes other than capital investment, namely to cover unfunded liabilities and buyback shares they liberally printed to reward management in the first place. The US is, thus, at or close to a situation whereby the percentage of debt financed by domestic savings is zero and the percentage of non-self-liquating debt is one hundred.

How does it end?

A debt-based monetary system has a lifespan-limiting Achilles heel: as debt is created through loan origination, an obligation above and beyond this sum is also created in the form of interest. As a result, there can never be enough money to repay principal and pay interest unless debt is continually expanded. Debt-based monetary systems do not work in reverse, nor can they stand still without a liquidity buffer in the form of savings or a current account surplus.

When debt grows faster than the economy, the burden of interest is bearable only so long as the rate of interest is falling. When the rate of interest reverses course, interest charges start rising faster than debt growth. This point was reached on 16 June 2003, the day the yield on the benchmark 10-year Treasury bottomed at 3.09%. Since then, debt grew from $32 trillion to $40 trillion, an increase of 25%. During the same period, annual interest charges rose by over 50%, from $1.28 trillion ($32 trillion at the prevailing average interest rate for debtors of 4%) to $2.0 trillion ($40 trillion at 5%). When interest charges exceed debt growth, debtors at the margin are unable to service their debt. They must begin liquidating.

Dipping into savings or running a current account surplus can offset liquidation for a time. The greater the pool of savings and the current account surplus, the longer an economy can endure liquidation at the margin without experiencing cascading cross-defaults. The US in the early 1930s and Japan in the early 1990s had such a liquidity buffer. In both cases, mobilizing domestic savings to increase government debt reversed the decline in total debt outstanding in two to three years and interest rates stayed low because savings financed the new debt. As a result, interest charges no longer exceeded debt growth and the need for marginal debtors to liquidate disappeared.

The US is now in a fundamentally different position than it was in 1930 or Japan was in 1990. Aside from a dearth of domestic savings, its vulnerability is compounded by a current account deficit. There is no buffer and no margin for error. Thus, when interest charges, now $2 trillion per year and accelerating, overtake annual debt growth, now $3 trillion and decelerating, liquidation will immediately trigger cascading cross-defaults. Without domestic savings to mobilize, the Fed cannot facilitate the expansion of government debt to fill the breach and simultaneously hold down interest rates. It cannot win the battle to keep debt growth greater than interest charges, the precondition for the viability of a debt-based monetary system. Once started, cascading cross-defaults consume all debt within an economy. The Fed has only two options: institute a new monetary system with a new currency or return monetary authority to the market and shut down.

I say we take off and nuke the entire economy from orbit. It's the only way to be sure.

Note to self: Cancel iPod purchase. Get 12 gauge "Sluggers" instead. Seriously, this is getting crazy. There's too much happy talk on the TV and radio. Even my wife, who is a happy go lucky person is noticing what is going on (empty stores, etc..).

The really sad part about this Ticker is that about %60 of the income earning population in this country will not believe/understand all this until they are about a week/month away from destitution. For others (talking J6P's here) its already too late...their fate is sealed...they'll either be debt slaves for life or destitute.

lol @ Wearedoomed...what a great movie, one of the best SciFi of all time.

The rest is inevitable, I'm cash poor at the moment but in a few months I should have a nice chunk of coin to put on stored food. I've got the guns and bullets but being in Canada I don't expect we'll get that bad. Food, OTOH is going to be the real gold and I fully expect a run on that worldwide when this sucker finally does goes down.

They can't keep trading 5 zombie stocks back and forth forever and call it recovery....right?

I totally agree. Maybe Obama isnt lying in his rhetoric when he days the bubble and bust economy days are over. I used to think he was going to try and inflate another but when I look at the "stimulus money" he still has spent very little of it. I think maybe just maybe he too sees the writing on the wall. Peoples credit scores are hammered and the people with good scores either dont want to take any risks or they too are getting turned down.

The stock market when its not being manipulated by banks runs on earnings. The earnings are just not going to be there because the credit is not going to be there. What does this mean? It means we have a stock tanking coming. When wages grow so will the economy because like I said and what Karl is saying, the gig is up.

Some of you likely read Paul Krugman's magazine article over the weekend. It was a nice, if irrelevant comparison of neo-liberal macroeconomics to Keynesianism. As should be expected, Paul showed that neo-liberalism is fine while there is growth but badly fails to deal with recessions - the flip-side of the business cycle. Paul then goes forth to suggest that a good old Keynesian stimulus (increased government spending) is just the tonic we needed. Not one word was written regarding debt. Frankly, I am stunned that an erudite economist, a Nobel laureate no less, is so friggin myopic. The base problem with the U.S. (and global) economy is not the macroeconomic school of thought it has followed. Rather, the problem is in failing to recognize that there is a very real limit to debt. Karl has shown that there are very real limits to debt (one cannot pay more in debt service than one's disposable income) and that there is likely an inverse function fit to defaults as a function of total debt and we are currently in the asymptotic portion of the curve.

Would someone please explain to me how a thoughtful financier, like Karl, and his class (we TFers) can see things (the debt monster) that Nobel laureates refuse to acknowledge? Professor Krugman has bragged of his invitation to the White House to discuss economics. I would like to suggest that President Obama invite Karl for a little sit down as well. He might learn something.

Tjeff, no, Obama does not get it. It hasn't been spent because they can't borrow enough.

but can't game over mean 10 years before the final curtain

CNBC will react to that graph like a vampire to a silver cross.

Guess it is time to buy more stuff that can't go to zero.

I think I'm on the other side of this trade...today I went into my locally owned (a solvent, conservative) bank intending to put $50K into a 1 year-no penalty CD. The best they could offer was 1.5%, down from 2% just a few weeks ago. Disappointed, I left without getting a CD. I mentioned to the rep that apparently they had no one who needed to borrow the money from their bank and she nodded that it was pretty much the case right now.

Phif

They dont have to borrow the money its already been borrowed from China and is sitting in our account waiting to be spent. Why doesnt he just drop it into the system? I mean maybe Im just trying to be optimistic that someone knows what is going on, and maybe at my own peril, but maybe just maybe they are keeping that money to bleed into the system as **** gets worse and worse (coming down from our 30 year credit binge) to prevent a collapse. Then again what I see them trying to do with national health care kinda blows that out of the water huh?

Ticker wrote..

There is no way out of the box via this method; we are in fact headed for a sovereign credit, monetary system and thus GOVERNMENT failure if we don't stop!

The Alex Jones tinfoil crowd, in "The Obama Deception" (2hr docu all over Youtube), maintains this is the deliberate plan. (I'd link it, but there's some throw-away troofer references in it; 90% of the vid is very interesting, however.)

Interesting analysis and I can't say I'm not surprised. The bars and shops where I live (DFW) have been dead for quite sometime. The people I knew who were living the $30k millionaire lifestyle are at the end of their credit limit, and many are getting laid off for the second time in at least as many years. The ex girlfriend was a very special case though. $45k in card debt, $100k in student loans. Even as a lawyer, running the numbers, there was no way she was going to pay off the debt on her salary and have any money left over for bills or food. Apparently bankruptcy wasn't an option with her job, but with the recent cut backs in city budgets around here and rumored layoffs for DA's, it's likely to be her only option. What's really funny is the fight that led to the breakup was her mad at me after she had asked me to help her figure out a way to pay down the debt. I think it was more her ****ed that I broke the news that she couldn't afford her coach purses and designer shoes, much less a place to live or bills. It's finally starting to hit home for some folks though, and thankfully so. It just boggles the mind that so many people I personally know are so far in the hole, when the last few years it's seemed that I was the outlier by cutting back on the lifestyle when things got expensive.

Do you think the contraction in PCI, when updated, will mirror the contraction in PCD, which has, itself, contracted to 2002 levels?

Also, am I reading the chart right regarding the small decline in mortgage debt so far? That looks set to waterfall in a catastrophic way.

The current Mortgage Debt number (off the latest flow-of-funds number) is essentially flat-lined with the EOY 08 number.

Therefore there is no real reason for me to have updated it, as it is not expositive.

The reason it hasn't fallen is that the banks are hiding the losses, as noted dozens of times. The defaulted loans are in fact dead but still being carried as "active debt" - that's pure horse****, obviously, but there is ZERO recognition of that in the numbers.

And yeah, its bad, because mortgage debt outstanding is some 4x consumer credit, so WHEN (not if) it cracks it will blow the banks to hell.

It will also blow the government to hell if they don't cut this **** out before it happens.

Assuming we don't deviate one bit from the current course - we just keep printing, borrowing, quantitatively easing, etc. until the crap really hits the fan (Treasury holds an auction and no one comes)... what's a person to do to come out on top financially? I'm not talking about having enough bullets, firewood and bottled water (althugh that might be most important). I mean what should a person be doing now with sizeable amounts of cash? Where should one look in history for parallels? Weimar Germany?

As a fun exercise, if you posit that bank mortgage "assets" are worth say .65 on the dollar, can your data project that result on a graph like this ?

1930.

A bet on Weimar is a bet that The Government will, as a last-ditch effort, fire the fed and print on its own.

The Fed kills itself if it hyperinflates. It therefore won't. However, Congress might if it was to repeal The Federal Reserve Act of 1913 and then undertake to attack the problem with direct printing - which it might.

I consider this a low-probability outcome but absolutely nothing is off the table in a situation like this, as the desperation level will rise dramatically when the next round comes.

The problem is in figuring out EXACTLY when it will all crack. I can't predict that. It could happen tomorrow, a month from now, a year from now or a few years from now. But that it will come on this trajectory is a mathematical CERTAINTY, not conjecture.

Tesla: Yes. Just extend that line straight down about halfway.

I think best structure is: Zero Debt, Cash is King -- buy assets when others cannot. I do not think Weimar is a good parallel.

but...but... the DOW is up 71 points right now. You mean it's not party time?

Quote:

The problem is in figuring out EXACTLY when it will all crack. I can't predict that. It could happen tomorrow, a month from now, a year from now or a few years from now. But that it will come on this trajectory is a mathematical CERTAINTY, not conjecture.

This is the EXACT problem. Care to place odds?

Your chart is one of the best explanation I have ever seen for the whole issue.

I wish there was a much finer resolution .(larger version)

When the cashflow becomes insufficient to cover the hidden defaults.

I think its coming very soon, weeks or months, and The Government had better be OUT of direct intervention when it does.

They won't be able to stop the cross-defaults and if they're in it, they go too.

Yaldor - Click the chart to get a bigger copy.