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Big Picture Ponzi Update

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By RodgerRafter
June 16, 2008

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This decade, our rate of borrowing has been unsustainable, as Americans have participated in a great Ponzi scheme. The more debt we piled up, the more we had to borrow to sustain economic growth. The scheme has begun collapsing on itself, with foreclosures and bankruptcies on the rise. Credit has tightened both because banks are in financial trouble and because a growing number of individuals and businesses have become poor credit risks:

Total debt growth by sector:
2000 4.9%
2001 6.3%
2002 7.3%
2003 8.1%
2004 8.8%
2005 9.2%
2006 8.8%
2007 8.2%
2008 6.5% (Q1) (D.1)

The household sector is getting hit hardest first. The business sector has recently begun to feel the credit crunch. The federal government is trying to keep the economy moving with greatly increased borrowing:

Year-Household-Business-Federal Govt.
2008----3.0%--------9.2%-------9.5% (Q1)

National foreclosure filings continue to rise as the mortgage part of the Ponzi scheme unravels. May numbers from RealtyTrac:
May 2006: 92,746
May 2007: 176,137
May 2008: 261,255

Mortgage Equity Withdrawal was running at a $500 billion per year rate in 2005 and 2006, but dropped to around a $100 billion annualized rate in Q1 2008. (chart 3)

Of course, households never should have been allowed to extract that much equity in the first place. Banks should have shown restraint in lending. Foreign investors should have demanded a more reasonable return on US investments, but there was just too much investment capital flowing back into the US as a result of the trade gap. The dollar stayed too strong, too long and trade gap dollars fueled the market for sub-prime mortgage backed securities, junk bonds, and government debt.

As part of the big Ponzi picture, foreign investors, especially foreign central banks, have been financing America's debt at an accelerating rate. Official and International custodial accounts at the Fed have tripled in the last 7 years, with the growth rate now over $350 Billion per year:
$707,966 million 6/13/01
$770,502 million 6/12/02
$936,154 million 6/11/03
$1,230,805 million 6/9/04
$1,436,087 million 6/15/05
$1,632,988 million 6/14/06
$1,957,585 million 6/13/07
$2,307,941 million 6/11/08

Our trade gap is about the same as a year ago, but now we're going deeper in debt buying gas, rather than other consumer and industrial goods and services:
Jan-Apr 2007 Petroleum Goods = $85,603 million
Jan-Apr 2008 Petroleum Goods = $132,124 million
Jan-Apr 2007 Non-Petroleum Goods = $177,936 million
Jan-Apr 2008 Non-Petroleum Goods = $143,232 million (Exhibit 9)

This is a dramatic macro measure of what is happening to average consumers. Rising food and energy expenses are squeezing most consumers into a lower standard of living and driving many into bankruptcy and/or foreclosure.

Things should only get worse from here. Ponzi finance of the household sector still has a long way to go. Consumer credit write-offs are rising along with mortgage defaults. Traditionally job losses are the big trigger for defaults from the household sector and these have recently begun to rise. As conditions worsen for businesses and state and local governments, more consumers will lose their jobs.

The business sector has only just begun to feel the squeeze, with the retail sector slowing and the financial sector going through a significant contraction. Export related industries are likely to benefit from a falling dollar... if the dollar is allowed to fall.

Eventually the Federal government will reach it's borrowing limits. Treasury yields have been on the rise as the total federal debt approaches $10 trillion. As tax revenues decline, state and local governments will face a very difficult budgetary environment, necessitating more layoffs.

A sustainable economy, with $60 billion less in monthly foreign trade deficits is probably where we are heading. That will mean far less consumption and greater imports. It will mean a much weaker dollar and a re-definition of the middle class American lifestyle.

Our economy is structured so that the poor are taking the biggest hit first. Food costs are breaking many budgets. Homeless shelters are filled and encampments are growing and multiplying.

Much of the middle class is being forced into lifestyle changes by the economic realities. I think most of us have noticed that there are fewer cars on the roads and in line at gas stations. Tightened credit is preventing many from buying more home or more toys than they can afford. Excessive consumption is going out of style.

All this was foreseeable and unavoidable. Ponzi schemes always collapse under their own weight. This one just may have been the biggest one in history.