Monday, January 23, 2012
Commercial & Industrial Loans (a good proxy for bank lending to small and medium-sized businesses) have been expanding at an accelerating rate for more than a year now, having grown by $154 billion since their low in October 2010. Over the past six months, C&I Loans have risen at a 13.4% annualized pace. This is a rather remarkable development that has been way under-appreciated, in my view. It is now very clear that not only are banks increasingly willing to lend, but that businesses are increasingly willing to borrow. I view this as convincing evidence of returning confidence. The deleveraging and general risk-aversion that dominated the private sector's financial decisions since the financial panic of late 2008 has now been replaced by a renewed willingness to take on risk.
Banks are required to hold "bank reserves" at the Fed to support their deposits. Required reserves, shown in the chart above, are thus an excellent indicator of the net impact of bank lending. The fact that required reserves (above chart) have more than doubled since the beginning of the Fed's first Quantitative Easing program in late 2008 is convincing evidence that banks are expanding the money supply by making net new loans. And by an amount that is unprecedented: the M2 measure of the money supply has increased by over $1.9 trillion over this same period, or by 25% in just over 3 years. It's hard to imagine how anyone could think that the Fed's efforts to add liquidity to the economy have failed. At the very least, it can be argued that the Fed's massive attempts at accommodation have been sufficient to satisfy the world's voracious demand for extra dollar liquidity, since inflation has been positive and ongoing, the dollar is roughly unchanged against other major currencies since QE began, gold prices have doubled, industrial commodity prices have risen 14%, and the inflation expectations embedded in TIPS and Treasury prices have risen from almost zero in late 2008 to levels now that approximate what inflation has averaged over the past two decades. If the Fed had been stingy with money, we would most likely have seen convincing signs of deflation in these same indicators. Instead, these indicators strongly suggest that the Fed's efforts to be accommodative have succeeded in adding at least some inflationary impulse to the global economy.
If the economy is suffering from a lack of anything these days, it is most certainly not a shortage of money.
Consequently, I continue to believe that the economy will continue to grow, albeit at a sub-par pace given how far it fell in the last recession. Moreover, I have every reason to think that the pace of nominal GDP growth will likely accelerate at least somewhat over the next few years. If that is the case, faster nominal GDP growth will support growth in corporate cash flows and profits, and help keep default rates low, thus auguring well for the outlook for equities and corporate bonds, particularly those rated below investment grade, where implied default rates are still relatively high.
Posted by Scott Grannis at 3:28 PM