Sunday, September 27, 2009

Taking a Minsky Cruise on the Flow of Funds Datastream (part 1)

Financial Instability Hypothesis: The idea that over periods of enduring economic expansion that only record a few small recessions, more and more economic units are involved, voluntarily or not, in Ponzi finance. Balance sheets become more sensitive to the nonrealization of expected cash inflows, changes in interest rates, changes in taxes, changes in asset prices and other factors that affect cash flows and funding methods. Levy Institute

You know the old warning about mixing wine and beer (or was it gin and vodka)? Along the same line of thought, don't revisit the work of Hyman Minsky before a long term look at the Fed's Flow of Funds data. It might make you queasy.

If, however, you have a strong stomach like me, thanks, perhaps, to a few years spent eating road-side food in SE Asia (Sate Angin in Jakarta, anyone? that's a joke, btw- angin is haram and stall food is often delicious) lend me your eyes as I show you a few graphs and offer a few ideas to consider.

If you're unfamiliar with the term, flow of funds, this link might be useful. In the interests of full disclosure I traded for many years before I got my head around it.

The first graph shows the breakdown of debt owed divided by GDP (chosen more to remove inflationary effects than to suggest other relationships) among various economic sectors: HH- households and NonProfits, Biz-Non Farm Corporate and Noncorporate Businesses, Fed- Federal Government, Fin-Total Financial Sector, RoW- Rest of the World

The second graph shows the breakdown of debt owned by various economic sectors. Yes, It's true the banks do own (or at least have a hell of a mortgage on) the country.

Removing the financial sector from the second graph you can get a better sense of who's going to be second in line when bankruptcy proceeding begin on the USA (just kidding, I hope).

Putting the pictures into words, Banks (who are, of course, owned by people, equity liabilities are not included in that data set) have always had a big lien on the country, but that lien has doubled (relative to GDP) since 1980.

Households used to be a major source of finance in the country but as their distaste for debt faded along with memories of the depression they started to borrow more than they leant. Then, as restrictions to foreign capital inflows fell (how else to maintain a trade deficit without settling in specie) the Rest of the World became a significant source of funds. In 2001, The RoW overtook US Households as a source of funding and this trend has accelerated.

Warren Buffett was wrong, we weren't going to become a sharecropper society, we already were one.

But, you might be wondering, I've got the queasy stomach but where's the Ponzi finance.

I should have part 2 of this essay ready later tonight or certainly by tomorrow.