What If?

Another day, another Chinese data dump. Today's figures were perhaps more of an unalloyed positive, with retail sales coming in slightly better-than-expected, while industrial production confirmed recent leaks by comfortably exceeding consensus forecasts. Today's data also left little doubt as to the source of this economic "miracle", meanwhile; M2 growth printed a robust 25.7% y/y. This left Macro Man wondering....given the sturm und drang of FX reserve managers over American policy choices recently, what would they say if the US pursued an expansion of the money supply as aggressively as China?

Elsewhere, yesterday saw the release of one of Macro Man's favourite datapoints, the quarterly Fed flow of funds report. The ebb and flow of household wealth has been a valuable tool in mapping the sometimes bewildering behaviour of the US consumer over the years.

The good news from the report, at least if you are a member of the Church of the Second Derivative, is that the pace of decline in household wealth and home equity slowed in Q1. Net wealth fell by "only" $1.3 trillion last quarter, while home equity declined by $450 billion. That compares favourably with losses of $4.8 trillion and $673 billion, respectively, in Q4 of last year. Hey, even the y/y chart has started turning up....good news, right?
Maybe, but when looked at in absolute dollar terms the chart is less encouraging. The wealth destruction in the household sector is breathtaking and provided an obvious explanation as to why savings have increased (and, in Macro Man's view, will continue to do so.) edit: Note that the chart below should be labelled billions, not millions.

Of course, net wealth may well stabilize in the current quarter courtesy of the stock market rally. Of course, what Mr. Market giveth, he can also taketh away. Meanwhile, another interesting note in the flow of funds report was a continued rise in the household debt-servicing burden as a percentage of net wealth has reached all time highs.

So it was interesting to observe that the US household sector did a little asset-liability matching in Q1, dramatically increasing its direct holdings of Treasury securities by nearly $400 billion.
There are a couple of notable things about this. The first is that households' nominal Treasury holdings remain comfortably below their all-time highs notched in the mid-90's, suggesting that there is ample room for households to buy more. The second is that the Q1 quarterly rise in household Treasury holdings was nearly as large as the top three quarterly rises in Fed custody holdings for central banks combined.

This has led Macro Man to wonder....what if the household sector financed the budget deficit by taking down the issuance? The market seems to subscribe to the view that foreign central banks are the only entity that could possible take the other side of the Treasury's all-too-frequent auction calendar, but this seems misplaced. A steady rise in savings and a rebalance of household asset towards fixed income could easily take down the Treasury's entire auction calendar.

In that vein, it was interesting to see that the much-feared 30 year auction came off without a hitch yesterday, delivering a solid bid-to-cover and nary a whisker of a tail. In the follow-through, bonds put in an impressive bounce, forming a key day reversal pattern on the charts in the process....a rather bullish development.
Macro Man has stayed out of the melee in Treasuries over the past few weeks, but yesterday's developments have him wondering if we might not be on the cusp of a healthy bounce. It might be a trifle dangerous to play a week and a half ahead of the next FOMC meeting, but on his charts we could easily see a 2-3 point bounce in the 10y note future from here.
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Anonymous
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June 12, 2009 at 10:02 AM ×

US based investors soaking up treasury supply which is being issued to bailout the economy/financial system... Sounds like Japan in the 1990's to me and look where that got them...

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H(oratio)
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June 12, 2009 at 10:22 AM ×

The genius trade of the week may be played out like you say. If Treasuries bounce, does not Uncle Buck as well. While I had the wild fantasy that the Barclays Global Investors take out caused the sterling to jump a mere eight pence in four days, that does not help me much with my sleep cycle now, does it? I called my Congresslady and asked her to consider reconvening the House Unamerican Activities Committee to inquire of Messrs Sachs and Stanley why they were keeping a couple of million tons of crude at sea, while calling another 30% uptick on it. Perhaps Czar Putin was diversifying his personal portfolio out of the dollar as well, but you are closer to that action over there. The Field of Dreams reference must have set the borg econometricists on a little Baidu search, non?

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June 12, 2009 at 10:28 AM ×

Japan comparison is a good one - would be interesting to see how many self managed 401Ks there are now. That's a big trend in Australia and people have gone from punting mid cap mining stocks to bonds and appear to be reducing their expectations of how they will live in retirement. With QE being dusted and half the macro funds short treasuries we could be in for a bit of a squeeze.

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Tim
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June 12, 2009 at 11:06 AM ×

Think it is a bit of a stretch to say what happened in Japan will happen in the US. I have no evidence to back this up, but my intuition tells me the risk tolerance of Mrs Watanabe (along with other structural factors in the Japanese economy inhibiting growth) has driven the propensity to buy and hold JGBs. In contrast, while the risk tolerance of Americans has declined significantly in recent months/quarters, I would expect it to increase once again in coming years, resulting in reduced Treasury purchases.

MM, your US household wealth chart seems to be off by a factor of 1k.

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Dimitry
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June 12, 2009 at 11:45 AM ×

I am on board with the Japan comparison... Things in the US are, in fact, starting to look eerily familiar. We're not quite at 180% debt/GDP, but let's give it time. That would argue for a political Fed, low rates for a long time and all sorts of interesting games with CPI. I, for one, think it's an entirely possible scenario.

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June 12, 2009 at 12:00 PM ×

I'm on the US deflation wagon, China is just going to piss away its banking system for the next few years and in the end look typically EM: short of cash, efficient businesses, or good institutions.

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Anonymous
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June 12, 2009 at 12:01 PM ×

Hi

You may be right on US Treasuries but please do NOT use a 'key day reversal' as your sole entry mechanism. I have statistically tested this so called 'pattern' on over 30 years of data using robust 'in' versus 'out' of sample measures across 20 + markets - Macro Man, IT IS BOGUS. Like many visually appealing chart formations it just does not test out (despite some spectacular successes).

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CV
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June 12, 2009 at 12:19 PM ×

"This has led Macro Man to wonder....what if the household sector financed the budget deficit by taking down the issuance? The market seems to subscribe to the view that foreign central banks are the only entity that could possible take the other side of the Treasury's all-too-frequent auction calendar, but this seems misplaced. A steady rise in savings and a rebalance of household asset towards fixed income could easily take down the Treasury's entire auction calendar."

Exactly MM, this is the point. We may well soon be in a situation where the US will be able to finance this out of domestic savings. Didn't you yourself point this out a while ago? Or perhaps I read it somewhere else.

I think this is an important aspect relative to all the talk about rising yields on the long end of the curve as a sign than people expect the US to default.

Claus

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Macro Man
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June 12, 2009 at 12:48 PM ×

Tim, you are of course correct. Mea culpa.

While the Japan comparisons are attractive, I believe on balance that they are misguided. True, Japan had a property/equity/banking system bust.

But the first real serious efforts to address it took nearly a decade after the bubble burst.

More important are the differences between the US and Japan before the bubble burst.

Just before the bubble burst in Japan, the country ran a healthy current account surplus and the household savings rate was 13.5%.

As Japanese households became more risk averse, the push into risk-free assets from already high savings levels, combined with the sluggish policy response, is what got Japan into the deflationary spiral that still grips it today. I am not sure what percentage of Japanese household financial assets were in deposits at the height of the bubble, but for the last decade that ratio has been in excess of 50%.

The starting point for the US, meanwhile, was a current account deficit country with a negative household saving rate. By definition, that means that some of the bubble financing was provided by non-domestic institutions, thus rendering diluting a portion of the implosion to non-domestic agents.

Moreover, an increase in risk aversion and savings on the part of US households will, frankly, just push them towards global norms. Since the crisis started, US deposits as a % of household financial assets have risen from 15% to 20% in Q1. That's a far, far cry from the story in Japan.

And regardless of what5 you think of the Fed/Treasury alphabet soup of programs, at least you can say that they haven't been bone-idle like the Japanese were for a number of years.

While I certainly accept that an output-gap framework suggests domestic deflationary pressures for some time, I think we've already seen that in extremis, the Fed's policies can have some traction- just look at equities/commodities/the dollar since the Fed launched QE.

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Anonymous
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June 12, 2009 at 1:31 PM ×

A record number of Chinese urban residents want to save, not spend, as they have turned increasingly gloomy about their incomes, according to a central bank survey released on Friday.
The survey of urban residents conducted by the People's Bank of China in late May showed that 47 percent would like to save more hit 47 percent, up 9.5 percent on the first quarter, and the highest since the survey began in 1999.

http://tinyurl.com/nntffp

Alrighty then.

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Martin
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June 12, 2009 at 2:34 PM ×

See Brad Setser for the best ongoing tracking of FCB purchases and US debt absorption in general. http://blogs.cfr.org/setser/

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Professional Gringo
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June 12, 2009 at 3:09 PM ×

Well, I shall miss the Macro commentary for two weeks as I have a powerful urge to swing the sticks in Wisconsin and Idaho before a final stop in Marin Co. Ca and a much needed reunion with the goddess creature. It's a long drive from S. Florida and I can't wait to see her with no clothes.
Oops, did I say that?

Cheers, keep your heads down.

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Macro Man
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June 12, 2009 at 4:33 PM ×

Enjoy, PG. If you're driving from Fla to the west coast by way of Cheeseland, I hope you've got a fast car, a radar detector, and a get out of jail free card.

Unless you mean driving from the back tees, in which case you'll need a bloody Enormous Bertha to reach Wisconsin from Fla.

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Steve
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June 13, 2009 at 5:07 PM ×

I traded prop in Japan from '90 to '94 and again from '96 to 2000 and I have to say I think the similarities outweigh the differences, and the differences that exist are pretty much a wash.

Both areas had bubbles in real estate (boxy 2-br apts went north of $1mm in Tokyo and now in NY) and equity valuations, though the Nikkei certainly went to a more extreme level than our SPUs. Both had gutted financial sectors. Both had deflation problems, though some will argue that in the US we have only experienced disinflation. (Stay tuned.)

Yes MM I agree Japan's response was not as aggressive, but there certainly was a response. The BOJ took rates to 1.75% in the third quarter of '93, and to 50bp in the fourth quarter of '95. Not zero, but since no one was lending anyway that may have been moot.

On the fiscal side, the ruling LDP announced package after package after package. All were highly correlated with meaty Nikkei bounces. The fiscal deficit approached 200% of GDP. These were not stopped until Koizumi pulled the plug on them in the early 2000s, sending the Nikkei to its first sub-8000 low.

The scary thing is, Japan's stimulus packages were not transfer payments like Obama's. They actually built stuff, of dubvious value tho they were.

Japan had a much higher savings rate, as you say, but it declined dramatically and eventually hit levels trivially above zero. Consumers actually increased consumption. We have gone from 0% to about 5% savings, meaning we are consuming much less.

Japan also had the benefit of an export economy during a global boom. We probably won't. Only China is powerful enough to be meaningful as a potential stimulus, and (a) their GDP is 1/4 that of the US, and (b) our export sector is something around 12%, not a combination that will pull us out.

We have done a much better job of managing the financial crisis' impact on banks, clearly. If there is hope, it's here. The Fed has pulled our fat out of the fire. But the turds remain, and I don't see much real progress in that regard. The green shoots may have done more harm than good. Yes, TARP funds are going back, but why? Most likely because bankers want to get paid, and don't have to mark to market, thanks to the friendly folks at FASB.

We ain't out of the woods, and the trees look to me like Japanese cedars.

I like your call on USTs, I am long and wrong, so you can see where my Japanese analogy has gotten me so far. But (as a final comparison) even Japan had three bond bear markets of over 100bp and one more of nearly 100bp between '93 and '98, so I'm staying pat.

Great site MM, I appreciate your considerable labor.

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Anonymous
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June 14, 2009 at 10:26 PM ×

The change in nominal wealth is significant to be sure, but isn't it worth noticing that gross wealth is only back to where it was 2 years ago. Isn't that quite something considering the nature of the correction we're going through?

Obviously it begs the question as to whether the correction is even close to moderating, letalone be over. But it's somewhat amazing that wealth is back to 07 and GDP probably somewhere similar. 07 wasn't so bad from an overall wealth perspective, was it.

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Mark T
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June 15, 2009 at 10:04 AM ×

The so called savings ratio was low when household wealth was high and generating a return on that capital that was in excess of the required return. It also meant US savers sold bonds at high prices to asians who were willing to accept a lower risk free yield and that wealthy americans took higher risk buying into asian equities. Now the asians have enough bonds and want to fund their own growth, the role of the US treasury shifts back to being a core part of US retirement plans. But that means a real return of at least 2.5% which funnily enough with GDP deflator at 2.1% is around about here. But that is a likely floor not a ceiling imho

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