3 Underappreciated Indicators To Guide You Through A Debt-Saturated Economy

Tyler Durden's picture

Submitted by F.F.Wiley via Cyniconomics blog,

If you’re my generation or older, you may remember taking the original Pepsi Challenge – the Coke versus Pepsi taste testing booths that you would find at sporting events, fairs and similar venues. I took the Challenge and stuck with Coke. The majority of people went the other way, as confirmed by even Coke’s private tests. Nowadays, though, I’m guessing the public version of a Challenge booth would bring heckling from the nutrition-conscious folks at the Just Juice stand. The bigger challenges for Coke and Pepsi are health risks linked to their flagship products. Researchers are zeroing in on a handful of ingredients that may be harmful, such as sodium benzoate and phosphoric acid.

We have nothing to add to the soda studies, but they somehow seem similar to our research on debt. Like soft drinks, you can think of debt as having different ingredients, some benign and others risky. At the highest level, here are the ingredients that everyone should be aware of (hereafter, we’ll call them funding sources):

  1. Funding from outside the U.S.
  2. Funding from the Federal Reserve system
  3. Funding from private banks
  4. Funding from non-money savings

Over any period, we can examine the total amount of borrowing and divide it among these sources with only a small residual. Here’s a breakdown for the last 60 years:

3 indicators 1

Now, you may look at this picture and see nothing interesting. If that’s all we have, then there’s no fizz in our soda, right? You already knew that foreigners, the Fed and private banks help to finance our debt. According to mainstream economic thought, that’s a good thing. We don’t think it’s quite that simple. We’ll show that credit financed by lenders outside the U.S., the Fed and private banks is a major source of economic volatility. We’ll also describe three indicators that help to size up the related risks.

First, though, we’ll define and comment briefly on each funding category shown in the chart. (If you’re just looking for the bottom line, skip to “Okay then, what should I be watching?”)

Funding from outside the U.S. Foreigners invest the proceeds of our current account deficits back into U.S. $-denominated investments. Therefore, the money that drains out of our real economy (when we import more than we export) flows back into our financial economy. Large amounts of these flows are unsustainable over the long-term and unstable through the business cycle. Inflows to the financial economy contribute to asset volatility and, in the extreme, bubbles. They also make it easier for politicians to increase public debt. Outflows from the real economy are linked to declining savings rates, which are harmless in the short-term but come back to bite when low-savers inevitably learn they’ve overspent.  America’s mix of low personal savings and high public deficits owes much to credit market financing obtained from outside the U.S.

Funding from the Fed. Like foreign funding, too much credit from the Fed (primarily debt securities held on its balance sheet) contributes to financial volatility and declining savings rates. These effects are largely intentional. Central bankers who ramp up the supply of credit through, say, quantitative easing, aim to lower interest rates, thereby pushing up asset prices and encouraging more spending and less savings. What you won’t hear from these central bankers (unlike ex-central bankers, who sometimes spill the beans) is that near-term benefits are invariably followed by an opposite reaction once interest rates, asset prices and savings rates normalize.

Funding from private banks. In a fractional reserve system, banks create (“print”) money by conjuring up deposits to deliver loan proceeds. Generally, the extra deposits remain in the banking system for as long as the corresponding loans are retained on bank balance sheets. When loans are either paid down or sold off and removed from bank balance sheets, the extra deposits are extinguished. In other words, bank funding increases when the amount of credit that’s extended and retained on bank balance sheets is greater than the amount that’s paid down and removed from bank balance sheets. (Note that banks also create money through activities that don’t involve loans, but these tend to be either less significant or on the Fed’s behalf.)

Because of the link to loan issuance, bank funding typically boosts spending more immediately and certainly than funding supplied by the Fed. Not only that, but loans retained by banks deliver the extra oomph that comes from the fact that deposits are created from thin air. Setting aside potential inflation effects, bank lending essentially turbocharges the economy, creating a “virtuous” feedback loop where more spending leads to more production, which then leads to a higher level of income and reinforces the initial lift in spending.

Unfortunately, though, turbocharged lending eventually reaches borrowers who produce things that can’t be profitably sold. Or, it flows to home buyers and consumers who spend more than they can afford. Either way, loans go sour and the virtuous loop gives way to a vicious loop of less lending, spending, production and income.

Many economists, although mainly from outside the mainstream such as Austrian business cycle theorists and Chicago Plan advocates, recognize that vicious loops are a natural consequence of balance sheet expansion by banks in a fractional reserve system. While it’s not the only culprit, we’ll demonstrate the link between bank balance sheets and economic volatility in just a moment.

Funding from non-money savings. Debt that’s placed directly with domestic, non-bank investors – through either debt security issuance or loans that banks choose to sell and move off their balance sheets – is fundamentally different from other sources of funding. It’s financed by 100% genuine, domestic savings. It excludes the monetary expansion that occurs when banks match a loan on the asset side of the balance sheet with a newly-created deposit on the liability side, thereby lifting the supply of credit without a prior increase in savings.

Most of the non-money savings in our economy comes from households, pension funds and insurance companies. You shouldn’t think of these sources of funding as completely risk-free, but they’re the Just Juices of the credit markets. Or, you can think of them as the relatively harmless ingredients in your soda that are mixed with the more dangerous stuff when other funding sources come into play.

Uncategorized funding. This is our residual category, which has negligible effects on the analysis. It’s explained in the accompanying “technical notes” post.

.               .               .

Okay then, what should I be watching?

Now for our three indicators. We start by estimating the percentage of total borrowing that’s funded by the three riskiest sources (the red-shaded areas of the chart above), rather than non-money savings:

3 indicators 2

As noted on the chart, three periods stand out for an unusually high percentage of risky borrowing. The first two coincide with the creeping inflation of the 1960s and Great Inflation of the 1970s. The third overlaps the serial bubbles of the last two decades and leads into the 2008 financial crisis. While some may call this a coincidence, we beg to differ. Problems with either inflation or financial instability are exactly what you should expect when debt funding is tilted heavily towards risky sources.

Next, we divide risky borrowing by GDP:

3 indicators 3

This chart can help you gauge how hard the economy might fall after the inevitable cracks appear in credit markets. Not surprisingly, it shows that the three periods with the greatest amounts of risky borrowing were followed by the three hardest falls – severe recessions in 1973-75, 1980-82 and 2008-09.

You may have also noticed that virtually every recession follows a drop in risky borrowing. This, too, shouldn’t be surprising. If you agree that large amounts of risky borrowing eventually lead to vicious circles – in which soured loans and a slower borrowing pace drag economic activity lower – then you should expect recessions to occur after risky borrowing peaks. This is exactly what we see.

We create a third indicator by measuring the change in risky borrowing. Using two year changes, it looks like this:

3 indicators 4

This isn’t a perfect recession predictor (there’s no such thing), but it helps to narrow down recession probabilities. And while it doesn’t offer ironclad proof that borrowing in excess of non-money savings leads to recessions (once again, there’s no such thing), it fits into the very process described by economists who’ve dared suggest that such borrowing is risky.

The bigger picture

We recommend including the three indicators in any risk analysis, alongside other factors such as debt ratios and interest rates. Debt ratios show the economy becoming more and more saturated with debt. We’ve seen steady increases in debt-to-GDP, debt-to-income, debt-to-sales, debt-to-assets; name the ratio and we’ll show you an unsustainable upwards trend. (We won’t repeat the charts here, but you can go to our last post and work backwards to others showing data on public and private debt.)

These upwards trends are a direct consequence of the risky borrowing shown in the charts above. If borrowing was limited to amounts funded with non-money savings, debt ratios wouldn’t rise. Even a modest margin above non-money savings would leave debt ratios stable. As it is, risky borrowing averaged 8% between 2002 and 2013, a pace that you can call hell-for-leather without much exaggeration. The post-2009 average is only slightly lower at 7% of GDP, thanks to money printing at the Fed and a shift in the debt mix from private borrowers to the U.S. Treasury.

Interest rate developments are another important part of the picture. Falling rates may explain why risky borrowing declined sharply in the mid to late 1980s without an especially severe recession. The secular decline in rates continued to provide tailwinds in the 1990s and 2000s, but these tailwinds shouldn’t have much power left, if any, now that we’ve reached the zero lower bound.

Conclusions for today’s economy

There are two particular messages in the latest indicator readings. First, with risky borrowing on the upswing, we’re still not seeing a recession signal. This is consistent with several other business cycle indicators that remain benign, such as profit margins (still high), bank lending standards (mixed) and the yield curve (still positive).

Second, the risky borrowing indicators are troubling, nonetheless. They show that we’ve reverted to old habits of borrowing far more than we can fund with non-money savings. At almost 10% of GDP in 2013, risky borrowing is higher than in all but the early 1970s and middle part of the last decade. This tells us that we’re accumulating risk at a rapid clip, although not for as long as in those earlier episodes. (Yet.)

Worse still, policymakers and mainstream economists are unperturbed, failing to acknowledge that some types of financing are riskier than others. It’s as if we’re stuck at a 1970s Pepsi Challenge booth, watching people debate cola tastes with no mention of health risks. With ample evidence of these risks, how can this be? One theory is that the current generation of mainstream economists staked their careers on the soda business, filling resumes with research on topics such as sweetness and carbonation, but nothing on health. It’s just too big a step for them to acknowledge that the old research is unhelpful and the resumes hollow. We can only hope that the unpopular, long-term thinkers who are willing to take that step become more influential over time.

In the meantime, keep an eye on the sources of financing and, in particular, the three indicators of risky borrowing discussed above.

(Click here for technical notes about this article and a few more charts.)

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LawsofPhysics's picture

Simply put, that which cannot be sustained, won't be.  Go ahead, "create" all the paper bullshit/credit out of thin air that you want to., without energy available for consumption you won't actually do shit.


These "banks" have done everything they can to remove words like "accountability" and "collateral" from the language.  Fuck em..

El Vaquero's picture

I think this will help:


Work, from a physics standpoint is (net) force times (dotted with) distance.  Energy is the ability to do work.  If you want to get shit done, you need energy.

Newsboy's picture

I preferred Coke in the '70s.

CheapBastard's picture

Free Money is always in great demand esp when they never have to pay it back.


"Party on!"

island's picture

Yes, they will indeed do shit.  They will pillage the middle-class, luring them into the games played at Las Vegas East and robbing them blind.  They will create inflation of basic necessities with their futures games (e.g. oil, ag).  When their games come apart, they will legislate that "the small people" must bail them out.  Shit indeed.

DoChenRollingBearing's picture

Excessive debt of course is always bad.  But, I am do not get "actionable intelligence" from the above, other than the aversion to debt I have always had. At some point, and one way or another, the debts will have to be paid.  For all of us, as a nation, as a company and as individuals.


ZH-er "ron",

Take another LOOK!


(re the $1,000,000 BTC transaction and the "Gulf of Guinea")

HardAssets's picture

What if the 'debts' were a fake ?

What if what they 'loaned' was absolutely nothing ?

What if the only real wealth exchanged was that produced by those entrapped by the illusion of the 'debt' system ?


Observe your (possible) automatic, indoctrinated response to these questions.

Also notice that 'they' don't play by the same rules. They run up massive debt - - and put it on your shoulders. They commit crimes and go free. They own the lawyers who write the 'laws' and change them or ignore them as they please.

Stuck on Zero's picture

The real problem is that those who are running up the debt will never have to pay it back.  Case 1: Congress.  They are creating a debt fuelded monster but their personal finances are fabulous.  Case 2: Wall Street.  They speculate on borrowed funds and suck in the billions when it works and walk away rich when it doesn't.

Carl Popper's picture

This is good news actually.


We need more debt creation and consumption to keep the ponzi àlive long enough to buy more subsidized gold, right?

JR's picture

Prior to formation of the Fed, big bankers were unable to control the interest rate and, thus, increase debt, i.e., profits.

Thus, says G. Edward Griffin, a Federal Reserve objective was to reverse the trend in a growing increase in “private capital formation.  

“That's banker language for a process in which an individual or a corporation uses their own savings to pay for something instead of going to the bank and borrowing it, if you can imagine that happening. It was happening at the turn of the century.

“The trend was that businesses in particular were withholding some of their dividends each quarter and putting that money into a sinking fund and then as the money accumulated or as the capital formed, then they finally had enough that they could use their own money to build that new factory or to launch a research & development project or whatever instead of going to the banks and borrowing for it. The banks were very concerned over this trend because this is their life-blood. Loaning money is what they do so how do you loan money when people don't want to borrow it? The answer they knew…was to lower interest rates, get those rates down so that they were so attractive that people would be crazy not to come to the banks and borrow money at those good interest rates.

“How do you lower interest rates?

“Today it's easy when you've got the lever at the Federal Reserve you just throw it up or down and interest rates go up or down; you have total control over it. In 1913 there was no lever. The money in those days was backed by gold and silver and they couldn't control it. They hated that. These guys hate gold and silver behind money because under those conditions interest rates are the result of the natural forces of supply and demand; they couldn't just create money out of nothing. It was the result of the interaction of millions of people bidding for products and services and digging money out of the ground, literally gold and silver and converting into money.

“They were looking for a way to artificially push the interest rates down. How do you do that? They said the only way you can do that is with a flexible currency. That was the cry that they put up in those days. What the nation needs, they said, is a flexible currency to meet the demands of industry and agriculture. You still hear that phrase today--"flexible currency." …

Flexible currency does not mean the paper stuff in our pockets that bends, it means money created out of nothing. The trick here is not hard to figure out. If you can create money out of nothing, you don't have to charge an awful lot of interest on it to show a profit. It's that simple. If you have a flexible currency you can in fact lower interest rates and still do pretty well, can't you? They wanted a flexible currency so they could lower interest rates and entice people back into the banks to borrow money and to reverse the trend toward private capital formation.”


LawsofPhysics's picture

"Prior to formation of the Fed, big bankers were unable to control the interest rate and, thus, increase debt, i.e., profits." -


Precisely, they actually had to work for a living and do their due diligence on any loan.  If they didn't, it was their ass...

1stepcloser's picture

Thus is was easier to make assignation attempts on presidents, ultimately sending the message...this is going to happen...get it???  Either Be our agent or die...your choice

LawsofPhysics's picture

...and the outcome will be the same as it always is.  There will be blood a plenty.

Radical Marijuana's picture

Great article!

The first chart was very informative. It demonstrated how relatively trivial "savings" are in a system overwhelmingly dominated by legalized frauds. It also showed how the worsening whip saw effects of legalized frauds dominating the economy had diminished the abilities of the private banks to reliably operate what used to be their routine cake walk. In that context, I enjoyed the resort to the paradoxical language required to refer to "Funding from non-money savings." Ironically, that is what most of the public still believes, in their common sense way, is "money," but, within a better analysis gets labeled "non-money!" As always in our Bizarro Mirror World, where Fraud is King, the language which we use to describe things has gradually been perverted, and inverted.

As JR commented above, "flexible currency" was a euphemism for fraudulent currency, whereby the Fraud Kings could control the economy, while the increasingly wrong common sense of ordinary people regarding their investing "non-money savings" sustained the runaway triumphs of financialization based on legalized frauds, enforced by governments.

The metaphors with respect to the Profit From Junk Food systems are correct. That analogy could be extended to say that making that operate requires taking advantage of people's weaknesses, while surrounding the Junk Food with a fantasy culture. The existing political economy was scientifically designed to exploit people's weaknesses, while inculcating a fantasy culture surrounding the economic processes.

The bigger picture questions raise the issue of HOW BIG? For people who want actionable intelligence in order to personally operate more successfully within the established systems, they mostly have no practical use for, nor much interest in, the BIG PICTURE. However, my view is that our fundamentally fraudulent financial accounting system has been financing the strip-mining of planet Earth. Since that IS the system, everyone already MUST live inside of that! Thus, there appears no practical point at which anyone within that system can get out of it?

Human beings could always be perceived to be operating as gangs of robbers in their environment. From general energy systems' perspectives, groups of human beings were entropic pumps, organized into civilizations which were greater entropic pumps. The history of Neolithic Civilizations was about the exponential growth of systems of organized lies, operating robberies, which have grown to become globalized strip-mining of the planet. Since the industrial revolution, the debt engines of fraudulent finance have been "paying" for the steam engines to develop, until those became the globalized electronic frauds, backed the force of atomic bombs, which exist today.

While that was happening, Neolithic Civilization mostly could continue to take for granted the life-support systems of the planet. The strip-mining of that planet started off small, and only slowly developed, but that was still on an exponential growth curve, towards what exists now, where the real limits of being able to continue to strip-mine the planet are manifesting in ways which are getting more difficult to deliberately ignore.

THE BIGGER PROBLEMS are due to the history of Neolithic Civilization being based on lies, backed by violence, which went from War Kings, through to Fraud Kings, as there gradually developed combined murder/money systems, in which death controls backed up the debt controls, but those were most socially successful while operated through the maximum possible deceits and frauds about themselves. THE BIG PICTURE is whether the human species can survive through to develop surviving and sustainable systems of integrated human, industrial, and natural ecologies, while, at present, the human and industrial ecologies are operated through the maximum possible deceits and frauds, while the natural ecologies are therefore being destroyed at exponential rates.

It is in that context that I appreciated this article stating:

"... the current generation of mainstream economists staked their careers on the soda business, filling resumes with research on topics such as sweetness and carbonation, but nothing on health. It’s just too big a step for them to acknowledge that the old research is unhelpful and the resumes hollow. We can only hope that the unpopular, long-term thinkers who are willing to take that step become more influential over time."

My attempts at extrapolated BIGGER PICTURE presentations are about "the unpopular, long-term thinkers who are willing to take that step become more influential over time." Indeed, that is so extremely "unpopular" that there appears no practical point in attempting to promote that view in the context of our current culture, where things like the Profit From Junk Food Systems were components integrated into the social pyramid systems, based on privatizing the profits, while socializing the losses, in ways which were designed to exploit people's weaknesses, while filling their minds with a fantasy culture.

In my opinion, the American economy, which still dominates the world's economy, is about 99% based on legalized lies, backed by legalized violence. It may seem paradoxical, but nevertheless, it makes sense from the perspective of general energy systems how and why the political economy ended up being almost totally dominated by the Fraud Kings, in ways which result in people having attitudes of evil deliberate ignorance to their real environment, while their social world operates through bizarre beliefs in a fantasy culture, in which "risky borrowing" is a necessary part of a fundamentally fraudulent financial accounting system.

It remains to be seen IF it will ever be possible for human civilization to apply a more scientific understanding of itself to how it behaves. The problems with respect to doing that are recognizing how and why that civilization became almost totally dominated by systems of legalized lies, backed by legalized violence, so that its political economy became controlled by privatized "money" made out of nothing as debts. Furthermore, understanding that would also involve understanding that was only possible due to the ways that the methods of organized crime were applied to the political processes, where discrediting and destroying crucial politicians were the most important particular events that directed how the murder systems, that backed up the money systems, actually worked.

It remains to be seen whether or not human civilization could ever develop any better human and industrial ecologies, which were integrated within the natural ecologies, while the primary obstacles are that the already established systems of human and industrial ecologies were actually made and maintained on the basis of the maximum deceits and frauds, as the most socially successful strategies regarding how to operate human civilization as an entropic pump, which requires a flow of energy to pump.

... skip to Okay then, what should I be watching?

The bottom line is the natural capital, which our kind of "economy" is converting into garbage and pollution, as fast as possible, because everything is financed fraudulently, through everyone having to run on accelerating debt engine treadmills. Just like a little Junk Food in an otherwise good diet is not a problem, but a totally Junk Food diet is extremely bad, similar observations could be made overall about "A Debt-Saturated Economy!"

These days is our Economy is so totally Debt-Saturated that it appears like our society is terminally sick and insane. To more scientifically understand our society, we would have to be able to perceive the evolutionary ecology of its entropic pump functions. However, it is NOT an accident that along the way our concept of "entropy" was itself inverted, because everything, including the philosophy of science, was dominated by the biggest bullies' bullshit social stories. Our civilization is necessarily organized systems of lies, operating robberies. It necessarily went from War Kings, to Fraud Kings, where the central banks are the primary Fraud Kings, while the Bank of International Settlements is the current King of Kings of Fraud within the globalized political economy.

We could not fix any of those problems with respect to drowning in "A Debt-Saturated Economy," without more radical truths, starting from revolutions in the philosophy of science, in order to understand how and why our combined money/murder systems ended up becoming what they are now, which enables them to operate through attitudes of maximized evil deliberate ignorance towards their natural environment, because that society is almost totally dominated by fantasy cultures based on frauds, which were deliberately designed to exploit people's weaknesses.

autonomos's picture

I totally agree with you and all your posts. But please do not forget that entropy is a chemistry / thermodynamics principle only. Not a electrical / mecanical / gravitational / etc concept. So no honest scientist endorse it as a global truth about the whole universe. I don't think that scientist do understand it backwards. Entropy principle is valid for energy systems (engines etc). (Honestann too seems to forget that). To sum it up: scientists do not claim anything and the rest of sheeple do not give a shit... I think we should discuss more thoroughly the individual salvation, which merges "ancient mysticism" with "post-modern science", in my words: mysticism and science insitinct.