Two Hidden Forces in the Economy

 | Feb 01, 2013 | 2:00 PM EST
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I've been talking about the fiscal backdrop being poor. We've seen the effects of austerity in Europe for the past three years, and they aren't pretty. Now they're about to come here. They're already here to some degree.

The past two months' budget balance produced a surplus of $20 billion in December and what looks to be a deficit of $27 billion for January. In contrast, the "normal" level of monthly deficit spending over the past four years has averaged about $100 billion. Recently it's been running at about $90 billion.

We can look at that number as being the minimum amount of net new creation of dollar financial assets to keep the system stable. Without that, people and firms could find it hard to pay their taxes. Remember, government spending literally creates the dollars with which people pay their taxes.

So the fiscal backdrop is not supportive at all.

But we could be getting some help from two other places: private credit creation and savings. Over the past four years -- that is, since the crisis bottom in 2009 -- the component of bank credit that is total loans and leases has been growing. We went from about $7.0 trillion in total bank loans and leases in 2009 to $7.23 trillion currently. That's a nice recovery, yet total loans and leases outstanding still remain below their record high of $7.3 trillion. Banks have been picking up their lending, just not that aggressively.

We also know that household debt service as a percentage of disposable income is at the lowest level since 1984. This comes right from the Federal Reserve's own Financial Obligations Ratio, which it publishes quarterly. This means that household balance sheets are far healthier than they have been at any time in the recent past. While this in and of itself is not a guarantee that we'll see another credit cycle, it certainly does not hurt. It's like potential energy: It has the power to "blow" at any time. And if it does blow, it could easily power a major growth boom in the private sector.

The second potentially bullish fundamental is the high level of personal savings. The Personal Income Report the other day showed personal savings to be an astounding $805 billion in the month of December. That's the second-highest nominal reading on record. The highest was $958 billion back in 2008. Personal savings exploded in December, thanks to a massive transfer of savings from corporations to individuals via dividends. I talked about that in yesterday's column.

We know from basic economics that investment equals savings. In other words, for any level of savings, you get some level of investment, and vice-versa, any level of investment equals some level of savings. Clearly, when looking at the massive increase in personal savings, the firepower is there.

Should households decide to "dissave" (i.e., consume), they can now do an awful lot. And if you tie in the possibility of a new credit cycle, perhaps driven by rising confidence and increased loan demand, then the one-two punch combination of dissaving and private credit creation could swamp any of the negative effects of austerity. This would mean a significantly stronger economy and higher stock prices.

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