Deleveraging Over, Releveraging Underway
When the real estate bubble began to burst in 2006, I was one of the few lonely voices that claimed a recession would be necessary to pare down the onerous debt levels that caused credit crisis to begin with. However, those in power are not very fond of relinquishing it. Therefore, in order to keep their jobs intact, the deleveraging process was cut short. The Federal government issued Treasuries like never before and the Fed ended up buying most of the debt. In case you’re keeping score the publicly traded debt has soared by $6.8 trillion (133%) since the start of 2008.
Recently we learned that the White House in now predicting a budget deficit of “just” $759 billion for fiscal 2013. The media cheered this number because it will be the first deficit for Mr. Obama that comes in under $1 trillion. But we should keep in mind that the deficit for 2007 (the year before the credit crisis hit) was $160 billion. Also released recently were the numbers for consumer credit put out by the Federal Reserve. Credit to consumers jumped by $19.6 billion in May, which is annualized increase of 8.4%. Credit Card debt surged by $6.6 billion in the prior month as well.
These numbers prove that the government has been enormously successful in piling even more debt on an already overleveraged economy. Adding debt to an economy that desperately needs to reduce the level of its borrowing can only be a temporary solution if borrowing costs are constantly falling.
Of course, this is where the Fed steps in. They cannot stop QE because even the threat of doing so causes interest rates to soar. And a rising cost of debt service means lights out for this fragile economic recovery. That is why members of the FOMC did the Moonwalk on ending QE just one day after Mr. Bernanke laid out his timeline for getting out of the bond-buying business.
I still believe the Fed will start to taper its purchases of bank assets this fall. That’s because Bernanke is now 100% focused on his legacy before leaving at the end of this year. He wants to say he not only increased the size of the Fed’s balance sheet to record levels but was also able to start unwinding it too. Look for rates to rise this summer causing the economic data to worsen over time.