Saturday, June 28, 2008

Bank Credit & Money Supply

Three of the more prominent "deflationists", Mike Shedlock, Paul Kasriel and Caroline Baum, have recently made a big deal out of the apparent contraction of bank lending since March. This supposedly proves that monetary conditions have become deflationary.

This is a quite interesting development since these 3 writers completely ignored this indicator when it expanded sharply, which it did until March. Instead they focused on the monetary base, which is now ignored, perhaps because it by contrast have begun to accelerate in recent weeks from its previous weak growth rate.

But setting aside their convenient flip-flop in chosen indicators, does this development indicate a shift in monetary conditions?

No, not necessarily, and no evidence exist yet that it does.

First of all, as I explained in my post Assets & Liabilities & Myths About Write-downs bank credit is part of the asset side of bank balance sheets, while money supply is on the liability side (all too many economists, including presumably the aforementioned three, aren't educated in accounting so they don't understand these sort of things).That means that although bank credit and money supply are usually correlated with each other, they need not be and often aren't. And as I also explained at the time, while bank credit will be reduced as a result of write-downs, the components of the money supply will be unaffected (except maybe indirectly at a later point in time). And while money supply growth have slowed somewhat it is still quite high.

Nor are bank credit equal to total credit. Commercial bank lending totals only $6.9 trillion, or less than 30% of total private sector debt. One reason for the slowdown in bank lending is likely that conditions on the credit markets have improved, enabling companies who want to borrow to get capital from the credit markets rather than the banks. The super high growth rate in bank lending between August 2007 and March 2008 reflected to some extent the collapse in commercial paper issuance, but in recent weeks this have started to stabilize and rise again. It would be interesting to see statistics over total private sector debt, but as far as I know no such statistics will be available until the next flow of funds release on September 18.

I should finally emphasize that I have no permanent commitment to the inflationist (inflationist/deflationist in the sense of forecasting the future, not advocating policy) outlook. If the facts change, then I would have no problem changing my outlook. However, until total debt growth and more importantly, money supply growth halts, I stand by the inflationist outlook. And that wouldn't in anyway make my current assessment wrong. Furthermore, the lagged effect of current monetary inflation is likely to keep price inflation high. However, if monetary conditions would become less inflationary this would relatively fast contribute to lower commodity prices.


Anonymous newson said...

i know this is probably as boring as batshit, but to repeat the question of some weeks ago, do you have any further idea of why saville ( uses tms + retail mmf as preferred money aggregate?

one other thing, when the short-term loans made by the fed to the banks (against sub-prime & other dodgy paper) come up for renewal (september?), won't they end up being rolled over indefinitely? otherwise the paper will come back to the banks' balance sheets and be marked-to-market, effectively wiping out vast swathes of equity. surely the fed will oblige...

5:09 PM  
Blogger stefankarlsson said...

OK, as I understand the so-called TMF measure, it appears to be MZM minus all Money Market Mutual Funds ( both retail and institutional), which is actually a deviation from the original Shostak definition which also excluded savings deposits.

I don't know why they exclude Institutional Money Market Mutual Funds. From what I can tell after having looked it up, money invested there is immediately available.

As far as these new Fed credits, it remains to be seen what happens to them, but most likely they will indeed be rolled over indefinitely.

10:57 PM  
Anonymous Anonymous said...

hi Stefan, can i check with you where you got your figure for "Commercial bank lending totals only $6.9 trillion"?

12:09 PM  

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