Team Obama has taken to trumpeting the idea that the recession is over. As Ed Harrison likes to point out, the fact that we will see inventory restocking will produce a statistical recovery, at least in reported GDP. But the US in 1931 and Japan after its bubbles burst both featured a period in which the economy stabilized, and pundits for the most part concluded the worst was over. And in both cases, the economy resumed its slide.
The data have moved from bad to mixed, which is a relative but not absolute improvement. But one of the negative developments, highlighted by Ambrose Evans-Pritchard, is ugly indeed. Despite massive bailouts and liquidity supports, credit is contracting, and at a very rapid clip. If we are lucky, this may be a short-lived aberration. But if this pattern persists for any length of time, the prospects are not good at all.
From the Telegraph:
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….
Mr Congdon said a key reason for credit contraction is pressure on banks to raise their capital ratios. While this is well-advised in boom times, it makes matters worse in a downturn.
“The current drive to make banks less leveraged and safer is having the perverse consequence of destroying money balances,” he said. “It strengthens the deflationary forces in the world economy. That increases the risks of a double-dip recession in 2010.”
Referring to the debt-purge policy of US Treasury Secretary Andrew Mellon in the early 1930s, he added: “The pressure on banks to de-risk and to de-leverage is the modern version of liquidationism: it is potentially just as dangerous.”
US banks are cutting lending by around 1pc a month. A similar process is occurring in the eurozone, where private sector credit has been contracting and M3 has been flat for almost a year.
Yves here. Note that the “reducing loans” takes place not only via tougher lending standards, but also pricing. Look at how banks have jacked up rates on credit cards. Now admittedly, many consumers are trying to cut back, but now it is becoming too costly not to.
William White, of the BIS, one of first to warn of the dangers of leverage, today said that he saw a strong recovery as particularly unlikely. But the true believers are not deterred.
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Utter lack of traction for monetary and fiscal policy.
It is unclear why the US Federal Reserve has allowed this to occur.
Trust me, if there were any way to get lending encouraged that hasn’t been tried yet, it would be thrown on top of that bathroom sink. The transmission mechanisms all totally break at the zero bound. They might re-engage, but as this article shows, we’re not seeing it.
CP continues to shrink very rapidly too. The only category that’s sort-of okay is financial paper. Which is, in and of itself, very much not okay.
That said, they would serve themselves better if they stopped relying on discontinued data series like M3(where did they even source that?), and noted that all these measures are a bit flaky in our modern financial markets.
What will it take for our policies to get a little transmission going?
Yves,
This makes full sense although it may be unpleasant: “The pressure on banks to de-risk and to de-leverage is the modern version of liquidationism: it is potentially just as dangerous.”
The relevant questions are then how far this will go and how long time it will take to get there. Also, in what ways will governments be forced to intervene to mitigate the macro and micro “side effects” (people losing jobs and homes, etc.).
Deleveraging is now taking place on an unprecedented scale – almost – and governments are frantically turning the controls of the economy back and forth as best they can, however without being able to do much about it. Since the process of deleveraging started from a level higher than ever before in history, liquidationism could continue to be brutal for a longer period of time before the debt ratios reach sane levels. Laissez-faire financial expansion was unhealthy while laissez-faire deleveraging could become deadly.
My view is still that it would have been a lot better to nationalise the systemically important banks last year in order for governments to exercise direct control over the deleveraging process that way. Nationalisation is of course the solution of last resort and only slightly more appealing than outright liquidation. However, since governments already openly or tacitly own or underwrite the banks anyway, they might as well use them as another tool in the toolbox to get the levels of debt in society down from current surreal levels step by step by exercising direct control over the banks (you can call it temporary receivership instead of nationalisation if you want). This way, governments would have been able to address the crisis a bit more up-stream in a very hands-on fashion and would have been able to avoid the high costs of social exclusion further down-stream while also avoiding profiteering by the middlemen and women employed at the banks.
**Mr Congdon said a key reason for credit contraction is pressure on banks to raise their capital ratios. While this is well-advised in boom times, it makes matters worse in a downturn.**
Is this really true? I mean, are the regulators putting on so much pressure (or have the banks adopted this on their own) that a bank is not going to lend to a credit-worthy borrower when it has the chance–especially at the margins they can make now? Or is it a matter of not having credit-worthy borrowers who want to borrow money?
The two are very different problems and require different solutions–if indeed, there is a good solution for the second problem (there are always solutions, just not good ones.) If it’s the first problem, the solution is simple–allow the banks to pretend and extend. I know it sounds intellectually and morally dishonest, but it can work for a long time. If it’s the second, you have two main choices–call the non-credit worthy borrowers credit worthy (another version of pretend and extend), or just create the money outright and give it away to the populace until it causes inflation–nothing will get people to borrow like the perception of impending inflation.
I didn’t say it was a moral, ethical, or a desirable solution–but it is a solution.
Why do people believe there is some easy way out of the financial crisis? There isn’t. Banks are in a mess, a mess of their own creation. It is pointless for Congdon to say it is a madness to force probity on the banks. The deleveraging process is the necessary, and alone, sufficient means of getting back to a proper balance between real income growth, real productivity and real GDP growth. There is no other way. It will be painful. It is necessarily painful. That is the only way people learn. It is over for the flower generation.
But What do I Know? said “Or is it a matter of not having credit-worthy borrowers who want to borrow money?”
I can relate cause I don’t know a damn thing either ;)
Have house prices everywhere fallen to supportable levels, with buyers who can really afford them? (not just 50% off when they should be 80% off). Are there not enough cars being produced in the world? Not enough strip malls? I got 8 sham wows, but maybe I need 16, or perhaps 32 (you know, they actually are great). Considering there has been a decade without real income gains (and I don’t know why it is reported that way, when the data clearly shows income isn’t as high as in the 70’s), where in the world do people get the idea that spending above your ability is good?
I guess it is bizarre to maybe ask about instead of increasing borrowing, how about increasing income?
fresno dan says: “where in the world do people get the idea that spending above your ability is good?”
I believe the article has the (somewhat counter-intuitive) answer:
““The rapid destruction of money balances is madness.””
The paying off of debt is money destruction. Money is therefore debt. Consequently, if all debts were paid off, there would be no money.
I know that this is not a direct answer, but I think very linked to your question. The economy is fuelled by debt (credit extension). There is therefore, of course, general and continuing pressure to get people and businesses to borrow. If money is good, debt is good.
And, because is ALL money is created as interest bearing debt, there can never be enough money in the system to pay back the interest plus the loan. Therefore, people must go bankrupt to keep the system (more or less) balanced. Therefore some people must think spending more than they can afford is good, for the good of the very system itself.
Ipso facto.
Left uncommented upon is the apparent fact that unless Americans are constantly going into debt little or nothing happens economically — there is no growth. A substantial portion of economic activity depends on debt creation.
The banks say that lending demand is falling. Frankly, I find that the more plausible explanation.
Much of the current loan demand is probably insolvent borrowers who shouldn’t be lent more money. Who wants to borrow to expand? Capacity utilization is at historic lows.
I don’t think Professor Tim Congdon has a clear understanding of whats going on.
I find it to be unremarkable that lending is declining, in fact, I feel that the contraction in lending is not nearly rapid enough.
The uncomfortable dislocations we are experiencing today are the product of greedy, asinine if not criminal mis-allocations of capital and labor that created such things as CDOs and CDO^2, the ultimate in the financial engineering and concentration of risk vehicles that ever garnered a AAA rating.
What is not happening is that the criminality of this collapse is going un-punished.
Mr Congdon said a key reason for credit contraction is pressure on banks to raise their capital ratios. While this is well-advised in boom times, it makes matters worse in a downturn.
Hard to tell if this is common sense or stupidity. The banks that DID raise capital ratios during the boom times got swallowed up by their more leveraged competitors.
There’s sensible reason for not wanting any banks to get too big, but the last 20 years was one of penis envy in regards to US banks being dwarfed by foreign competitors. That envy hasn’t changed a bit even during this so-called crisis; it isn’t even acknowledged.
Nobody remembers the hardships of their grandparents. Mistakes are bound to be repeated two generations later. If you do the math, 1929 + 80 = 2009. So it’s deja vu all over again. Unfortunately, there is no way to avoid the Kondratieff winter…might as well hunker down and get used to it.
Have any economists considered the economic disruption from how quickly and intrusively the Internet and information revolution came on to the scene from about 1996 on? Does the pace of communications technology from the mid 90’s cause problems when working with economic data that spans decades? The world is so vastly different with respect to communication now.
There is a common statement that the supposed recent improvement in our economy is due to inventory adjustments, and that this might or might not then lead to further improvements. But the data from the Commerce Department do not show this inventory increase. See http://www.census.gov/mtis/www/mtis_current.html
Yesterdays release states that manufacturing and trade inventories, adjust for seasonal variations, are down 1.0 percent in July, 2009 compared to June 2009. The seasonally adjusted inventory-to-sales ratio is also still decreasing, month-to-month. However this ratio is about 10 percent above the levels from 2004 to 2007, so there seems to be room for further drops in inventories. Where is this story coming from that inventories are rising?