Friday, December 12, 2008

Deflation’s Root


The Lehmann Letter ©

Yesterday the Federal Reserve released its third-quarter 2008 flow-of-funds report. Households’ $117.4 billion reduction in outstanding debt caught the attention of many. Consumers are pulling back.

But there was another aspect of the report that generated less attention. To review the numbers for yourself, go to (

Calculate total private nonfinancial borrowing by subtracting federal borrowing from the total for all domestic nonfinancial sectors and then adding foreign borrowing. You should arrive at these totals for 2008.

First Quarter $1,555.0 Billion
Second Quarter $772.0 Billion
Third Quarter -$277.7 Billion

The following chart is current through the second quarter. Update the chart in your mind’s eye by including the third quarter drop of -$277.7 billion.

Private Borrowing

(Click on chart to enlarge)

(Recessions shaded)

This is the first time that private borrowing was negative. That is, the private sector is repaying its debts rather than incurring new debt. So what, you might say. Isn’t it about time the borrowing binge came to an end?

Not so fast. Borrowing supports spending. The surge in household and business indebtedness since 1990 financed the growth in aggregate demand. Mortgage borrowing’s support of residential construction is the most clear cut example, but not the only one. And borrowing’s current collapse is, of course, an obvious sign of the current recession’s seriousness.

Moreover, borrowing’s collapse is also an omen of impending deflation. It’s difficult to maintain prices when demand’s most important prop – borrowing – disappears.

(The chart was taken from [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of economic indicators.)

© 2008 Michael B. Lehmann

No comments: