EXTRAORDINARY Q1 2020 Z.1 FLOW OF FUNDS / CREDIT BUBBLE BULLETIN

Extraordinary Q1 2020 Z.1 Flow of Funds

Doug Nolan


Financial crisis erupted in March. The Fed slashed rates at an emergency meeting on March 3rd – and then began aggressively expanding its holdings/balance sheet (creating market liquidity). Even from a “flow of funds” perspective, it was one extraordinary quarter.

Total Non-Financial Debt (NFD) surged a nominal $1.597 TN during the first quarter ($6.379 TN seasonally-adjusted and annualized!) to $54.325 TN.

This was the strongest quarter of NFD growth on record (blowing past Q1 2004’s $1.234 TN).

Indeed, Q1 growth surpassed full-year NFD expansions for the years 2009, 2010, 2011 and 2013.

This pushed one-year growth to $3.271 TN (6.2%), significantly exceeding 2007’s record $2.521 TN expansion.

NFD increased $20.857 TN, or 59%, since the end of 2008.

NFD as a percentage of GDP rose to a record 260%. This compares to previous cycle peaks of 226% (Q4 ‘07) and 183% (Q4 ’99).

Financial Sector borrowings jumped $963 billion during Q1, surpassing the previous record $656 billion from Q3 ’07. This pushed one-year Financial Debt growth to $1.247 TN (7.6%), the strongest expansion since ‘07’s $2.065 TN.

Total Credit (Non-Financial, Financial and Foreign) surged nominal $2.391 TN for the quarter to $77.861 TN, surpassing the previous record from Q1 ‘04 ($1.512 TN). One-year growth of $4.790 TN was the strongest since 2007. Total Credit jumped to 362% of GDP, the high going back to 2010.

Federal Liabilities (excluding massive “contingent”/off balance sheet liabilities) jumped to $22.0 TN during Q1.

At 102%, Federal Liabilities surpassed 100% of GDP for the first time in at least six decades.

For perspective, Federal Liabilities ended the seventies at 50% of GDP; the eighties at 63%; the nineties at 59%; and 2010 at 85%. I would not be surprised to see this ratio approach 150% over the next three to five years.

Outstanding Treasury Securities jumped nominal $500 billion during the quarter to a record $19.518 TN.

This pushed one-year growth to a staggering $1.612 TN (9.0%) and two-year growth to $2.472 TN (14.5%). Treasuries ballooned $13.467 TN, or 223%, since the end of ’07. Treasuries-to-GDP jumped to 91%, more than doubling the 41% at the end of 2007.

The Dept. of the Treasury and Federal Reserve are not the only profligate debt issuers in Washington. Outstanding Agency Securities jumped a record $340 billion during the quarter to a record $9.771 TN. Agency Securities surged $899 billion, or 10.1%, over the past year – just below 2007’s record expansion ($905bn). It’s worth noting outstanding Agency Securities increased $1.866 TN, or 24%, over the past five years.

Washington didn’t merely fail to resolve the GSE issue during the “longest expansion on record.” These institutions were once again exploited to juice the markets and economy.

The government-sponsored enterprises these days essentially have no meaningful amount of capital. Since receivership, hundreds of billions of accounting profits were transferred to Treasury coffers, helping dreadful fiscal deficits appear a tad less dreadful. Payback time starts now. Treasury will be on the hook for what will surely be years of enormous losses.

Combined Treasury and Agency (“Washington”) Securities surged $840 billion during Q1 to a record $29.289 TN, or 137% of GDP. Combined, “Washington” Securities jumped $2.237 TN over the past year and $3.371 TN over two years – accounting for the majority of system Credit expansion.

This is a replay of the “alchemy of Wall Street finance” dynamic from the mortgage finance Bubble period. Endless “AAA” debt securities these days transform increasingly risky end-of-cycle Credit into perceived money-like, safe and liquid instruments (experiencing insatiable demand).

Total Debt Securities jumped $973 billion during the quarter (vs. $357bn from Q1 ’19) to a record $48.362 TN. This pushed one-year growth to an unprecedented $2.912 TN, surpassing previous record growth of $2.679 TN from the 2007 period. Total Debt Securities-to-GDP jumped to a record 225%. This ratio ended the nineties at 162% and the eighties at 75%.

The S&P500 dropped 20% during Q1. Total Equities dropped $12.064 TN during Q1 to $42.460 TN, the low since Q1 ’17. Total Equities dropped to 198% of GDP, down from Q4’s record 251%, yet remained above the cycle peak 181% from Q3 ’07 (and just below Q1 00’s 202%). Total Equities-to-GDP bottomed at 93% during Q1 ’09.

Total (Debt and Equities) Securities dropped to $90.922 TN during Q1. Total Securities-to-GDP fell to 422%, down from Q4’s record 469%. Even after Q1’s decline, Total Securities-to-GDP remains significantly above previous cycle peaks of 379% during Q3 ’07 and 359% in Q1 ’00.

As always, the Household (and Non-Profits) Balance Sheet is an essential facet of Bubble Analysis.

Household Assets dropped $6.464 TN during Q1 to $127.421 TN. With Liabilities increasing $84 billion during the quarter, Household Net Worth fell $6.548 TN to $110.787 TN.

As a percentage of GDP, Household Net Worth declined to 514% (from Q4’s record 540%), while remaining above previous cycle peaks 492% during Q1 2007 and 446% in Q1 ’00.

For comparison, Household Net Worth bottomed at 419% of GDP during Q1 ’09. Household holdings of Financial Assets declined to $87.00 TN, or 404% of GDP (down from Q4’s record 432%).

This compares to previous cycle peaks 376% in Q3 ’07 and 355% during Q1 ’00. It’s worth noting the value of Real Estate holdings increased $433 billion during Q1 to a record $33.950 TN. At 158%, Household Real Estate-to-GDP increased to the highest percentage since Q4 2008.

Rest of World (ROW) holdings of U.S. assets dropped $2.903 TN during the quarter to $31.990 TN, led by a combined $1.651 TN decline in Equities and Mutual Fund holdings. As a percentage of GDP, ROW holdings declined to 149% from Q4’s record 161%. This ratio ended ’07 at 108% and ’99 at 74%. ROW boosted holdings of Treasuries by $118 billion (to a record $6.813 TN) and Agency Securities by $84 billion (to $1.265 TN). Over the past year, Treasury and Agency holdings rose $340 billion and $147 billion.

Bank (“Private Depository Institutions”) Assets gained an unprecedented $1.866 TN during Q1 to a record $21.918 TN. This was more than triple the previous record expansion during Q4 ’08 ($596bn). During the quarter, Reserves at the Federal Reserve increased $926 billion to $2.474 TN. Loan Assets jumped $575 billion, or almost 20% annualized, to $12.302 TN. This was more than double the previous record expansion (Q4 ‘18’s $261bn). Loans gained $1.033 TN over the past year, or 9.2%. The previous record annual Bank Loan growth was 2005’s $690 billion. Q1 saw Bank holdings of Agency Securities jump $189 billion (to $2.823 TN), while Treasuries added $15.0 billion (to $894bn).

On the Bank Liability side, Checkable Deposits surged $519 billion (to $3.157 TN) and Time & Savings Deposits jumped $621 billion (to $13.505 TN). This had Total Deposits expanding $1.140 TN, or almost 30% annualized. Over the past year, Checking Deposits expanded $740 billion, or 30.6%. Savings Deposits rose $1.076 TN, or 8.7%. Total Deposits expanded $1.816 TN y-o-y, or 12.2%. Net Interbank Liabilities jumped $471 billion during Q1 to $489 billion.

Securities Broker/Dealer Assets surged $281 billion during the quarter, the strongest expansion since Q1 ‘07’s $440 billion. Assets expanded to $3.749 TN, the highest level since Q3 ’08. Repo Assets jumped $87 billion to $1.483 TN. Miscellaneous Assets gained $173 billion to $831 billion. On the Liability side, Loans jumped $208 billion (to $1.114 TN). Bond Liabilities rose $83bn (to $257bn).

Total Checking Deposits and Currency expanded an unprecedented $905 billion in Q1 to a record $5.750 TN, with one-year growth of $1.167 TN, or 25.4%. Money Market Fund Assets (MMFA) surged a record $704 billion during Q1 to $4.338 TN. MMFA jumped $1.259 TN over four quarters, or 40.9%. Fed Funds and Security Repurchase Agreements gained $393 billion, or 36% annualized – with one-year growth of $710 billion, or 17.6%.

I received a lot of pushback in 2009 when I argued that QE was spurring growth in bank and money market deposits (“money supply”) then flowing into the markets. It’s become rather self-evident these days.

It’s been a historic global Bubble, with bipolar U.S. and China epicenters. It’s no coincidence, then, that recent Credit dynamics share alarming similarities.

China’s Aggregate Financing (a gauge of system Credit expansion) surged $450 billion during the month of May. This was 86% ahead of May ’19 growth. A booming May put year-to-date (five months) growth in Aggregate Financing at a blistering $2.450 TN. It’s crazy to think how much Chinese Credit will grow this year – Credit of Rapidly Deteriorating Quality. How long can systemic risk continue to inflate parabolically?

Global markets reversed sharply lower this week.

“Risk on” careens to “Risk off” – for global stocks, corporate Credit, EM currencies/equities/bonds and commodities. One Big Unwieldy Speculative Trade. Pundits struggled to explain the abrupt reversal of fortunes. Was it something Powell said? A second wave of COVID infections that might hinder economic recovery? Election anxiety?

Let me suggest Plain Old Speculative Market Dynamics. Daydream, fantasize or hallucinate - if you choose. But this is a fiasco – and rather tangible, at that.

It started years – even decades – ago.

The craziness turned extreme last year, with the Fed aggressively stimulating in the face of highly speculative markets. It was never going to end well.

And when the Bubble began imploding in March, the Fed and global central bankers responded immediately with Trillions of liquidity support. This fueled a rally, short squeeze and reversal of hedges that developed into one dazzling speculative melee.

From my analytical perspective, events over the past few months confirm Bubble Analysis – the Global Bubble Thesis.

This week likely marked the beginning of a painful second leg of the bear market or, at the minimum, the return of wild volatility. There appears to have been both capitulation on the short side and “blow-off” speculative excess for the bulls.

It was almost like 1999 all over again – frenetic retail online trading, penny stock euphoria, derivatives run amuck, fun and games and throw caution to the wind speculative froth.

The Fed owns the frail Bubble – this disastrous mania.

How ironic is it that the more cautious (i.e. realistic) the Fed’s view of economic prospects, the greater liquidity-induced market euphoria propagates delusions of V’s, perpetual bull markets and permanent prosperity?

And of all the nonsense emanating from this historic financial mania, history will trash this foolhardy notion that there is no limit to the quantity of central bank Credit and government debt that can be issued.

Reviewing the Q1 Z1 report, I was thinking this is how things look as a system self-destructs.

Q2 will be worse.