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Atle Willems, CFA
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Atle Willems, CFA, is an equity investor with a long-term view investing in undervalued listed shares with solid operational track records and sensible balance sheets. He holds a master's degree in finance from Nottingham University Business School, UK, a bachelor's degree in business... More
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  • Goodbye Fed (For Now), Hello Banks: A Classic Boom Bust Cycle Now Being Added On Top Of The Fed Bubble

    Clearly, bank credit expansion cannot increase capital investment by one iota. Investment can still come only from savings.

    Man, Economy, and State, Murray N. Rothbard

    U.S. Money, Credit & Treasuries Review (as of 25 June 2014)

    On June 18th, the Fed decided to taper its monthly asset purchases further, from $45 billion a month to $35 billion starting July (my bold):

    The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in July, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $15 billion per month rather than $20 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $20 billion per month rather than $25 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee's sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee's dual mandate.

    Since December last year, asset purchases has now been reduced by $50 billion a month, a decrease of 58.8%. As a result, combined with a higher base, the year on year growth rate of the monetary base is declining rapidly. At 24.2%, the growth rate is now a significant 15.2 percentage points lower than the 39.4% growth rate at the end of last year.

    (click to enlarge)

    What repercussions will this tapering by the Fed have for the U.S. economy?

    Firstly, it could affect treasury yields. In 2013, the Fed bought $45 billion worth of longer-term treasury securities every month to help push down yields on government securities. During that year, the federal debt increased $919 billion, of which the Fed was the (end) buyer of about $540 billion, or just under 59% of the increase in debt. During the first half of 2014, the U.S. federal debt has been growing at a substantially slower pace in U.S. dollar terms compared to the first half last year; $306 billion increase from 31 December 2012 to 18 June 2013 vs $180 billion increase from 31 December 2013 to 18 June 2014. The Fed will have bought about $190 billion worth of longer-term treasuries as of June this year, which is more than the increase in federal debt (105.6% of the increase in debt to be exact). This helps explain why the Fed is indeed tapering: the need to monetize new debt is simply currently much smaller than it was last year. Therefore, at the current pace of both Fed purchases and increases in government debt, the Fed's role as the marginal buyer of treasuries is still intact and in this sense the tapering by itself should not push yields higher.

    Secondly, the tapering could affect the distribution of the newly created money, including its overall growth rate. Basically, the money supply increases through two main channels: banks issuing new loans and the banks and/or the Fed buying securities from parties other than banks. Last year illustrates this well: during the year, the M2 money supply increased by about $565 billion, of which banks created a modest (in a historical perspective) $115 billion, or about 20%. The rest of the increase in the quantity of money outstanding was made up largely of the U.S. government issuing treasuries with a bulk of these ending up on the books of the Fed as discussed above. As the Fed tapers, presumably in tandem with the U.S. government continuing to reduce its debt expansion, less new money is created in the process. This will first hurt those people and companies that have become accustomed to receiving the newly created money early, e.g. government contractors. How this process will go about is difficult to tell, but some sectors will be affected which will then again ripple through the economy and lead to changes in the distribution of money in one way or another. Also, unless banks compensate for this reduction in the money supply growth rate now being caused by the government and the Fed, the overall growth rate in the money supply could head downwards sharply and thereby bring the economy and the financial markets with it. As I've stated before, banks have indeed started to expand lending. More on this below.


    The M2 money supply growth rate compared to last year ended on 6.6% for the bi-weekly period ending 25 June, the highest since October last year and higher than the 6.3% average during the last 12 months. Bank Credit increased 4.6% on the same basis, up from a 4.0% growth rate two weeks ago and substantially higher than the 1.1% growth rate at the end of last year.

    (click to enlarge)

    This substantial growth in bank credit, combined with an expanding growth rate of the money supply, suggests banks are indeed creating enough credit, and with it new money, to compensate for the reduction in the growth of government debt and the Fed taper.

    During the last 12 months, bank credit expanded by about $475 billion, or 4.6%. Where did this growth come from? Bank credit consists of two main items; Securities and Loans & Leases. Of this $475 billion growth, about $91 billion (19.1%) was due to an expansion of Securities held by banks while the rest, $384 billion (80.9%), was from an increase in Loans & Leases.

    As Loans & Leases consists of Commercial & Industrial Loans, Real Estate Loans, Consumer Loans and Other Loans, each category's share of bank credit growth during the last 12 months can be broken down as follows:

    (click to enlarge)

    Loans & Leases, which currently makes up 73.3% of bank credit (securities makes up the rest, see table below), increased 5.1% compared to same period last year to record the highest growth rate for almost two years. Increased bank lending has therefore been the major driver of the bank credit expansion during the last 12 months...

    (click to enlarge)

    ...of which a 10.5% increase on last year in the issuance of Commercial & Industrial Loans has been the main driver, making up 43.3% of the growth in Loans & Leases (and 34.5% of bank credit growth) during the last 12 months.

    (click to enlarge)

    In short, the negative effect the reduced expansion of government debt and the Fed taper has on the money supply growth rate has been largely offset by a corresponding expansion of bank credit this year. Whether this will continue remains to be seen and will be monitored in this bi-weekly report going forward. This shift in how and where new money is generated will have implications for the structure of the economy. In the aftermath of the banking crisis in 2008 and 2009, the money supply expanded predominantly by way of deficit spending: the government issued debt (monetized partly by the Fed) and spent those money in the economy. The trend now is that the bulk of the new money is generated through the conventional channel, namely the banks, of which a bulk ends up directly with corporations that then spend these new money. As a result, those who previously received the new money first will now lose or gain less than they have in recent years in terms of spending power while the new receivers of the new money generated by banks will increase theirs.

    Finally, with reserve balances, most of which classified as "excess reserves, approaching $2.7 trillion, banks are in a position to greatly increase lending (ignoring other constraints such as qualified borrowers and the demand for credit). As they now appear to be doing just that, not from prior savings but from issuing new money (Cash Assets at banks are still increasing even as lending grows) the U.S. economy is now well on its way to discover the full force of the classic meaning of the Austrian Business Cycle Theory: an increase in the quantity of money generated by bank lending to corporations. If the growth in bank credit fueled by a growth in lending not backed by a commensurate amount of prior savings continues to push the money supply growth rate up, another artificial boom could be on its way. Perhaps that is what the U.S. stock market has noticed, or is anticipating, as it keeps hitting new record highs again this week. If that turns out to indeed be the case, the economy is now building up to a spectacular bust (even worse than the one which has been in the pipeline for years) which will make the previous one look like a walk in the park. Why? Because this time the U.S. government is seriously indebted to which can be added that the U.S. economy is much more dependent on government spending now than some six years ago. Also, bank balance sheets are no more solid now than pre Lehman: on 10 September 2008 the equity to total asset ratio for all U.S. commercial banks was 10.62%. Today it is 10.89%. Yes, banks hold a lot more cash this time, both in total and as a percent of total assets. But with the Fed always ready to bail out banks, it perhaps makes little difference if bank assets consists of mostly cash or treasuries (or MBSs) exchangeable for cash immediately at the sign of liquidity problems.


    Key U.S. monetary statistics as of 25 June 2014 (treasury yields as of 2 July 2014):

    (click to enlarge)

    (click to enlarge)

    Visit the U.S. Money, Credit & Treasuries Review here.

    Related: The Fed has Created Yet Another U.S. Stock Market Bubble: 10-year Average Earnings- and Dividend Yields, S&P 500 (as of 31 Dec-13)

    Disclosure: The author is short MYY.

    Tags: Macro, Economy
    Jul 08 6:14 PM | Link | Comment!
  • Removing This Driver Of GDP Per Capita Sends The U.S. Economy Right Back To 1998...

    (Orignally published on 30 May 2014)

    ...but with substantially more government debt.

    The revised U.S. GDP figures for Q1 2014 was reported yesterday showing that Real GDP decreased at a seasonally adjusted annual pace of 1.0%.

    Nominal GDP for the quarter on the other hand increased at a seasonally adjusted annual pace of 0.27% compared to previous quarter. Compared to Q1 20013 Nominal GDP increased 3.42%.

    (click to enlarge)

    Of this nominal growth, Personal Consumption Expenditures made up 73.0%, the highest since Q4 2011. Gross Private Domestic Investment made up 24.7% of the growth, the lowest since Q1 last year while Government Consumption Expenditures & Gross Investment and Net Exports made up the rest (-1.4% and +3.8%, respectively).

    The annualised seasonally adjusted Nominal GDP for Q1 came in at US$ 17,101.3 billion. This was the highest GDP figure ever reported and 15.2% higher than the pre-recession high from Q3 2008.

    (click to enlarge)

    The Real GDP figure meanwhile came in at US$ 15,902.9 billion, the second highest ever (beaten only by previous quarter) and 6.05% higher than the pre-recession high back in Q4 2007.

    Now, Real GDP is calculated through adjusting Nominal GDP for price inflation. While the latter is a money-value measure, the former is supposedly a measure of the quantity of total output.

    But what happens if the nominal figures are adjusted by the increase in the money supply, that is, the monetary inflation, instead of price inflation? Below I will use the M2 as a measure of monetary inflation, i.e. money supply growth. Why in the world adjust the figures this way you might ask. The reasoning is straight forward: all else remaining the same, the more money in circulation (i.e. the higher the quantity of money) the higher Nominal GDP will be - as the money supply expands, GDP expands with it as all transactions are measured in money. As more money in circulation does not create more real goods available (if it was that simple we could all stop working and just turn on the printing press), it's only affect can be to redistribute purchasing power and drive prices higher than they otherwise would be.

    During the last twelve months ending March, the M2 money supply increased 6.09%, since the end of 1999 it has increased 142.5%. Since Q4 2008, the money supply has increased 38.7% and today represents 65.1% of Nominal GDP. This compares to 55.2% in Q4 2008 and 51.7% in Q1 1981. Since 1981 it has averaged 53.1%. The current figure of 65.1% is the highest ever reported based on data since 1981. Since bottoming at 45.2% in Q3 1997, the quantity of money has swallowed an increasing share of Nominal GDP. As an increase in the quantity of money does not create wealth (if anything, it destroys it as it allows governments on fiat standards to expand beyond what it could do through taxation other than monetary inflation) this trend is bad news indeed and makes the Nominal GDP figure even less useful as a measure of economic growth. This increasing share of GDP by the money supply also helps explain why the U.S. economy is in such a bad state even as Nominal GDP is growing and despite Real GDP being at its second highest ever reported.

    (click to enlarge)

    The difference between Nominal and Real GDP is the GDP Deflator. The chart below shows the significant difference between the growth rates in the deflator and the money supply, the latter growing substantially quicker.

    (click to enlarge)

    So, removing the increase in the money supply from Nominal GDP yields the following money supply adjusted GDP figures:

    (click to enlarge)

    The data shows that the current money supply adjusted Nominal GDP number is the lowest since Q2 2009 and 14.71% lower than the peak from Q4 2007. It also shows that the current number is virtually unchanged from 10 years ago. Compared to Q1 2013, the adjusted GDP figure fell 0.95%.

    The U.S. population however continues to grow and the country, with a population of more than 317 million, is today the most populated it has ever been. This means the money supply adjusted GDP figures reported above is even worse on a per capita basis.

    (click to enlarge)

    The current figure of US$ 23,889 per capita is the lowest it's been since Q4 1998 and it's still getting gradually worse almost every quarter. Of course, the U.S. federal debt and the Fed balance sheet was substantially smaller back then. Compared to Q1 2013, the adjusted GDP per capita dropped 1.65% in Q1 this year and is now 18.74% lower than the record high from Q3 2007.

    In conclusion, the money supply adjusted Nominal GDP figures point a bleak picture of the progress in the U.S. economy. It also perhaps helps explain the ever growing federal debt (the economy is simply not generating enough income to balance the budget, though of course perhaps it never can given the high level of spending) and the still high unemployment figures. It also indicates that monetary policy injecting ever increasing quantity of money in the economy does not improve the underlying money supply adjusted GDP figures.

    Just as both Nominal and Real GDP numbers are not accurate measures of economic growth (due to insufficient data and as it only measures final output), or lack thereof, the adjusted numbers suffer the same weakness. In addition, not all money supply growth necessarily ends up in items forming part of GDP. However, assuming this relationship is fairly steady over time, and the fact that increases in the money supply will by itself drive GDP up and as an increase it the quantity of fiat money in an economy has nothing to do with wealth, it's perhaps not unreasonable to conclude that the adjusted measure help explain economic developments better than both Nominal and Real GDP.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Tags: Economy, Macro
    Jun 05 3:35 AM | Link | Comment!
  • The Short Version Of The "Austrian" True Money Supply (TMS), As Of 21 April 2014

    The short version of the Austrian True Money Supply (SVTMS) for the U.S. decreased by 0.52% (23.85% annualised) during the most recent week ending 21 April 2014 to hit $10.1252 trillion. The money supply is calculated from the latest data published by the Federal Reserve.

    (click to enlarge)

    Currently, of the three components making up the Short Version of the Austrian True Money Supply, Currency makes up 11.8%, Checkable Deposits make up 14.9%, while Savings Deposits make up the bulk at 73.3%. As the chart immediately below shows, Savings Deposits have increasingly made up a larger portion of the money supply since 1995 though it has flattened since 2008 and declined somewhat during the last couple of years.

    (click to enlarge)

    The 1-year growth rate in the money supply ended the week on 8.39%, the highest reported since week ending 28 October 2013.

    (click to enlarge)

    The growth rate was however 1.69 percentage point lower than during the same week last year and was the 95th week in a row with a declining growth compared to a year ago. The downward trend in the growth rate hence continued.

    (click to enlarge)

    The 5-year growth rate came in at 11.17%, the highest reported for nine weeks, but 65 basis points lower than one year ago. It hence recorded the 21st consecutive week with a declining growth rate compared to previous year.

    (click to enlarge)

    In summary, money supply growth continues to slow down with all growth rates spanning the 26 week to 5 year periods expanding less than one year ago.

    (click to enlarge)

    Visit the short version of the Austrian True Money Supply archive here.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    May 03 6:56 AM | Link | Comment!
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