US Credit Growth – the First Cracks?

Pater Tenebrarum:  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 actuallyaccelerates. 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.

Below are several charts illustrating the current situation in bank lending growth. The first chart shows commercial and industrial loans and their annual growth rate over the long term (so as to illustrate what growth rates are usually associated with booms and busts).

Commercial and industrial loans. The current annualized growth rate of 10.87% remains consistent with boom conditions – however, it does represent a slowdown from the secondary peak just above 12% annualized attained in 2014. Interestingly, these growth rates tend to peak before recessions begin, but bottom after recessions end. So C&I loans are a leading indicator of busts and a lagging indicator of new booms. Note that the big upward spike in 2008 was the exception from the rule: at the time companies desperately drew down their credit lines, as bond market funding froze and they feared banks would unilaterally cut their credit lines – click to enlarge.

Next we take a look at total loans and leases, i.e., commercial and consumer loans together (excl. mortgage debt). The growth rate of this category has been slower than that of C&I loans, due to the comparatively slower growth in consumer loans. Consumers are still reeling from the after-effects of the burst real estate and mortgage credit bubble and their eagerness to buy things they don’t need with money they don’t have in order to impress people they don’t like is evidently much reduced. Here too we see a slight slowdown in growth to a recent 7.53% – this presumably largely reflects the slowdown in C&I lending.

Total loans and leases and the annual growth rate. Note that previous post-crisis slowdowns in bank lending were more than compensated for by massive QE on the part of the Fed – however, currently any slowdown in inflationary lending should also lead to a slowdown in money supply growth. Until “QE4”, that is – click to enlarge.

Next we take a look at consumer loans. In this case we show the annual growth rate in a separate chart, as there was a change in accounting rules in 2010 which brought several 100 billions in loans that were previously held off-balance sheet back onto bank balance sheets. As a result there were wide short term swings in the annualized growth rate, making a combined chart a bit hard to read.

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