Monday, January 23, 2012

Bank lending still accelerating

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risk-aversion that dominated the private sector's financial decisions since the financial panic of late 2008 has now been replaced by a renewed willingness to take on risk.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.


Benjamin Cole said...

"Consequently, I continue to believe that the economy will continue to grow, albeit at a sub-par pace"--Scott Grannis.

This is the sad and key take-away, from yet another excellent presentation by Scott Grannis.

Why are we growing so slowly? And why are inflation expectations, at least as measured by the Cleveland Fed, falling?

When unit labor costs are falling, when inflationary expectations hit historic lows, when the CPI is flat to to down month after month---is this the time for dithering on the part of the Fed? When we are 13 percent below trend GDP?

The QE program needed a lot more oomph, and the fed needed to telegraph loud and clear it was targeting growth---not targeting 2 percent inflation when half the nation's property is underwater.

You know, Bernanke in the late 1990s went to Japan on an advisory mission--what we didn't know that it was the Bank of Japan advising Bernanke, not the other way around.

JGW said...

How do you reconcile m2 velocity and money demand with this analysis?

Scott Grannis said...

JGW: good question. As I mention in the post, it seems obvious that most or all of the Fed's "accommodative" monetary policy actions have been met by a huge increase in the world's demand for dollars. How do I know this? Because there has not been a surge in inflation, and that in turn means that the increased supply of money has not exceeded the world's demand for money by a significant amount. In short, M2 is up huge because the demand to hold M2 money has surged. Increased money demand is the flip side of money velocity (money demand = M2/GDP, and money velocity = GDP/M2), so my observation is perfectly consistent with the rise in money demand and the decline in M2 velocity that we observe.

See this post for more details:

brodero said...

It is very hard for me to picture
a scenario where the US posts consistent y-o-y
nominal GDP growth of 5%..

Benjamin Cole said...


If a central bank cannot increase nominal GDP, then everything we know about macroeconomics is bunkum. Usually, we hear the hysteria that any Fed stimulus is but one step away to the Weimar Republic.

BTW, Fed researchers say that an expansion of the US monetary base does not lead to global commodities inflation, another common bugaboo .


Board of Governors of the Federal Reserve System
International Finance Discussion Papers
Number 979, August, 2009

Did Easy Money in the Dollar Bloc Fuel the Global Commodity Boom?

Christopher Erceg, Luca Guerrieri, Steven B. Kamin**


Among the various explanations for the runup in oil and commodity prices of recent years, one story focuses on the role of monetary policy in the United States and in developing economies. In this view, developing countries that peg their currencies to the dollar were forced to ease their monetary policies after reductions in U.S. interest rates, leading to economic overheating, excess demand for oil and other commodities, and rising commodity prices. We assess that hypothesis using the Federal Reserve staff’s forward-looking, multicountry, dynamic general equilibrium model, SIGMA. We find that even if many developing country currencies were pegged to the dollar, an easing of U.S. monetary policy would lead to only a transitory runup in oil prices. Instead, strong economic growth in many developing economies, as well as shortfalls in oil production, better explain the sustained runup in oil prices observed until earlier this year. Moreover, a closer look at exchange rates and interest rates around the world suggests that the monetary policies of many developing economies, including in East Asia, are less closely influenced by U.S. policies than is frequently assumed.


Another hoary, encrusted monetary shibboleth turns out to made of wet paper tissue paper. I hope Scott Grannis relaxes about US monetary policy causing global commodities inflation.

There is no reason for the Fed to have cranked down on the money supply in 2007, triggering the worst US recession since the Great Depression. And there is no reason now to keep "fighting inflation" when the CPI is dead in the water and GDP is 13 percent below trend line.

Bernanke is badly out of step with modern-day realities. This ain't the 1970s, as my now-bald head can tell you.

JGW said...


A quick follow up to my earlier question (and I hope this isn't too naive a question), but when you forecast near-term nominal gdp growth, does that imply a corresponding rise in aggregate demand (a lack of which Bill Gross has been harping on for awhile now) and does it by extension also imply the demand for money must, at least in a relative sense, slow?

Scott Grannis said...

I think the pickup in nominal GDP will be driven by the public's declining demand for money, which will cause people to try to spend some of the M2 cash that they have accumulated (i.e., rising M2 velocity). This will probably show up as an increase in aggregate demand, but at least part of that will be due to inflation.

JGW said...

Scott, thanks. How does real wage growth play into that scenario in your view? In other words, can your thesis play out without a corresponding rise in real wages? I guess in my head I'm trying to nail down certain factors or economic measures which absolutely MUST turn for the nominal gdp train to really pick up self sustaining steam.