We don't know and neither do they.

Ruminations on the Coming Credit Bubble Implosion (6/16/01)

Stepan N. Stool, PH&D

One of Dr. Stool's favorite pieces of bathroom reading is Doug Noland's weekly Credit Bubble Bulletin. Noland has a unique way of making complicated, arcane subject matter understandable, even for a dolt like Dr. Stool. 

Noland's thesis is that our economy has been driven by the greatest bubble in the history of the world, in this case a credit bubble. Week in, week out he patiently expounds on the expansionist mechanisms of the bubble, and warns of dire consequences to come. He has few peers as a purveyor of gloom and doom. Although Dr. Stool doesn't quite "get" all of it, he finds Noland's arguments persuasive. 

Noland has generally refrained from predicting when the bubble would finally burst. This week however, Noland closed his column:

"There is absolutely no doubt today that attempts to sustain levitated U.S. asset prices and dysfunctional processes by perpetuating this bubble economy creates further impairment and risks potential financial collapse. It is our sense that the marketplace is beginning to recognize this predicament."

This had a more ominous ring than his recent remarks, which, while sufficient to cause constipation, did not convey a sense of urgency. Which got Dr. Stool to wondering, "How do we know when this big monster is going to come down?"

Dr. Stool has been fascinated by gas bubbles since childhood, and by financial bubbles ever since he first got burned by one back in the late sixties. There are big bubbles, and there are little bubbles, and there's usually a bubble of some sort, somewhere, all the time. When they blow, they tend to lose momentum for a time before the final peak and initial breakdown. For example, certain momentum indicators topped out and began falling two to three months before the final peak in our fondly remembered tech bubble. There are always little cracks in the facade that forewarn of a coming collapse.

But how in the world do you measure an endemic,  multifaceted international credit bubble. Unlike a stock market or commodity bubble, it cannot be measured by price alone. Or maybe it can, but Dr. Stool isn't sure how.

So your stock proctologist thought it might be interesting to look at a few of the manifestations of the credit bubble, such as broad money supply, commercial and industrial loans, industrial capacity growth, commercial paper, and a bunch of other stuff (Apologies for the technical terminology.) to see if there were any signs of reversal. Under the theory that a few pictures are worth thousands and thousands of woids, here are some pretty pictures for your viewing displeasure. Dr. Stool has added a few comments, but feel free to fill in your own. There are no experts in this business, because even the "experts" don't know what the hell they are talking about. 

Here's M3 broad money supply.

Still growing at an annual rate of 11.8%. Mygod, it's been growing that fast, or almost that fast since late in 1998. No sign of a slowdown there. Is that a good thing? How, pray tell? Seems things keep gettin' worse.

Now here's institutional money market funds.

Growing at only 42.77% annually. Hmmm.

We all know there's been a real estate bubble. So lets look at real estate loans by commercial banks.
Gee, is the economy growing at 11% annually? 

Industrial capacity was growing at nearly 7% through 1999. The rate of growth is slowing dramatically but it's still around 3.75%. And we know what's happened to capacity utilization. Now how does this square with zero growth in demand and flat final sales?  If you look at real estate loans, and other C&I loans, below, the debt burden is growing, while income available to service debt is shrinking. But that's a whole 'nother story.

Here's commercial and industrial loans at large commercial banks.

Looks like they're doin' the Tighten Up. As of May 30, the annual rate of growth had dropped to 1.6%, while the 13 week rate of change went negative. Looks like banks are getting out of the lending business. Fed pushing on a string? How is business going to roll over all that debt they can't pay on all that excess capacity they can't use? 

Finally, let's look at the non-financial commercial paper market.

Uh-oh. Now there's a market that's a shuttin' down. Is this the first crack in the facade, or is it the fact that all that moolah floatin' around ain't stimulatin' squat.   

One thing all these charts have in common is that they all took off into the stratosphere in 1994. Things were relatively tame before that. The breakdown in the commercial paper market, and tightening in commercial lending are possible signs that things are starting to break down. But looking at M3, institutional money market fund assets, and real estate loans, it's clear that some things were recently still inflating at ridiculous rates. 

Dr. Stool will keep you posted on any signs of further deterioration in the Hindenburg's flightworthiness.

As for the stocks, they are, for a change, sticking to the script projected by cyclical patterns. Projections for cycle lows, apparently due this week, have shifted down a notch, so the guess here is that we'll get a little more washing out early in the week, followed by a short covering rally of little consequence. The schedule still calls for the market to get flushed in July.