Ambrose Evans-Pritchard writes in the Telegraph: “US credit shrinks at Great Depression rate prompting fears of double-dip recession“. From the article:
Professor Tim Congdon from International Monetary Research said US bank loans have fallen at an annual pace of almost 14pc in the three months to August (from $7,147bn to $6,886bn).
“There has been nothing like this in the USA since the 1930s,” he said. “The rapid destruction of money balances is madness.”
The M3 “broad” money supply, watched as an early warning signal for the economy a year or so later, has been falling at a 5pc annual rate.
Similar concerns have been raised by David Rosenberg, chief strategist at Gluskin Sheff, who said that over the four weeks up to August 24, bank credit shrank at an “epic” 9pc annual pace, the M2 money supply shrank at 12.2pc and M1 shrank at 6.5pc.
“For the first time in the post-WW2 [Second World War] era, we have deflation in credit, wages and rents and, from our lens, this is a toxic brew,” he said.
This can’t be inflationary.
At the same time, one wonders how the dollar carry trade fits into the picture. Does the money created by the dollar carry trade (or other carry trades, for that matter) show up as bank credit or money? If not, could financial speculators drive asset price inflation, even while the real economy is starved for money and credit?
Scary article. Not much to add, except that the situation looks even worse if you account for off-balance-sheet liabilities at Fannie and Freddie. Buffet quotes Keynes:
“By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens…. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”
With deflationary pressure from elevated unemployment and massive deleveraging, I think Buffet is right that the effects of greenback emissions could “remain latent for a long time”, but it’s hard to imagine that Washington will have enough spine to make the tough choices required to protect the dollar. If they did, we wouldn’t be in this mess to begin with! Julius, how much time do you think we have? Two years? Five?
As observers debate whether extremely loose monetary policy will lead to runaway inflation, Julius and I have had our own long-running discussion on the topic. My experiences in Japan have lead me to expect a sustained period of deflation, though I’m not at all confident in this view. There may be another possibility: yet another round of asset bubbles. It had seemed unlikely to me that the game could be restarted, but perhaps the combined efforts of the world’s central banks can do the job. The Telegraph raises the possibility in a recent article “Excess liquidity thesis gains traction as financial markets soar“. From the article:
in their anti-deflationary fervour, central banks may be creating more money than depressed economies require. The surplus creates “excess liquidity” – which may be feeding a new series of stock, commodity, property and bond bubbles.
Interestingly, the Telegraph suggests that the depressed state of the real economy may encourage money to flow into financial assets:
But the very decline in GDP may be causing the excess money problem. Economic activity has contracted sharply and consumer prices are deflating, so a constant stock of money buys more, in real terms, than it did a year ago. This deflationary money adjustment may be generating excess liquidity – and feeding buoyant markets.
Though I’m not a macro economist, this seems plausible: if individuals are cutting consumption to rebuild their balance sheets and corporations are cutting investment in the face of slack demand, then the money forced into the system by the central banks has few places to go. Of course, the article also notes that China is expanding the money supply so rapidly that new bubbles seem a virtual certainty. As usual, Michael Pettis has the details.
The Shanghai stock market is booming again (it has nearly doubled since last November), and a securities brokerage called Everbright recently went public in an offering that raised $1.6B, was more than 100 times oversubscribed, and valued the company at 59 times 2008 earnings. Enough said.
In an article entitled “U.S. Needs More Inflation to Speed Recovery, Say Mankiw, Rogoff“, Bloomberg states that leading economists Gregory Mankiw and Kenneth Rogoff are advocating significantly higher inflation to reduce real debt levels. This is patently absurd, because is bails out irresponsible borrowers at the expense of responsible savers, and threatens long-term economic performance by undermining confidence in the dollar and the Federal Reserve. Moreover, intentionally inflating away debt would constitute a massive, discriminatory, and non-transparent wealth transfer, so it runs counter to ethics and basic constitutional principles.
Julius, I’d be curious to hear if you disagree, but I believe that a central bank should have only one role: to hold steady the value of fiat currency. The government may elect to engage in popping bubbles and cushioning downturns.
Whether deficit spending and expansionary monetary policy become inflationary depends in part on whether they lead to credit expansion. Although this appears to be happening in mortgage lending, that probably won’t be inflationary as long as foreclosures and excess inventory continue to put downward pressure on prices. So how about lending to businesses? Krugman predicts that the administration’s attempt to “muddle through the financial crisis” will leave the banks weak and unable or unwilling to expand credit. This BusinessWeek article suggests that the matters may be even worse: under pressure to strengthen their balance sheets, banks are aggressively contracting credit:
beginning in March, according to documents obtained by BusinessWeek, JPMorgan Chase suspended credit lines for a large number of business owners. According to someone familiar with the matter, the move affected thousands of businesses. They had been clients of Washington Mutual before Chase bought the ailing bank in September 2008. …
suspending lines of credit is certainly an efficient way to reduce the risk on a bank’s balance sheet. According to officials at the Office of the Comptroller of the Currency, bank reserves for bad loans are based on the total exposure to a customer. So if a bank has a $100,000 line of credit with a small firm and only $20,000 is drawn down, the total exposure is still $100,000, and the bank usually will reserve for loan losses based on that amount. But if they convert the $20,000 outstanding to a term loan and cancel the line of credit, or if they simply cut the line to $20,000, the reserves would be based on that $20,000 figure.
Interest rates don’t matter much if you can’t borrow.
A pair of articles in today’s New York Times by Paul Krugman and Allan Meltzer nicely capture our awkward predicament. At the moment, deflationary pressures appear to be dominant as wages fall, credit conditions tighten, and consumers throttle back. Going forward, the Fed’s extremely expansionary policies seem likely to lead to rapid inflation. Japan’s example suggests that inflation may not be inevitable, but the alternative may not be so great either.