Growth In Lending Increases Even As Banks' Equity Ratios Approach 2008 Levels

by: Atle Willems, CFA

Bank credit expansion is again becoming the driver of money supply growth as fed tapers.

Consequently, the U.S. economy shifts from simple monetary inflation to a classic boom bust cycle.

The U.S. economy is once again left at the mercy of under-capitalised banks.

It's taken a tremendous amount of hard work by the busy treasury and mortgage-backed security traders at the New York Fed, but here we are: the U.S. monetary base a few days ago eased passed the perhaps not so magical US$4 trillion mark. Since week ending 10 September 2008, five days before the Lehman collapse, the monetary base has fattened by a stunning US$3.145 trillion, or 359% during the course of less than six years.

But why? To decrease the unemployment rate which today remains 1.2 percentage point higher than it was at the beginning of 2008? Well, the Fed acts primarily in the best interest of the banking system as a whole and government finance, not for the unemployed. Buying treasuries and mortgage-backed bonds from banks and other institutions will not create jobs nor help, in any shape or form, the majority of U.S. citizens. To the contrary, as new money is channeled to some at the expense of others it will leave many, especially those on fixed salaries depositing savings in their bank accounts, worse off following the investments in wrong lines of business, unsustainable spending, increased moral hazard, lower interest rates and higher price inflation (than would otherwise be the case) that ensue.

This monetization of the U.S. debt has allowed the government, in a desperate attempt to move toward an economy based on government dictate and Keynesian stimuli (no way even Keynes would have approved of what we've witnessed in recent years) rather than honing the free will of market participants (all of us, that is), to pile up a mountain of debt that has to be paid for one day by the very people the spending spree supposedly benefit. Meanwhile, bureaucrats, the federal government, government contractors and the military and intelligence complex suck eagerly away at scarce resources, heating up the competition of who can get the biggest piece of an ever shrinking cake. These are the winners, together with an ever decreasing number of U.S. banks controlling an ever larger share of the economy and the money supply (less competition apparently is a good thing when it comes to banks, not attacked, by the looks of things, by the perfect competition advocates). In fact, U.S. commercial banks' total assets in percent of GDP is now at the highest level ever.

Long gone are the days we worried about an invasion from space. Today we are preoccupied with our own mischief. And long gone are the days politicians had to worry about a savvy electorate. Anything goes in politics now, in the U.S., Europe and almost everywhere else. In the high circles of economics and political economy, a book about inequality dwarfs the wise words of the long forgotten, except in small circles with little or no influence on public policy, economists of the past who laid out an economic doctrine based on sound principles and reasoning.

"A society that puts equality before freedom will get neither. A society that puts freedom before equality will get a high degree of both."

-Milton Friedman

Today, the brilliant economists of the past have been replaced by statisticians hardly spending a day in the field, playing with economic time series and performing endless exercises of data mining with a touch of a few buttons, uncritically and incorrectly looked upon and admired as economists.

Since 2008, the Fed and the government together have created a big chunk of the new money put into circulation (through monetizing an ever expanding government debt). Following the gradual reduction in monthly asset purchases by the Fed, what created the 2008 banking crisis in the first place is now back with a vengeance: bank credit expansion. This is the channel new money is normally brought into circulation. You apply for a loan, the bank approves it, with it creating a debit on its books (the loan) and a credit (the newly created deposit which you are free to spend as money). Lending for commercial and industrial purposes is now expanding year on year at a growth rate north of 10% and has been doing so since mid April. American companies are increasingly becoming the first receivers of newly created money as business lending currently makes up about 31% of the growth in bank credit during the last year.

Lending for other sectors are also increasing; Real Estate loans are expanding at the fastest pace since September 2009, Consumer lending is also on the up while Other Loans and Leases are growing at a pace not seen for almost two years. All culminating in a bank credit expansion outpacing the much followed GDP growth number by quite some distance.

And there is an abundance of Bank Reserves to support this credit expansion following Fed actions ever since the end of 2008. As the Fed nears the end of QE (for now) the relay stick is being, in a well-orchestrated and timed operation by the looks of things, handed over to the commercial banks to keep the monetary inflation going. It appears to be working, for now.

However, money supply growth remains lower than both last year and 2012 and therefore continues to present a risk to nominal growth rates and asset prices going forward. Ever increasing bank credit expansion will be required to push the money supply growth rate further up. Despite the surge in bank reserves, U.S. commercial banks remain highly geared with assets exceeding equity by a multiple of around 9.3. On this measure, banks are no more solid today than back in September 2008 when the U.S. banking system collapsed.

An under-capitalised banking sector, with an equity to total asset ratio of about 10.8%, and hence still dependent on cheap loans from the Fed when a crisis hit, is at it again expanding credit at well above 5%. And most of the credit appears to be newly printed money as the money supply is growing at a faster pace even as the Fed tapers and the federal debt is increasing at a substantially slower pace.

The U.S. economy (and world markets with it) is once again left at the mercy of a highly leveraged banking system showering the markets with new money created out of thin air. Sustainable? Of course not. But as long as it continues, it will push nominal economic aggregates measured in money up, giving mainstream news reporters unfounded reasons to cheer the economy onward and upward and with it increased confidence, increased spending financed by increased borrowing...well, you know this story.

"To combat the depression by a forced credit expansion is to attempt to cure the evil by the very means which brought it about; because we are suffering from a misdirection of production, we want to create further misdirection - a procedure which can only lead to a much more severe crisis as soon as the credit expansion comes to an end"

- Friedrich Hayek

Meanwhile, this simple U.S. stock market risk indicator has been flashing red like never before for a few months (here for details).


Key U.S. monetary statistics and charts as of 23 July 2014 (treasury yields as of 6 August 2014):

Disclosure: The author is short MYY. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.