Saturday, 19 July 2014

The Classic Boom Bust Cycle Continues, Rampant Business Lending In The U.S.

Further stock market gains are facing heavy headwinds in the U.S. as earnings growth is slowing and the Fed is indeed tapering (for now). The reach for yields driven by artificially low interest rates have rocketed many asset prices upwards to new all-time highs, some reaching spectacular highs (though some have slipped back a little in recent weeks).

Where to put your savings at work is an all too crucial question as interest on ordinary bank savings and deposits often doesn't even cover consumer price inflation and is significantly outpaced by money supply growth, spanning from the U.S. to Norway and beyond.

This has no doubt played a role in the current dire situation faced by many savers and investors: equity prices in general have reached such a bloated level any decent gambler with a knack for probabilities would stay way clear of making major bets on further outrageous gains, or even gains covering price inflation, the 10-year U.S. treasury yield has once again plummeted following an increase in the yield in the aftermath of Bernanke uttering the possibility of Fed tapering in May last year and junk bonds credit spreads are plunging towards the insane levels seen in 2007. 

As of 18 July 2014
What are investors to do in such an environment? Buy gold, allegedly endlessly battled by governments and central bankers in coordinated efforts to keep its value down with the lurking risk of outright confiscation? Jump back into all housing related ventures only to be left with empty pockets when people once again realise prices don't always just go up? Or invest in a real businesses and employ staff at artificially expensive salaries deemed reasonable by the high lords in their ivory towers, businesses soon to be choked by another credit and debt crisis? These are truly difficult times by most standards. Luckily enough, it's just as simple these days to make money from falling asset prices as from rising ones. Just better hope the corporations running the various ETFs and other financial instruments remain solvent to pay out any potential gains made by investors. 

With all the above having been built on a base of ever surging government debt and quantity of money, it's a true struggle finding positives about the U.S. economy at this stage. If anything, it's substantially worse than back in those grueling, but inevitable, days in September 2008. Yes, U.S. commercial banks hold substantially more cash now, but their capital to asset ratios are broadly unchanged and far from adequate to survive a substantial storm without the help of the Fed (read: tax payers). As is the case with the EU and the Euro Zone (and countless countries suffering from an utter lack of prudence and sound economic reasoning), unless the fundamental flaws of the economic policies are rectified and put right by our dearly beloved highly paid bureaucrats which the rest of us feed through high income taxes, VAT and all else evil (abandon all hope of a general awakening of the electorate at large), true economic progress in the U.S. and elsewhere simply cannot be achieved. More free market policies, less rules and regulations, including a substantially smaller government, and a complete end to all government bailouts orchestrated by the Fed and other central banks are what is necessary - administration and overheads do not create prosperity, they reduce it. No bank or other company has ever been too big to fail (if it truly was, investors would line up to take it over, at a reasonable price). Nor should it ever be going forward. 

"Without bank credit expansion, supply and demand tend to be equilibrated through the free price system, and no cumulative booms or busts can then develop. But then government through its central bank stimulates bank credit expansion by expanding central bank liabilities and therefore the cash reserves of all the nation's commercial banks. The banks then proceed to expand credit and hence the nation's money supply in the form of check deposits. As the Ricardians saw; this expansion of bank money drives up the prices of goods and hence causes inflation. But, Mises showed, it does something else, and something even more sinister. Bank credit expansion, by pouring new loan funds into the business world, artificially lowers the rate of interest in the economy below its free market level.
The Austrian Theory of the Trade Cycle and Other Essays, Murray N. Rothbard 

This is pretty much what is happening in the U.S. now. The Fed has assisted the banks in piling up tremendous amounts of regulatory excess reserves (through granting loans at virtually no costs, buying assets from banks that private actors probably would have paid a lot less for and through paying interest on reserves) which means the banks are in a position to create, for all theoretical purposes, limitless amounts of credit (current excess reserves is ca. US$ 2.5 trillion). It's therefore perhaps not without reason the Fed monthly asset purchases have been reduced to US$35 billion this month (from US$85 billion a month last year). And the Fed is doing so presumably with a firm expectation that banks will expand credit to make up for these reduced purchases With government debt expanding at a slower pace, regular readers of this bi-weekly report were notified months ago of the increasing importance commercial banks now play in ensuring the money supply continUues to grow at a significant pace. More money in circulation cannot improve on real economic growth. All it can do is alter who receives the new money first, redistribute wealth and create unsustainable classes of consumers of resources (e.g. government employees in excess of what is sustainable). An increasing money supply can do one more thing however: as most economic indicators are measured in money terms, an inflating money supply will show a gradual increase in many nominal indicators of so-called "economic growth" and fool politicians, businesses and consumers alike that the economy is progressing when in fact it is not. An increased money supply hence can conceal, temporarily, that the economy is not improving or maybe even deteriorating. This becomes apparent, for all to see, when the money supply growth slows down and all the cards are finally revealed. In light of the Fed taper, what banks do going forward is hence of crucial importance for all and an important reason why it is monitored in this report.

And banks are no doubt currently driving money supply growth (also see article from two weeks ago). In fact, lending to commercial and industrial ventures are booming in the U.S. as it has increased by more than 10% compared to last year for the last seven bi-weekly periods in a row, most recently by 11.5%, the highest since January last year. As explained two weeks ago, what is happening now in the U.S. economy is a text book example of the classic trade cycle theory which explains how a portion of easy credit and newly created money ends up being malinvested resulting in a false boom followed by a very real bust (e.g. here). How long it continues and to what extent remains to be seen.

According to some reports, a portion of this borrowing by companies is used to lever up balance sheets (e.g. here). During the last twelve months, increases in Commercial & Industrial Loans (CIL) made up 44.3% of the overall growth in Loans & Leases, of which CIL is a sub category. This increase in CIL has again helped fuel Bank Credit and money supply growth. Bank Credit increased 5.4% for the bi-weekly period ending 9 July 2014, the highest since January last year and nearly five times higher than the 1.1% reported at the end of last year. The M2 money supply growth came in at 6.5% for the week, slightly down from the 6.8% reported two weeks ago, but slightly higher than the 52 week moving average. 

The 1-year treasury yield was unchanged from two weeks ago while the 10-year declined by one basis point. Compared to the end of last year, the two have declined by 2 and 46 basis points, respectively, but are virtually unchanged compared to the same period last year. The yield on both remain of course substantially lower than the long term averages since 1984, while the spread between the two is 91 basis points higher than average.


Key U.S. monetary statistics and charts as of 9 July 2014 (treasury yields as of 18 July 2014):

The U.S. Money, Credit & Treasuries Review is a report issued on a bi-weekly basis by EcPoFi. You can access all previous issues since February 2013 here.


Friday, 18 July 2014

The Short Version of the "Austrian" True Money Supply (TMS), as of 7 July 2014

The short version of the Austrian True Money Supply (SVTMS) for the U.S. increased 0.78% (50.14% annualised) during the most recent week ending 7 July 2014 to hit a new all-time high $10.2253 trillion. The money supply is now up 3.51% year to date.

The 1-year growth rate in the money supply jumped to 8.34%, up from 7.88% last week.

The current growth rate remains lower than one year ago and this week was the 106th week in a row with a declining growth rate. The difference is now however declining rapidly and the differential this week was only 35 basis points, having averaged 216 basis points during the last 52 weeks.

The 5-year annualised growth rate headed up slightly compared to last week, but remained lower than a year ago for the 32nd week in a row.

Visit the short version of the Austrian True Money Supply archive here. 

Thursday, 17 July 2014

Norway's Biggest Bank Poses Serious Threat to Financial Stability

DNB ASA, of which the Norwegian Government owns 34.0%, is the by far the biggest bank and financial services group in Norway. 

As of Q1 this year, loans to customers for the bank amounted to NOK 1.344 trillion according to the quarterly statements issued by the company. At the same time, loans to and claims on customers for all banks in Norway amounted to NOK 2.294 trillion according to Statistics Norway. This means DNB's share of all bank loans issued in Norway was 59.0% as of the first quarter this year, up significantly from the 52.1% share as of Q2 2009. During the Q2 2009 to Q1 2014 period, DNB's average share of customer loans issued by banks in Norway was 57.0%.

Moreover, of the NOK 1.771 trillion in deposits reported as part of the money supply in Norway, NOK 0.9002 trillion, or 50.8%, was deposited with DNB as of Q1 this year.

In "normal" times, the bulk of the new money in a fractional reserve banking system is predominantly created by banks (but ultimately controlled by central banks). This means that DNB, more so than any other bank, exerts tremendous control over the money supply in Norway. This significant influence over the money supply also implies that DNB to a large extent influences economic developments as well in the country. It's not without reason that Mayer A.B. Rotschild stated, more than 200 years ago, "Give me control of a nation's money and I care not who makes it's laws".

Understanding the financial risks facing Norway therefore demands a look at DNB's balance sheet. One week ago, the bank reported results for Q2. And the numbers should be less than reassuring for anyone caring about "financial stability". Here's a couple of observations based on the report:
  • The Total Equity to Total Assets ratio was 6.0% for the quarter, lower than the 6.9% average for all Norwegian banks (as of May 2014). Though higher than the 4.5% reported in the midst of the banking crisis in Q4 2008, the ratio is extremely low by most standards, e.g. the average ratio for U.S. commercial banks is currently around 10.8%. The 6% ratio basically means that DNB's equity will be wiped out if assets shred 6% of its value. Such a scenario is not too hard to imagine as during recessions, the value of banks' loans and other assets tend to fall while deposits (a liability for banks) remain unchanged. 
  • The Total Equity to Deposits from Customers ratio was 16.8% for the quarter. This is higher than the 15.4% average since Q4 2007, but means that 83.2% of customer deposits is not backed by anything. In effect, if customers chose to withdraw all their deposits and DNB liquidated all their assets and settled all other claims at book value, the bank would only be able to pay out 16.8% of the deposited money - the rest, the 83.2%, is simply not there as it was created out of thin air (as it was unbacked by prior savings - the hallmark of fractional reserve banking).
  • The Cash and Deposits with central banks + Commercial Paper and Bonds to Deposits from Customers ratio was 65.2% for the quarter. This compares to an average of 73.9% since Q4 2007 and down from the 91.4% reported in Q2 last year. 
The bank's highly leveraged balance sheet, combined with highly indebted Norwegian households, therefore pose a serious risk to financial stability in Norway. It is more than baffling the regulators and politicians have not fully grasped this risk, a risk ultimately created by themselves. The bottom line is that DNB and other banks and financial institutions in Norway need significantly more capital. 

Though U.S. banks are by no means solid (fractional reserve banking is inherently risky), DNB and the average Norwegian bank need to almost double their capital just to be in line with the equity to total asset ratios reported for U.S. commercial banks. Some, including myself, recommend a substantially higher capital than that for banks in general. More specifically, banks should carry 100% reserves against their deposits and become true financial intermediaries. Only then can "financial stability" truly be achieved. 

Saturday, 12 July 2014

Friday, 11 July 2014

The Short Version of the "Austrian" True Money Supply (TMS), as of 30 June 2014

The short version of the Austrian True Money Supply (SVTMS) for the U.S. increased 0.57% (34.18% annualised) during the most recent week ending 30 June 2014 to hit $10.1454 trillion. The money supply is now up 2.69% year to date. This measure of the money supply is calculated from the latest data published by the Federal Reserve. 

The 1-year growth rate declined sharply this week, from 8.55% last week to 7.88%, the lowest reported for 11 weeks and lower than the 8.30% average since 1980. Compared to same week last year, the 1-year growth rate dropped by 1.07 percentage points. 

The 5-year annualised growth rate in the money supply continue to go nowhere but down. At 10.42%, it was the slowest growth since week ending 28 May 2012. The growth rate was 0.95 percentage point lower than a year ago and was the 31st week in a row with a declining growth rate. 

Key growth rates in the short version of the "Austrian" True Money Supply as of 30 June 2014: