by Pater Tenebrarum
US Monetary Backdrop
Last week we discussed the fact that China's money supply growth has slowed precipitously and also looked briefly at some long term euro area data. As we have mentioned on previous occasions, the annualized growth rate of US money TMS-2 has declined noticeably, but remains brisk in a longer term historical context. Between late 2008 and late 2012, the growth rate briefly dipped below 10% only once, as it was kept high not only via 'QE1' and 'QE2', but also the phenomenon of funds fleeing from euro-dollar markets into depository institutions in the US (in order to ensure financing of the dollar liabilities of European banks, these funds were partly replaced by the now permanent currency swap arrangements between central banks). The situation regarding euro-dollar deposits changed when the sovereign debt crisis abated; moreover, a blanket deposit guarantee for large scale deposits granted by the FDIC in the wake of the 2008 crisis expired, further reducing the advantage of holding such deposits in the US banking system.
Lastly, while 'QE3' has been both open-ended and has involved the largest monthly amounts of debt monetization yet in absolute terms (with the sole exception of the massive alphabet soup programs initially launched in late 2008), there are basis effects to consider: when 'QE2' was launched in November of 2010, the total extant money supply was still a lot lower than it was when 'QE3' began in late 2012. In addition, bank lending growth has steadily declined since early 2012, so there was little impulse from inflationary lending on the part of commercial banks (very recently, growth in bank lending has picked up a bit).
Note that 'Operation Twist' did not directly influence the money supply, as it merely amounted to an altering of the maturity structure of the Fed's securities portfolio.
The most recent data show that the true broad US money supply has by now expanded to almost $10 trillion, with the year-on-year growth rate ticking up again slightly in January, but still remaining below the y/y growth rate recorded a quarter ago and a year ago. In short, the downtrend in the rate of growth in evidence since the end of 'QE2' has not really been interrupted. That may change if commercial banks increase their lending at a faster pace than the Fed reduces its securities purchases. While bank lending growth has indeed picked up since the 'taper' announcement, it is too early to come to conclusions about it, as it is a fairly recent phenomenon that may yet be reversed.
Note however that something along these lines actually happened in the UK: when BoE credit was expanded via 'QE', money supply growth actually declined initially. In the meantime however, there has been a big push in UK TMS growth, which briefly topped 10% last year. In this particular case it appears that various government interventions designed to restart the mortgage credit bubble have been quite effective in spurring lending, as the seemingly inexorable rise in UK property prices has resumed at full blast, with prices in London especially rising at a very fast pace.
US money TMS-2 – the 'parabolic' advance continues, but its growth momentum has actually decreased – click to enlarge.
TMS-2, year-on-year growth rate. From late 2008 to late 2012, the annual growth rate only once briefly dipped below 10%. Since the end of 'QE2', it has however been in a steady downtrend – click to enlarge.
Total loans and leases, all commercial banks. Note that the number is a bit distorted due to accounting changes introduced in 2010, but there has clearly been a push higher so far this year – click to enlarge.
Since early 2012, the rate of growth in bank lending has been in a downtrend, but recently it has picked up a bit – click to enlarge.
The sector in which bank lending has increased the most are industrial and commercial loans, which have reached a new record high. Not surprisingly, the net debt ratio of US corporations is at a new record high as well. The aggregate cash position of US corporations has risen to a record high, but debt has increased even faster, leaving them in a worse net position than prior to the 2008 crisis. Don't worry, nothing bad can possibly happen, since no-one in policymaker circles currently thinks there are bubbles in sight anywhere.
Commercial and industrial loans are at a new record high, on the heels of record junk bond issuance in 2013 – click to enlarge.
The annualized growth rate of commercial loans has picked up lately – click to enlarge.
Lastly, here is another look at the ratio of the industrial production indexes referencing business equipment and consumer goods production. We must stress that the comparison of such aggregate index values (the indexes employed are so-called Fisher indexes that involve a lot of estimates – for a backgrounder see here) only gives us a very rough idea of what is happening in terms of the economy's production structure, but history indicates that the ratio can be a useful guide. As one might expect, the main element causing it to gyrate is of course spending on capital goods production. The basic idea is that during times of heavy monetary pumping and suppressed interest rates, factors of production are increasingly diverted toward longer and more capital intensive production processes, even though consumers have not lowered their consumption and increased their savings. This results in the erection of a capital structure that does not properly reflect consumers' wishes and is therefore unsustainable. One could also state that it ties up ever more consumer goods in higher stages of production relative to the amount of consumer goods it releases. Experience shows that the ratio tends to expand during boom times caused by monetary pumping, while it contracts sharply during busts, as a more sustainable balance between production and consumption is restored and malinvested capital is liquidated.
After a while, renewed monetary pumping as a rule tends to arrest and reverse the process. Recently, the ratio has stalled out and begun to dip. It is too early to say whether this is already a meaningful signal or whether it is just a short term interruption in the trend, but it certainly bears watching:
As the gray 'recession bars' show, this ratio tends to fall sharply during busts. Recently it has stalled out and turned down somewhat, but it cannot be stated with confidence yet that this constitutes a definitive trend reversal. It is definitely a 'heads-up' though – click to enlarge.
Japan and the Euro Area
Monetary growth momentum in Japan and the euro area has recently converged, via an acceleration in Japan and a deceleration in the euro zone. Note that we only employ narrow money TMS-1 in these cases, as contrary to the US, it cannot be argued that savings deposits are available on demand (things are handled slightly differently from country to country in the euro area, but there is no uniform custom). As a result, only currency and sight deposits are included in the data. This makes their growth rates slightly more volatile, in the case of the euro area extremely so.
In Japan, the BoJ's heavy 'whatever it takes' pumping has finally succeeded in pushing money supply growth quite a bit higher, and Japanese money TMS is now growing at a rate near the uppermost boundary of its post-1989 range. Note that the growth in money supply stalled out after the 2006 draining of funds that had been provided via previous 'QE' operations. It has begun to accelerate again from early 2010 under former BoJ governor Masaaki Shirakawa, who was actually the initiator of the current 'QE' program (Kuroda merely enlarged it greatly). The most important point though is that the rate of annualized growth has accelerated considerably, recently breaking out to a new high for the move.
One conclusion that could tentatively be drawn is that the happy days in the JGB market won't last much longer. At the moment the BoJ's heavy buying and the refusal of large domestic holders of JGBs to lower their exposure are helping the market to hold up, but with regard to the latter one must keep in mind that major decisions regarding the allocation of funds move at a very slow pace at many of these institutions. Should they decide to markedly alter their allocations, there could be some fireworks in the JGB market. As a friend recently remarked, this would ultimately likely be tolerated by the BoJ on the grounds that it would validate its 'inflation targeting'.
Japan's money TMS, total – click to enlarge.
The year-on-year growth rate of Japan's money supply has reached a new high for the move – click to enlarge.
10 year JGB, nearest contract, weekly chart. Will it finally succumb? - click to enlarge.
With regard to the euro area, last week we showed a long term chart of the euro area TMS total, in order to illustrate the extent to which it has been inflated in recent decades. Although it has continued to grow at quite a brisk pace overall since the 2008 crisis, its total growth since the beginning of 2008 amounts to only about 41% vs. the approximately 90% growth in US TMS-2.
In recent months, there is also the basis effect to consider, as well as the fact that ECB credit is actually declining sharply (due to banks paying back LTRO funds). While this doesn't affect money supply growth directly (reserve requirements are only 1% in the euro area anyway), it probably has at least some indirect effect. There has undeniably been a sharp acceleration in euro area money supply growth following the LTRO provision in early 2012, as banks embarked on a huge carry trade in sovereign debt. Concurrently, private sector credit growth has however declined. Recently there are some tentative signs that this trend may be on the verge of reversing, as tightening spreads between the sovereign debt of peripheral countries vs. Germany should be reflected in lower interest rate charges on private sector loans in the periphery as well (there has been a close correlation between them in the past). The main brake is probably credit demand, as major structural economic problems remain largely unsolved. Also, even as the economies in the periphery are coming up for a little bit of air, France's economy continues to exhibit a lot of weakness in the wake of the policies instituted by the Hollande government.
Below is a chart showing the year-on-year growth of euro area TMS. As can be seen, following the sharp acceleration between late 2011 and early 2013, the growth momentum of euro area money supply growth has begun to decline, and is now only slightly above Japan's, although a slight uptick has been recorded in January.
Euro area TMS, year-on-year growth – historically the current growth rate is actually on the low side. There has been extraordinary volatility in euro area money supply growth since 2008 – click to enlarge.
Almost needless to say, it is no coincidence that money supply growth fell to very low levels just ahead of the 2008 crisis and again ahead of the 2011 peak in the euro area's sovereign debt/banking crisis. Similarly the recessions of 1990-1991, 1994 and 2001-2002 were preceded by a sharp slowdown in money supply growth. This illustrates the extent to which aggregate economic activity as measured by GDP has become dependent on various bubble activities financed with money from thin air. Precisely the same consideration apply of course to the chart of the growth rate of US money TMS-2 depicted further above.
Conclusion:
Both in the US and the euro area, money supply growth is decelerating. At the moment, it is however still relatively high and the lagged effects of the strong growth rates recorded earlier are presumably still playing out. In addition, administered interest rates remain at rock-bottom levels. In Japan, money supply growth has accelerated to the highest level in more than a decade, which lends support to the Nikkei index and validates the weaker exchange rate of the yen to some extent.
All of this continues to keep numerous bubble activities going, which are erroneously widely referred to as 'economic growth'. The problem with this view is of course that measures of economic activity like GDP as such tell us nothing about the quality of this activity: capital malinvestment and government spending alike are thought to constitute 'growth', even though they actually waste and consume scarce capital.
The fact and extent of the waste is usually revealed as soon as money supply growth falls below a certain threshold. Then it is 'crisis time', and policy makers swing into action in order to repeat the same mistakes they have made before, only on an even grander scale.
As we have previously pointed out, we cannot say where the 'crisis threshold' will be this time around (i.e., to what level money supply growth rates need to decline to trigger an economic downturn that becomes clearly visible in the data). There is reason to believe that it may be higher than last time around, based on the fact that the recovery has been very weak and it probably won't take much to upset the apple cart. Keep in mind though that there are usually considerable lag times involved, which tend to vary somewhat from case to case. We can also not be sure yet whether commercial banks will pick up the inflationary baton from the central banks, but all these recent trends need to be watched closely.
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