A debt crisis at the economy’s edge

Good morning. Steady as she goes: yesterday’s bundle of potentially market-moving news — Home Depot earnings, the producer price index, a Jay Powell appearance — all came in more or less as expected. Home Depot same store-sales are still falling as a frozen housing market takes its toll, but the picture was no worse than expected. The PPI headline numbers looked hot, but the details were mildly encouraging; the components that feed directly into the Federal Reserve’s main measure of inflation (airlines, insurance) rose only moderately. Powell repeated his recent mantra: patience. All very calming, but if we get a consumer price index shocker today none of it will matter. Email me: robert.armstrong@ft.com.

Household debt

Household debt levels in the US, considered collectively, are not a problem. We learned our lesson in the 2003-2008 mortgage debt frenzy, and appear not to have forgotten it. Here is household debt as a percentage of GDP: 

Most of the fall in that chart is driven by the decline in the mortgage debt burden (the chart is broadly the same shape, by the way, if you divide household debt into total household assets rather than GDP). But of the major subtypes of debt, only student loans have grown relative to the economy over the past two decades, and they are declining now:

Americans, in aggregate, do not have a debt problem (except of course for the debt carried by their government). But aggregation deceives. As we have discussed in this space before, households who are on the lower end of the income spectrum and carry floating rate debt appear to be in real trouble. This is showing up in both delinquency statistics and the earnings of companies that serve the working class and poor.

The gold standard source for household debt data is the New York Fed’s household debt and credit report, and the update for the first quarter came out yesterday. What it showed is that in the most recent quarter the problems at the low end got worse, but not much worse. We have discussed the notorious chart of transitions to serious delinquency among auto loans before. Among auto borrowers under 40 the delinquency numbers continue to creep towards financial-crisis levels. There is also a distinct smell of stress in the chart of transitions to credit card delinquency:

This most striking bit is the red line: people in their thirties are going seriously delinquent at a rate way above the levels of the past decade. And this cohort is doing much worse, relative to their own history, than people in their twenties (the light blue line). I’m not sure what to make of that, but it ain’t good.

New York Fed economists, in a blog post accompanying the report, looked at delinquency rates stratified by borrowers’ credit utilisation. They found another striking trend: borrowers who have “maxed out” their credit limits are going delinquent at a rate unseen in the last decade. Again, these are typically younger and lower-income borrowers. Their chart:

The picture grows ever clearer. Strong household balance sheets on average — but acute stress at the margin.

The gold rally is still weird

In December we wrote that the gold rally was “weird”, given high real interest rates (real rates are the opportunity cost for owning financially inert lumps of shiny metal). Well, the rally has gotten about 15 per cent weirder since:

Back then, we offered four possible explanations for the rally: signs of falling real yields to come, a weaker dollar, rising geopolitical tensions, and central bank gold demand. In the intervening months, the dollar has strengthened and real rates have risen (the yield on the 10-year inflation-protected Treasury has gone from 1.98 per cent to 2.15 per cent), but gold has charged along.

Some argue real rates will fall when the Fed finally cuts its policy rate. But it doesn’t have to go that way. I have no idea what real rates are going to do in the month or years to come, whatever the central bank may do. This question is the subject of intense debate among economists — are we in a new era of higher rates, or are we headed back to the old, low-rates normal? If gold speculators believe they know the answer, I can only wish them well.

It is also possible that gold buyers see a new era of higher inflation ahead. But, again, gold has not historically been a great hedge against inflation in general; only a great hedge against high inflation accompanied by low real rates. Perhaps gold investors are anticipating a specific inflationary scenario — financial repression, in which inflation runs hot but central banks keep rates artificially low for fear that sovereign debt burdens will become unbearable. At the same time, perhaps, more countries will defect from the defunct dollar-based world order, holding more and more of their reserves in gold. Possible? Yes. Possible to predict with useful precision? Probably not.

As far as non-financial geopolitical risk — the spectre of wider conflict and the disintegration of the global security order — one must remember that markets are as useless at predicting this sort of thing as the rest of us are. When it comes to war, there is no wisdom of crowds.

Is any of this airy prognostication enough to explain gold breaking above $2,000 — the level in which Asian retail demand is reputed to diminish? Well, grand narratives and speculative frenzies grip markets all the time. Indeed, the FT recently reported that speculators in Chinese futures markets are having a notable impact on the gold price. But while the shadow of financial repression and war, along with the rise in Chinese speculation, may well explain the rise in the gold price, they do not justify it, in terms of forming the basis of a solid, long-term investment case. The gold rally is still weird.

One good read

Steak.

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