PARSING THE Z.1

On March 11, 2010, the Federal Reserve published the Z.1 Flow of Funds report for the 4^th quarter of 2009.  This invaluable report contains important insights into the current private sector deleveraging trends now in place.  We look at some of these trends below.

First, we’ll run through some quick math.  After the dramatic run-up in household debt, from 67% of GDP in the first quarter of 2000 to 97% in the first quarter of 2009, a normalization process now seems to be underway (thanks in part to debt charge-offs, but we digress).  In order to return this ratio to the random round number of 80%, household debt would need to fall by nearly $2 trillion.  A drop to 60% of GDP, still above the long term average near 55%, would imply a reduction in the neighborhood of $4.9 trillion from the household balance sheet.  For context, since its peak in Q3 2008, household debt has fallen by just over $300 billion.  Experiencing a more meteoric rise than even the household, in terms of debt, has been the financial sector.  Not surprisingly, this portion of the economy is also delevering.  The drop in financial sector credit market debt since Q3 2008 (which was nearly its peak), has been roughly $1.3 trillion.

Offsetting these decreases has been the increase in US government debt, which has risen over $2 trillion in the same time period.  If debt drives GDP, it seems like we will be relying on Uncle Sam for now.

As a result, total credit market debt outstanding has only been falling very slowly, and appears to have just begun its descent.  It’s always hard to spot a secular trend in its infancy, but this one is certainly a leading candidate.