A Second Look at Double Dip

The first piece in this series laid out the dumb statistical basis for expecting a renewed recession in the US within a year. Those dumb stats tell us that the low-risk bet must now be for recession – and this means that it’s a brave Street economist who in such uncertain times is prepared to spurn the low-risk bet. Among many other factors,  markets right now are anticipating an avalanche of downgrades of economies and earnings which we can assume will follow.

But the second article didn’t allow the data to be dumb – when we got it to talk, it had a tale to tell. It turned out that the pattern of 1Q and 2Q growth was at worst explicable, and at best compatible with renewed growth. The slowdown was largely due to the impact of the supply-jam in the auto sector, the impact of higher fuel prices on fuel consumption, and the predictable (but larger than previously seen) fiscal drags which appear regularly as an economy exits recession. Absent these effects, personal consumption demand is holding up well, investment spending far better. The private sector, in other words, isn’t rolling over.

Nonetheless, we are moving into a period where the statistics very likely to point to a recession. It’s also very likely that the Street will also change its forecasts, and maybe its view, to get into line with the dumb power of the stats.  Later, we must also factor in the impact of a falling stockmarket on household finances.

So is there a case for ‘no recession’ and if so, what is it?

To get a handle on the likely turning points in a business cycle, I look at what’s happening to the return on factors of production. If return on capital is rising, ceteris paribus, it’s unlikely that investment spending will fall. If return on labour (ie, real labour productivity) is rising, it is unlikely that unemployment will rise. If both investment spending and employment continue to grow, it takes something pretty extraordinary to overturn the business cycle. (Although, again,  a complete and prolonged collapse in financial confidence might just do it).

Working out what’s probably happening to return on invested capital isn’t necessarily easy (and conventional economics has shockingly little useful to say about it). What I do is express the flow of GDP as an income from a stock of fixed capital. The trick then is to work out what’s happening to the stock of capital, and this I do by taking a 10yr straight line depreciation over all fixed investment spending. If GDP is rising faster than the stock of capital, then it’s a fair bet that the return on that capital is rising.  This is an unconventional measure, which, as far as I know, I’m alone in calculating/using. However, it has two far more respectable relations. First, it is an attempt to replicate the ‘asset turns’ ratio (total revenues / total assets) used in the Dupont decomposition of return on equity. Second, it is kissing cousins with the ultra-respectable ICOR (Incremental Capital-Output Ratio) so beloved of the World Bank, IMF, OECD etc. Anyone who’s actually tried to work with ICOR will know its drawbacks: but if it helps, think of this measure as an ACOR (Average Capital Output Ratio). 

Here’s how returns to the US factors of production look right now: 

Even after the GDP revisions, return on capital is clearly rising fast, and is probably at its best since the turn of the century. Real labour productivity growth has come off slightly, but is still extraordinarily positive.

Has there ever been a situation in which these readings were so positive, and yet were interrupted by a recession?

Since 1980, we’ve had four recessions: each of them had been preceded by an inflection in this return on capital indicator. Contrariwise, we’ve not had a recession whilst this indicator was rising. It is extremely unlikely that this indicator is going to turn any time soon, since capital stock is still shrinking by around 0.32% YoY, whilst nominal GDP is growing (in 2Q) by 3.7%.  

What about labour? Here the picture is not quite so clear-cut. The three last recessions happened after a period when real labour productivity inflected had downwards, and was  sharply negative. Right now, labour productivity continues to grow very sharply, but it has inflected downwards. This negative inflection seems to have produced a period of labour market softness. However, this is very easy to exaggerate, and I believe it has been very much exaggerated by the seasonal adjustment process. Before seasonal adjustments, non-farm payrolls were growing by 0.9% YoY in June, down from a high of 1.1% in April. They grew 0.5% in May (in line with historic seasonal expectations) and grew 0.3% MoM in June (vs flat historic seasonal expectations). The rising unemployment ratio, of course, masks the continued growth in jobs.

If employment is still growing quite strongly, growth of wages has nonetheless slipped – and it’s this we see showing up flat personal income data.  

Once again, a little historic perspective might be helpful: compensation of employees as % GDP hit a multi-decadal low, nearly 3SDs from historic average, at the end of 2010, it recovered somewhat in 1Q 2011, but was steady during 2Q 2011. Do we think this is proportion has the potential to go lower? If not, then there remains some potential for a positive surprise from wages (and demand).

Notice, once again, that over the last 30 years, recessions have tended to happen after a period when this indicator was rising, or at a high level relative to recent previous experience. At the moment, we seem a very long way from that.  

My conclusion? The dumb stats point to the likelihood of recession. When you get the underlying data to talk, that doesn’t seem like a foregone conclusion. And when you look at what’s happening to returns to factors of production – even after all the revisions – a recession in the next year would be unprecedented in recent US economic history.

So it’s probably right to be brave at this point.  Unfortunately, that leads us straight into the next collision.  “The only thing we have to fear is fear itself.”  Was FDR right?

Growth Scare - What Killed US GDP?

Fear and greed: today, the sharpest fear - fear that takes down the S&P five percentage points in a single day, fear that recoils from the double-dip recession that today seems certainly upon us.

The markets have already done their own forecast revisions, leaving the economists as usual limping behind, blinking and sniffing as we try to understand the path. But as we tinker with our models, the truth is there is a biggish problem: there’s virtually nothing in the high-frequency monthly or weekly data which should have led anyone to anticipate such a collapse in growth during 1Q. That monthly data is statistical history right now, and ought to be safely dead and buried in the databanks. But now, like some bewhiskered Victorian detectives, we need to exhume it to see if, belatedly, it holds clues as to “What Killed 1Q.”

The odds don’t initially seem good. For years whilst in Asia I kept a small momentum model for US domestic demand, tracking employment, wages, retail sales, auto sales and construction orders. For all of these, I compared monthly movements against seasonalised historic patterns, and normalised the ‘error’. The results showed how many standard deviations this data was above or below what you’d normally expect. It’s a crude model, and not one I’d rely on now, but it has rarely been as abominably out of kilter with US GDP growth as it was over the last 12 months to June 2011:

(PS. There are loads of ways I could present this as a more attractive visual fit, either by a bit of quiet smoothing on both indexes, or just presenting the straightforward YoY GDP, rather than the annualized QoQ. But it would be particularly perverse to fiddle the visuals in a piece about how to read the underlying data. Actually, you’re looking at an R score of 61 over 60 observations.)

But when one looks at the personal consumption expenditure portion of GDP, things turn out not to be out of kilter with the underlying data after all:

This tells us immediately that whatever it is that afflicted the recent revisions, it wasn’t a shock about the underlying strength of demand in the US economy.  It’s something else.

In fact, the fall in consumption expenditure in 2Q is not so difficult to trace:  auto sales were down 22.7%  annualized, and it seems reasonable to accept this as a an enforced constriction of consumption with its origins in the disruption of Japanese supply systems post March 11. Gasoline sales were down 6.7% annualized, presumably as consumers adjusted their schedules to higher gasoline prices. Once again, it needs no great leap of imagination to expect this adjustment to have a lagged effect on the rest of consumption. Exclude those two exogenous impacts, and the rest of consumption expenditure was growing by 1.8% annualized in 1Q11, slowing to 1.4% annualized in 2Q11.

And that is about in line with the monthly surveys of personal income and spending, in which spending was running at an annualized 1.2% in 2Q11. It’s not a great result, but, crucially, it is an explicable result, and one which does not necessarily commit us to the early onset of a new recession.  There’s no surprise that the US economy slowed in 2Q – but equally it probably was a slowdown, not a stall.

What about ‘the rest’– the c29% of the US economy which is not accounted for by personal consumption? Here the news for 2Q is surprisingly good: ‘the rest’ grew by an annualized 4.2%, recouping almost all the ground lost in 4Q10 (when it contracted 0.5%) and 1Q11 (when it contracted an annualized 3.7%). Above all, the fluctuations of the last nine months look ‘normal’ – and particularly normal as the economy exits a recession. Look at the chart below, and in particular compare what happened in ‘the rest’ over the last nine months with what happened to it in 2002-2003.

When we look at the detail, things clarify quite quickly: gross capital formation is doing well, rising 7.1% annualized in 2Q after 3.8% in 1Q , with matters looking pretty similar even once you take out the inventory cycle (1.2% in 1Q followed by 5.8% in 2Q). Net exports were up 10.2% annualized in 1Q and down 16.5% in 2Q, but the net figure is so small (around 3% of GDP) that these fluctuations make little impact on the overall GDP total.

 

Which leaves government consumption, which at 18.9% of GDP, or 64% of ‘the rest’, is inevitably the dominant factor.  And the annualized growth trajectories over the last three quarters stand like this: -2.8% in 4Q10, -5.9% in 1Q11, and -1.1% in 2Q11.   I don’t want to antagonize either side of the US debate about the trajectory of government debt but, folks, this is good old-fashioned fiscal drag. As you come out of a recession, tax receipts begin to rise, social security claims begin to fall and before you know it, the pace of the build-up in the national debt begins to moderate, and net government consumption begins to fall. It happened in 2002-03, and it’s happening again now – albeit on the more exaggerated scale with which we are now in other respects familiar.

Yes, it’s snuffling works for dullards, this poking around in details. If you’re still hanging on in there at the end of it all, you deserve the conclusion. Which is simple enough: the presumption of a double dip is today exaggerated hugely by fear. There are shadows across the US economic x-ray, no doubt. But we know what they are, and, to me at least, they don’t look like The Big One. 

US GDP Revisions - Well Below "Stall Speed"

It hasn't happened quite yet, but whilst I'm away on 'holiday' it's a very safe bet that the US Street will be cutting its GDP forecasts for 2011 quite savagely. Quite possibly, the more venturesome of them will alter not just the numbers in the tables, but their underlying view. The onset of these downgrades will come in response not to the debt deal, but rather to the blunderbuss of GDP revisions with which the Bureau of Economic Analysis blasted the accepted version of recent US economic history.

Before we get into details, one bottom line is this: the US economy is approximately US$140 billion smaller than we though it was.

The details matter, though, particularly since the revisions tell us that in 1Q11 the US economy grew only 0.4% annualized, rather than the 1.8% previously recognized, and grew only 1.3% in 2Q (and that's a preliminary reading,too).  This means that the US economy right now remains smaller in real terms than it was immediately prior to the crisis - 0.4% smaller, in fact. Worse, the series of 0.4% followed by 1.3% is ominous, because it means that the US has been growing much slower than 2% now for two consecutive quarters.

This means the US economy is bumping along well below the 2% 'stall speed' which the US Fed economist Jeremy Nalewaik tentatively identified with developing recessions. In a paper for the Fed this May (available here), he observed that statistically since 1947, when two-quarter annualized real GDP growth fell below 2%, recession followed within a year 48% of the time. We're there already.


The odds get worse, however, when YoY real GDP growth falls below 2% in two successive quarters:  recession then follows within a year 70% of the time. We're not yet there yet, but annualized 3Q GDP growth would have to come in around 4% to avoid that fate. I've just checked the Bloomberg consensus, and only three out of 64 surveyed economists expect that (step forward the brave economists of Pierpoint Securities, MFGlobal and First Trust Advisors).

(One possible reason 2% might be a "stall speed" is that that labour productivity growth in the US tends to  average around 2% a year. So if the economy cannot manage to grow at such a pace, employment markets will certainly be slack. As we observe today.)

So economists, who had a consensus forecast for US GDP growth of 2.9% as late as May, and still apparently expect 2.5% growth this year, followed by 2.9% next, are now very firmly on the on the wrong side of historical probabilities.  Unless they can provide convincing reasons why this time is different, the low-risk, high-probability default position should now be for renewed recession in the US, within a year.

A third detail is also worth noting: the toll the financial crisis has taken on the US's stock of capital is greater than previously expected, and the recovery has not yet begun.

Working on a 10yr straight line depreciation schedule, the previous data suggested that by March this year US capital stock had shrunk 0.9% from its 1Q09 peak, but was expected finally to have started growing in 2Q11.  The revised data tells us that the contraction of capital stock has been 1.3% since the peak, and is still contracting in both YoY and QoQ terms. Capital accumulation is a fundamental engine of economic growth - and in the US, it's still now happening.

Holidays in Euro-hell

Later this week, I am going on holiday. To Cyprus.

Yes, Cyprus - which is shaping up nicely not just as the next Eurozone domino, but also as perhaps the first which no-one except Greece really has an overpowering incentive to rescue, and which may even be allowed to fail spectacularly 'pour encourager les autres'.

Where to start? The easy stuff first: Cyprus' collapsing Communist government is running a fiscal deficit of 5.3% of GDP, and that is contributing to a current account deficit running at 7.8% of GDP.

From these numbers, we can tell that its private sector is running a savings deficit of 2.5% of GDP. Which in turn means that the island's banking system must be consistently finding cash with which to keep the private sector's economy running.

So let's have a look at its banking system. Let's start with the loan/deposit position of the banks with Cyprus residents - by June this year it had hit 116%, up from 108% a year ago (as the savings deficit dictates).  But that's only the slightly  bad news.  We need to consider the total size of the banking system, which right now has deposit liabilities equivalent to just over 5X Cyprus' GDP, and has loans outstanding to residents of just under 4X GDP.

You will have spotted, of course, that these sorts of multiples and cashflows dictate Cyprus' banks are funded by a large net foreign liabilities position. Now, the Central Bank of Cyprus isn't publishing data on the banking system's net external bond liabilities, but from what is published, we can discover that the banking system is carrying more foreign deposits than its making foreign loans - a funding mismatch currently worth around 31% of GDP.  Very clearly, the real net foreign liability mismatch will be larger.

Additionally, we simply don't know how much of Cyprus' bank assets are, in fact, Greek 'assets'. However,  the Greek commercial and cultural presence in (South) Cyprus is obvious and omnipresent, so it would be something of a surprise if it turned out Cyprus' banks haven't been lending money to their Greek compatriots. Press reports say the banks have around Eu 5 billion of Greek sovereign debt - that's equivalent to just under 30% of GDP.

And then there's the economy itself, which as a result of being shackled to the Euro, is overpriced for tourists (I'm going there because it's where my parents-in-law live, for now) and sluggish. During 1Q11 it managed nominal GDP growth of 2.6% YoY, which didn't keep pace with the muted 2.9% YoY growth of its capital stock. In other words, return on capital is falling, and as a consequence, so is investment (it fell 2% YoY in 1Q).   Since 2Q nominal GDP will certainly be slower, we can be sure that all these ROC numbers and trends have not yet bottomed.

But in fact, the economy's in much worse shape even than that. For Cyprus is reeling from a catastrophe which, though utterly avoidable, is truly disastrous. Two years ago, Cyprus intercepted and impounded a shipment of high explosives originating from Iran making its way to Gaza. Britain offered its technical aid to help Cyprus store it safely, but this offer was not taken up. Rather, the high explosive was stacked up in 98 containers next to the island's largest power station, which generates about half of Cyprus' electricity. Now, Cyprus is a near-desert island, subject to brush fires during the summer. So the inevitable duly happened:  two weeks ago, the brush fire ignited the high explosives, which took out half of Cyprus' electricity-generating capacity. So we can add power cuts and brownouts to the list of woes.

How will the tourists like that? (And it matters, since the Eu3.8 billion in services surplus is the biggest offset to Cyprus' Eu 4.7 billion trade deficit).  More to the point, who in their right minds would pick  Cyprus as their destination right now - except perhaps for disaster-hunting economists?

I shall be taking a computer, and fear I may find myself reporting from the front line. Damn!

What Have the French to Be So Happy About?

It's easy to get inured to the grotesque when tracking European leaders 'tackle' the crisis of their own making and sustaining. But not today. Because today  I  read of the trials of Bankia. This is a Spanish savings bank, which, sadly, not longer enjoys access to the money markets.  Consequently, it joins the queue at the ECB's lending window of last resort. When it gets to the head of the queue and explains its predicament, the ECB's man at the window says: 'And what collateral can you offer me?'  Bankia rootles around in its exquisite leather briefcase, produces a piece of paper and say, triumphantly, 'Well, I've got this!'  And 'this' turns out to be the £80 million loan Bankia made to Real Madrid to allow it to buy Portuguese dribble-wizard Ronaldo from Manchester United.  In truth, the Bankia is offering to the ECB is nothing more or less than Ronaldo.  

So even if the ECB can't rescue the Eurozone, it still should have a sporting chance at the World Central Bank Football Cup, to be held in Basel (or Beijing) in 2015.

But back to France. What have the French to be so happy about? (except the wine, cheese, weather, light . . . oh God, the list goes on). Earlier this week, as Europe's financial foundations crumbled, French consumer confidence was measured as its most joyeux of the year.

The Franco-German relationship is au fond the point of the European Union: back in the 1950s the European Iron and Steel Community was initiated precisely a de-fang the strategic industries of the Ruhr (principally Krupps - read William Manchester's 'The Arms of Krupp' for details), so that they could never again subvert democratic governments into making war on their neighbours. The Krupps did magnificently out of the Franco-Prussian War, and also World War One, and the Krupp family spotted Hitler's potential, and funded his rise in the early 1930s - so you can see how powerful the analysis would have been. When President Mitterand announced that 'L'Europe, c'est la paix', that's how he understood it.

Notice, however, that even at this stage, the point of the pan-European institutions was to provide a countervailing institutional force to the enduring dissimilarities between France and Germany.  So when we look at the Euro, the really crucial question is not whether Greece or Portugal or Spain (or even Italy) is a viable part of a common currency zone, but whether France and Germany can coexist in the same economic, financial and fiscal state.  The introduction of the Euro finally seemed to answer that question with a triumphant 'Oui'. Now look at this:

That's the spread between French and German 10yr government bond yields. I've averaged it over the last month to make it easier on the eye - and as a result it mildly underestimates the current spread. As of yesterday's (Friday's) close, the spread was 68bps. The Greek 'rescue' packages, whether ultimately successful or not, seem irrelevant to the development of this spread. 

I'm conflicted about how to read it. One could say that it represents the market's correct judgement that France's fiscal foundations are somewhat flimsier than Germany's, and so the market is working. Or one could say that the emergence and endurance of a noticeable spread represents the market's view that should push come to shove, German tax payers won't be in the business of paying French state pensions. In short, that Franco-German fiscal union will never happen. 

Whatever the reason, unless one really believes in the possibility of Franco-German fiscal union one should expect the spread to widen over the medium and longer term.  Because when it comes down to it, the French and German economic models - ie, the way they grow - are now radically different. And for historic and structural reasons, that difference is going to be far more pronounced in the next decade than it was in the previous decade.  

The next couple of charts explain how and why. The first shows the different trajectories of return on capital in France and Germany, based on an indicator measuring the flow of GDP as a return from a an estimated stock of capital. (Nb, this is a directional indicator only, not a direct measurement of ROC.)

As you can see, Germany's ROC was climbing sharply before the financial crisis (as it economically digested East Germany), and has rebounded to near record levels since. No guesses for which way it's likely to continue to go.  France's ROC record, on the other hand, has been one of sustained and enduring erosion. More, only now is it beginning to show some recovery from the financial crisis. Germany's historically low ROC surpassed that of France in late 2007 and has never looked back (perhaps coincidentally, just at the time that the yield gap also opened up). The gap between the two has widened, is widening, and there's no reason to think that won't continue.

France's growth strategy meant that is didn't notice much, because it compensated for a slightly lower relative ROC by building its asset base faster than Germany. So in the years immediately prior to the financial crisis, French capital stock was growing 5%-7% pa, whilst Germany's was, well, hardly growing at all.  France grew by growing its asset base whilst its ROC fell; Germany grew by sweating a relatively static pool of assets. Taken together, the two models resulted in pretty similar growth rates.

But, as the economically observant of you will already have noticed - these were two growth rates passing like ships in the night. Regardless of the crisis eroding the fringes of the Eurozone, there are very different economic futures beckoning for Germany and France. Germany's higher and rising ROCs invite and justify further expansion of its capital stock - something that will become only more attractive as German labour markets tighten. All in all, then, we should expect a fundamentally-based acceleration in German GDP growth sustainable over the medium and long term. For France, the opposite it true: stagnant ROC will likely continue to weigh on investment spending, growth of capital stock and ultimately growth in the medium and longer term.

To sum it up, Germany's medium and long term economic future looks rather different (and considerably brighter) than France's, in a way which reveals a fundamental difference in the growth models of both countries.That difference has been masked throughout the short lifetime of the Euro by the costs imposed on Germany by its absorption of Eastern Germany. No longer - the mask is off, and Germany's underlying outperformance is going to become more and more obvious.

All of which raises two questions. First, can France change its growth model? And second, what have the French to be so happy about?

Sic Transit Gloria Euromundi

It's Monday, the day-after-the-rescue-before, Greek 10yr bond yields are up 11bps,  and both Spain and Italy's are up 25bps, and the EuroStoxx 50 is down nearly 1.1% on the day.

For me, the best commentary on last week's package is from J.P. Morgan's David Mackie, and I hope he will forgive me quoting him at length:

'Many commentators assume that because the Euro area’s consolidated fiscal position is better than the US’s, then a Eurobond that simply aggregates Euro area sovereign debt with a joint and several guarantee will be rated the same as US treasuries. But this may not necessarily be the case. The creditworthiness of US treasuries depends on the power of the US government to tax citizens and control public spending across the entire country. In a simple Eurobond without any change in governance, the creditworthy countries only have the power to tax citizens and control public spending in their own jurisdictions. They would not have the power to tax citizens and control public spending in the less creditworthy countries. 

Thus, if we get to a situation where Spain and Italy lose access to capital markets, a Eurobond as a simple piece of financial engineering would not solve the problem. The creditworthy half of the region would not be able to bear the burden of the less creditworthy half. Only a move to a fiscal union where either governments in the creditworthy half had the ability to tax citizens and control public spending in the less creditworthy half, or alternatively where the creditworthy countries had the ability to control debt issuance by the less creditworthy countries, could save the region. Thus, when a common Eurobond is most needed, say if Spain and Italy were to lose market access, it would be the least effective unless accompanied by huge governance reforms."

US Consumer, and the 2Q Slowdown

Barrels of analytical ink have already been spilled over the disappearance of US growth in 2Q.  The line generally taken is that it is explained mostly by bad luck: first the weather was foul and inventories were building a bit; then oil prices spiked because of the Arab Spring (and then Libya); and then the global auto industry discovered just how utterly dependent it was on a few parts plants in Tohoku, Japan, knocked out by earthquake/tsunami/power-outs.  All true, no doubt, but the best economists on the Street reckon even this combination doesn't account for much over half the slowdown.

Something else was going on as well. Can we understand it, and by tracking it get a heads-up on the likely direction for the rest of the year.

I think we can. In an economist's ideal world, national flow of funds tables would be published on a weekly basis, so we could track just what's happening to balance sheets. In that way, we could hope to get a better fix on cashflows.  But alas, the Fed serves them up on a quarterly basis. Still, they still have a story to tell.

And the most important, epoch-making story they tell is of a great restoration of 'normality' to US household balance sheets. Take a look at the following chart - it shows the net position of the US household sector with credit markets (including banks) between 1970 and 1Q2011.

Actually, this chart is one of the two mainsprings of the world over the last 50 years (the other being China's emergence). And it neatly divides into three parts. The first part is 1970-1991, during which time the US household sector behaved exactly as household sectors are historically expected to do: i.e., they save, bank the savings,  and the banks then allocate those savings to industry. (Well, that used to be the theory.)  By 1991, these net deposits amount to just under US$1.5 trillion - the equivalent then of 25% of GDP.   But that year is the pinnacle: for starting in 1991, we have an absolutely startling change in financial behaviour: the US household sector starts to run down its net bank savings systematically and increasingly rapidly. By  1999, it's spent the lot, but, being 1999 the party continues.  In fact, the recession of the early 2000s merely accelerates the trend, and by 2Q2007, the US household sector owes credit markets a net US$2.97 trillion, equivalent to 21% of GDP.

And that's it - that's the bottom.  Since then, the sector, voluntarily or otherwise, has improved its net balance with credit markets by US$1.5 trillion, and as of March 2011 its net debts had contracted to US$1.42 trillion, or 9.5% of GDP.

The chart tells you that one way or another, this is a fundamental, one-in-a-generation change in financial behaviour.  It is also the central fact that is dominating US economic growth, and, most likely will continue to dominate it for years to come. This household deleveraging - which, incidentally, is as much a function of diminished appetite for financial risk as represented by equity investment as it is of blunt debt-repayment - is the financial driver of the 'new normal'.

When we track its evolution via the flow of funds tables, we can make a very good guess at what the missing element was that sabotaged US growth in  2Q, coming so hard on the heels of comparative over-achievement in 4Q10 and 1Q11.

Take a look at this chart, which tracks changes in this net debt situation on a quarter-by-quarter basis - i.e., it gives the fine grain detail to the broad sweep of the first chart.

It doesn't look much, does it - another damned dull chart, in fact. But stifle your yawns, take a moment, and  you'll see that although this deleveraging seems to have a marked seasonality, with most net changes taking place during 1Q,  this year the deleveraging barely occurred. During 1Q2009, the household sector's balance improved by US$454 billion; during 1Q2010 it improved by US$288 billion; but during 1Q2011, it improved a paltry US$55.6 billion.

When I model US domestic demand momentum against underlying financial conditions (a model that's fraying heavily at the edges, to be honest),  we saw a marked and inexplicable over-performance in 4Q10 and 1Q2011.  My belief is that that over-performance was the result of a lapse in deleveraging behaviour which, by 2Q2011 was being noticed, regretted, and reversed.

Until the 2Q2011 flow of funds tables are issued (Sept 16, mark your diary!) we won't be able to prove it. As I say, ideally flow of funds tables would be published every week. They aren't - but bank balance sheets are, and we can use those to give us a good idea of what has happened since.  I do this by simply looking at how many deposits are coming into US banks, vs how many new loans are being made - in ridiculously simplistic terms, this is a cash in vs cash out measurement.  Here's what it looks like, up to early July:

And the picture does indeed tell the same story as the flow of funds charts: perennial negative cashflow (more loans going out than deposits coming in) is replaced in 2008 by massive and sustained deleveraging. The pace of that deleveraging declines (though remains positive) throughout 2001 and into the first quarter of 2011.  And then. . . . well, the pace is picked up again in 2Q, and appears now to be stabilizing. 

In terms of the domestic demand, that means a strength of demand in 2010 and into 1Q11 which runs slightly ahead of underlying 'organic' growth (which is also why we get a mini inventory-cycle), followed by a correction in 2Q2011. 

End of the earth? End of the cycle?  By no means - but growth with deleveraging is the new normal in the US, and that's not going to change.  Anytime it looks like it has abated, assume it hasn't. And watch carefully the swings in banks cashflows - at least until they get round to publishing flow of funds tables on a weekly basis.