Tuesday, 9 December 2014

The Artificial U.S. Economic Recovery: QE is Finally Showing Up Directly in Bank Lending

As I've written about many times this year, during 2014 the role of money creator has shifted to banks from the Fed following the Fed taper and the ultimate completion of QE3 in October. Back in mid March I wrote,
It appears the recent increase in the M2 growth rate has been spurred by increases in Loans & Leases for the commercial banks (part of Bank Credit). Having bottomed at 1.7% in early January, the YoY growth rate has since increased to 2.82%, the highest recorded since mid October last year. It's of course to early to tell if banks have committed to expand lending. What we do know however is that in order to avoid a significant reduction in the money supply growth rate, banks this year will have to increase lending substantially especially if the Fed commits to further tapering. It will certainly not be excess reserves that hold back bank lending growth as it currently amount to more than US$ 2.5 trillion.
The banks have indeed increased lending substantially as it is currently up about 6.4% this year. This has spurred bank credit, which consists of loans and securities, to fatten by almost 6.4% as well. During the last four months, the banks' excess reserves created by QE1, 2 and 3 are now being used directly to expand bank credit. This is a new development. As the monetary base consists of bank reserves and currency, the monetary base has actually been declining since early August due to bank reserves being employed to increase bank credit. Since hitting a record high $4.1045 trillion on August 6 this year, the base has since declined a whopping 6.55%, or $268.8 billion.

Banks using their excess reserves to increase bank credit therefore explains why the money supply growth rate has held up reasonably well (see below) despite the Fed taper and the end of QE3. For now, I must admit there is little credence in my speculation that the Fed might actually implement a 100% reserve banking system. This comes as no great shock however as the end of inflationary policies will perhaps never be brought to an end by political design.

Compared to the same week last year, bank credit is now up 7.1% while the M2 money supply is up 5.9%.

The chart shows the money supply growth rate has been fairly flat in recent months and that bank credit growth has jumped to levels not seen since 2008. Bank credit growth has been driven by both an increase in the total value of securities owned by banks...

...and an increase in bank lending.

Breaking bank credit down further into the individual components that make up securities and lending, we can identify the key drivers of bank credit growth during the last twelve months,

The table shows that 34.3% of the growth in bank credit during the last twelve months has come from securities owned by banks while the rest, 65.7%, has come from increased lending. The issuance of more loans has hence been the key driver of bank credit growth, of which Commercial & Industrial (C&I) lending has been the biggest component.

Since peaking at $1.5975 trillion on 22 October 2008, C&I dropped to $1.1797 trillion on 28 July 2010. It has made a serious comeback this year however and at $1.7668 trillion, C&I is now 10.6% higher than it was in October 2008 and has expanded a significant 13.1% during the last year. Excluding the 2012/2013 period when the expansion represented an increase from a previous sharp drop in 2009/2010, the current aggressive growth rate in C&I was last seen during the run-up to the 2000 and 2008 credit booms that both ended badly. With bank reserves currently exceeding $2.5 trillion, most of which is classified as excess, low capital (10.7% equity to total asset ratio, just slightly higher than the 10.62% the week Lehman collapsed), qualified borrowers and uncertainty are some key factors restricting banks in expanding credit even faster. Without these restrictions, there would be virtually no limit to the extent banks can create credit and money given the extraordinary amount of  excess reserves.

So what does this lending driven increase in bank credit and the money supply do with the U.S. economy? It will do what it always does and what it did the last time around: create an artificial boom which will lead to a very real bust, just like 2008. What is different now however is that unsustainable government programs are substantially bigger than back then. On top of that, a lot of damage has already been done to asset prices (and other prices) by previous monetary expansion and artificially low interest rates fueled by the various QE programs over the last six years, appearing to many as an "economic recovery". But this (GDP) growth is artificial, driven by money supply growth. Not to mention the various business sectors that have artificially expanded as a result of the debt monetization of government deficit spending programs. All these distortions, in one way or another, depletes an economy's saving as money supply growth outpaces saving growth - real growth can only by driven by saving and investment.

The coming bust must therefore be much, much worse than the previous one as there is more damage and more distortions to be repaired and repaid this time around. The market always wins in the end, though it sometimes can take a very, very long time indeed before it does...


Additional tables and charts


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