Saturday, August 8, 2009

Consumer Credit Contracting – It’s a Big Deal…

Friday afternoon the latest Consumer Credit numbers for the month of June were released. The consensus called for a contraction of between -$3.0 and -$10.0 billion. It came in with a contraction of -$10.3 billion. Here are the highlights according to Econoday:
Banks are cutting down credit while consumers, hit by job loss or the fear of job loss, are paying down credit, not good news for policy makers who are trying to stimulate spending. Consumer credit has been contracting at a record pace this year including in June when credit contracted $10.3 billion. The contraction was split evenly between revolving, down $5.3 billion, and non-revolving, down $5.0 billion. Consumer credit contracted at an annual rate of $5.2 billion in the second quarter, more severe than the $3.6 billion rate of contraction of the first quarter. There's never much initial reaction to the consumer credit report, mostly because it's issued near the end of the day. But this report is certain to appear in next week's commentaries, especially among the bears and realists.

“…especially among the bears and realists.” Ha, ha, they’re talking about us. Funny how he associated bears with realists like that. If you’re not a “realist” then you must be a part of the Economic Mass Psychosis (delusional) that seems to have terminally infected America and most of the world as well…

While a $10 billion contraction in credit may not seem like much compared to the multi-trillion plus mega numbers thrown around lately, it is, in fact, very significant as most modern recessions do not see ANY contraction in credit – maybe slower growth but almost never contraction.

There are two types of dollars – real dollars and credit dollars. Credit dollars are made every single time you or any consumer takes out a loan or even uses your credit card to make purchases. Credit dollars are NOT REAL dollars. They are different in that they carry interest and must be paid back with REAL dollars earned through your productive efforts – the bank will NOT take back credit dollars in repayment of your loan (unless of course you take out a loan from another source).

In the world of consumer credit, there are two types, revolving (mostly credit cards), and non-revolving (installment credit). Revolving credit is a relatively modern innovation that has caused vast credit expansion that has been a part of the overarching credit bubble that led to higher corporate profits and thus higher stock market prices as well.

Generally, in recessions revolving credit growth slows and then turns back up… the stock market then follows. That’s NOT what’s happening now. Consumer credit is continuing to fall at a faster pace while the stock market is zooming in a reflexive rally.

When you look at the chart of total consumer credit, you will not see a spectacular cliff dive like the employment ( lack thereof ) charts I recently posted. No, you will see a massive parabolic rise above $2.5 TRILLION, and a little hook at the end. Look carefully at the “little” hook though. You will see NOTHING even close going all the way back to 1940:

Now, when we view that same chart in terms of year over year percent change, then we begin to see what a rare occurrence a contraction in consumer credit has been over the past ¾ of a century:

Note that the dip below the zero mark is the first since 1992, the only other time total consumer credit has been negative since 1940.

Now let’s look at Revolving and Non-Revolving credit…

The chart below shows Total Revolving Consumer Credit since the late 60’s in yoy percent change. Note that this is the first time in history that Revolving Credit has been negative (did not have revolving credit prior to that time):

And here’s the same chart for Non-Revolving Consumer Credit – also negative and still trending downward:

Remember, the consumer is at least 70% of the economy. When they are no longer using credit – and this is just one aspect of their credit – then corporate earnings will suffer, and earnings are what ultimately underpin the price of stocks.

Of course we know that to offset the fall in credit that our own government is committing Seppuku (Hara-kiri) by gorging itself on debt that cannot ever hope to be repaid:

The shadow banking system is responsible for much of the bubble dynamics that were created. Consumer debt was securitized just like subprime mortgages were. In the following charts, note that the securitization of Non-Revolving and Total Consumer Credit began in about the year 1990 and is now very NEGATIVE:

Hmmm… 1990. Let’s look at a non-logarithmic chart of the DOW Industrials. Notice anything starting to happen in the stock market about that time?

Think there’s any coincidence?

In my mind there is no doubt that the shadow banking system and the securitization of debt process led to the largest credit bubble in history. That bubble grew out of control, mostly unregulated and untracked. We are now paying the price and will be paying the price for generations as that mechanism was so successful at pulling future incomes into “today” that there is now simply no way that people’s earnings can pay back all the debt (Death by Numbers). This is just the beginning of the debt flush, it, quite unfortunately, will take years and years to get under control.

The shadow banking system and securitization of debt - it’s the central banker’s “secret garden” that all of the politicians so desperately want…

Bruce Springsteen – Secret Garden: