U.S. Credit Growth – The First Cracks?

Inflationary Bank Lending and Money Supply Growth

Given that there is currently no “QE” program underway – with the exception of the reinvestment scheme designed to prevent the Fed’s balance sheet from shrinking (if it were to shrink, the money supply would decline as well) – money supply growth depends primarily on the amount of fiduciary media created ex nihilo by commercial banks.

Putting it differently, it depends on the growth in bank lending, since new uncovered deposit money comes into being by the extension of credit by banks. This deposit money is a money substitute that is only partially covered by standard money, or potential standard money (i.e., bank reserves). However, it has to be regarded as part of the money supply, given that it is used for the final payment of goods and services. From the perspective of its users, it is money.

Photo credit: .Kai

Since the crisis of 2008 and the collapse of the mortgage credit bubble, the following trends have been in evidence: lending to corporations has quickly reached growth rates usually associated with boom conditions. Consumer lending has by contrast been more subdued, with mortgage credit growth not surprisingly only very slowly moving back into positive territory. Most of the acceleration in bank lending could be observed once “QE” was tapered and ended – as a result, broad US money supply growth has remained brisk, even though it is far below its peak levels of recent years.

Since monetary inflation is the most important factor propping up malinvested capital in the economy as well as assorted asset bubbles, it is worth keeping a close eye on bank credit growth at the moment, as it should lead changes in money supply growth rates. The effect monetary inflation exerts on prices in the economy is unevenly distributed, both across goods and services and across time. For instance, a central bank can get away with a lot of money supply inflation as long as people believe the policy will one day be stopped or reversed. When this belief wanes for some reason, prices will tend to rise very quickly. So there is no one-to-one relationship between money supply growth and prices. Leads and lags and the uneven distribution of price changes are major characteristics; they depend on the demand for money (cash balances), resp. on the discrete points at which new money enters the economy.

Credit Growth Begins to Slow Down

Since the biggest price effect of the inflation of the money supply in recent years has been on assets such as stocks, bonds and real estate, these are the sectors that will be most susceptible to a slowdown in the pace of inflation. In light of current valuations, it could well be argued that asset prices are unlikely to rise much further unless inflation actually accelerates. However, annualized growth in bank credit has actually begun to slow recently. The slowdown is still small, and may yet reverse – but given the economy’s sluggishness, what reason is there for banks to extend more credit and increase their risk? Why should potential borrowers increase their credit demand?

It appears to us that a lot of the credit created in recent years has either fed malinvestment (e.g. in the oil patch) or financed financial engineering, with listed companies funding stock buybacks, M&A activity and in some cases even dividend payments on credit (much of this has been obtained via the bond market, but there are in turn many bond market investors using leverage, which is funded by banks). As Zerohedge recently reported, a sharp slowdown in free cash flow generation may be forcing a rethink with respect to this strategy.

As an aside to this, it is quite amusing to us that record lows in buybacks invariably coincide with times when stocks are actually cheap, while record high buybacks always occur when stocks are already horrendously overvalued and often near a major peak. Shareholders are usually happy when corporate chieftains announce big buybacks (which they do mainly for their own benefit), but they really should think twice about this. It often turns out to be a terrible waste of capital.