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As the chart above shows, Commercial & Industrial Loans outstanding at U.S. banks grew at a 19% annualized pace in the first three months of this year. These loans are mostly to small and medium-sized businesses that are not able to access the capital markets directly. It's good news not because more loans mean more spending and/or more economic activity (lending doesn't create growth, but it can facilitate growth by distributing capital to people and businesses can make productive use of the money). It's good news because it reflects a significant increase in confidence on the part of banks and businesses. Confidence has been in short supply for most of the current recovery, as can be seen by the tepid growth of business investment and the disappointingly slow growth of the economy. That looks to be changing for the better now.
Banks have had the ability to increase their lending virtually without limit ever since the Fed began its Quantitative Easing program in late 2008. However, lending didn't really pick up until the beginning of last year, right around the time the Fed announced the tapering and eventual end of QE. Things have changed dramatically since then. With rising confidence comes a reduced demand for money (i.e., money in the form of cash and cash equivalents like bank reserves, which exceed required reserves by about $2.5 trillion), and this validates the Fed's decision to stop growing its balance sheet. On the margin, banks are becoming less and less willing to sit on trillions of excess reserves; they'd rather lend money to the private sector than to the Fed, and they are beginning to do that in spades.
With lending activity booming, this is no time to be pessimistic about the economy's prospects.
13 comments:
Love the C & I lending. I suspect the rebound in commercial property values has allowed banks to extend loans to such borrowers. Banks like to lend on collateral.
Still, I would prefer the Fed error on the side of too much stimulus rather than too little.
Scott,
Do you have any concern about the $18 trillion in US debt and a potential currency crisis looming in the not too distant future? Will the US continue to absorb more debt or do you think there is a plan to pay it back?
Thanks,
Dave
Re: debt concerns. To begin with, our national debt outstanding is only $13.1 trillion. $5 trillion of the $18 trillion commonly cited is debt the government owes itself, so it really doesn't count—it's just an accounting fiction. What matters is the debt we owe to others, and that is $13.1 trillion. It's a little over 70% of GDP. That's a lot, but it is not a catastrophic number. It's manageable, especially now that our annual budget deficits are running around 3% of GDP. Debt becomes problematic when deficits exceed 9-10% of GDP and total debt exceeds 100% of GDP.
We're not even close to having a serious debt problem, though that could happen in my lifetime.
If the Fed conducts monetary policy in a a responsible manner, there is no reason for our current level of debt and deficits to lead to a currency crisis. So far they have managed things responsibly, I would argue.
The debt-related scenario that is troublesome involves ever-greater entitlement spending (e.g., social security, medicare, subsidies). Social security and healthcare spending could overwhelm things if these programs are not reformed.
A social security "fix" is difficult only in a political sense. From a practical standpoint, it would be simple to fix: just raise the retirement age and change the indexing formula. Healthcare could also be "fixed" rather easily if we just let market forces take over.
The future becomes worrisome, in other words, if we fail to tackle entitlement spending. Since solutions are fairly simple, I don't find it difficult to believe they will happen. Thus I am not worried about a debt or a currency crisis, at least for now.
As an aside, I think it would be foolish for the U.S. to pay off its debt. The existence of a liquid market for Treasury debt contributes significantly to the efficiency of financial markets all over the globe. Arguably, the efficiency gains outweigh the burden of a debt that remains in a range of 25-30% of GDP.
Scott: The roughly $3 trillion in Treasuries held by the Fed---that pot is seperate from the $5 billion you mention owned by the federal government. But the Fed is part of federal government too. Comment?
The Fed currently holds $2.35 trillion of Treasury notes and bonds, and $1.73 trillion of MBS. The Fed is not considered to be part of the government, so its holdings of Treasuries are part of the debt outstanding held by the public.
As I've explained a number of times, the Fed, via its QE program, has effectively "transmogrified" $2.5 trillion of Treasury debt into T-bill equivalents (i.e., bank reserves). The Fed hasn't absorbed $2.5 trillion of Treasury debt, it has simply used it as collateral to issue $2.5 trillion of bank reserves, which are in turn held by the financial system.
In a sense, the Fed has effectively shortened the maturity of outstanding Treasury issues by converting notes and bonds into T-bill equivalents.
Correction: as of March 31, 2015, the Fed held $2.46 trillion of Treasury notes and bonds.
Scott: you may wish to look at the New York Fed website and their explanation of portfolio rebalancing on the part of people who sold Treasuries to the Fed.
Who does not regard the Federal Reserve as part of the federal government?
Scott,
Thanks for the data on commercial lending. What other sources of credit creation are important for domestic demand? I realize that private equity has been booming (esp. credit-related PE), and direct corporate issuance has also been strong. I don't know if this covers non-bank lending, but it seems close.
It isn't easy to get comprehensive data on credit creation, so if you have any suggestions, I'm all ears.
Thanks,
Rob
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Robert J. Martorana, CFA
Right Blend Investing, LLC
Rob, re credit creation: Credit creation can come from individuals, businesses, and banks. But when an individual or a business lends money to someone else, that doesn't expand the money supply, it just shifts existing money from one person to another. When banks make loans, however, they do create new money. So I pay a lot of attention to bank lending, and I generally look at C&I Loans and Total Bank Credit. Both are growing at faster rates: C&I Loans are rising at a 12% rate, and Bank Credit (now $11 trillion) is rising at a 8-9% rate, up from 2-3% a year ago.
It's also important to watch the growth of M2 and how it compares to nominal GDP.
Scott,
Thank you.
I am beginning to think that a rebound in bank lending will be a catalyst for a second wind in the U.S. economy. Or bank lending may allow the Fed to "pass the baton" to the private sector.
Thanks again for the response.
Rob
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