Credit Is Shrinking?

By Jeff Harding.

The esteemed Ambrose Evans-Pritchard of UK’s Telegraph makes the unstartling announcement that U.S. bank credit has been shrinking for the past three months at a  rate (14%) that has not been witnessed since the 1930s.

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.

I’m glad someone over there finally noticed this, since, as noted, David Rosenberg and other deflationists (including The Daily Capitalist) have been reporting on this for quite a while.

But here’s the interesting point made by Mr. Evans-Pritchard:

It is unclear why the US Federal Reserve has allowed this to occur.

I suggest to Mr. E-P that if the Fed could have prevented a credit collapse it would have. Which means they have been flooding the economy with cash to keep financial institutions afloat, but somehow they haven’t been able to flog banks and consumers to lend and borrow. Which in turn means they can’t prevent it from occurring.

Here’s what’s been happening.

Money base (BASENS) has been expanding:

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But, Banks Reserves (RSBKCRNS) has been growing:

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As a result, money supply in the economy (M1 MULT, for example), has been declining:

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Which means that as much as the Fed tries to push cash into the banking system, they can’t make banks lend or make consumers borrow.

Mr. E-P’s view is based on his conversation with Professor Tim Congdon, a well-known British Keynesian-Monetarist. Prof. Congdon believes, like Milton Friedman, that the Great Depression could have been avoided had the Fed not allowed the money supply to shrivel up. It’s not that simple and I believe that line of analysis is wrong. It ignores the true causes and cures of a recession, and would be analogous to shoving a water hose down the throat of a drowning man. The man is not thirsty, guys.

In an environment where real estate values are still declining, where there is a high level of debt burdening consumers, where banks are holding undersecured loans, and where business inventories are still falling, where the Fed Funds rate is at near zero, it is unlikely that a flood of new money will solve anything. All any flood of new cash will do is lead to inflation which will just paper over the issue and, as they like to say, “kick the can down the road” for us to deal with another day.

Professor Congdon blames a shrinking money supply on rules requiring banks to reduce leverage to somewhat more reasonable levels.

He should listen more to IMF chief Dominique Strauss-Kahn, whom he criticized for arguing “that the history of financial crises shows that ‘speedy recovery’ depends on ‘cleansing banks’ balance sheets of toxic assets.” History and theory is on Mr. Strauss-Kahn’s side.