Credit, Money and Spending
Economies are simple to understand --- its the aggregate sum of transactions in a given year.
More transactions equates to more spending and a larger economy.
Spenders rely on income or credit to make transactions.
Incomes are easy to measure and anticipate but credit is difficult since it relies on various coincident and perceived factors from banks and borrowers.
Bank perception of its book equity and loss provisioning
Borrower expectation of future asset prices and incomes
Hurdle rates on investment opportunities
Credit creation cycles are what move economies off of trend growth.
Changes in credit is important because it represents new spending and money in the economy - credit lubricates the economic engine.
Only bank lending creates money in an economy via fractional lending - review this for a more detailed overview.
Monitoring credit creation is core to finding flow and systemic potholes in markets.
Banks apathetic to credit creation means less transactions and less money in the economy.
Money is created from bank lending --- let's see where we are today.
After robust money creation in 2020/21 --- YTD M2 growth has stalled.
This tells me credit intermediation has been weak (espeically inflation adjusted) which directly influences transactions.
Is it early? Yes.
Can M2 rebound as it has seasonally in prior years? Yes.
But it will be harder to see the same sort of M2 growth given where leading edge nominal rates / business conditions are currently.
On a YoY basis - growth has already trended below the 10yr average.
Lower M2 growth would be associated with transactions, money and inflation.
Bill Ackman had recent tweet storm where we suggested M2 will continue to grow despite QT and higher rates being prevalent.
So far that has not been correct year-to-date with below current run-rate interest rates and at much higher asset prices.
But this assumption lacks insight into the types of loans banks have and continue to make.
Remember if you can anticipate rate of change in bank lending you can anticipate transactions/spending and M2.
Here are some observations:
Real estate touches 40% of loan stock
C&I / other loans are ~40% of loan stock
Consumer loans (credit card / auto) are only 14% of loan stock
Homebuilders / REITs companies have gotten crushed as higher mortgage rates pressure affordability and construction - it's highly likely we see a large drop off in real estate credit creation.
Homebuilders vs New Starts
It's clear that sales / new starts will collapse from 2021 levels as inventories normalize.
Given how tight the inventory picture is today --- this will happen over quarters not months/weeks.
Additionally - when yield curves invert the market sends a signal to banks to withdraw from lending and hold cash instead.
The business environment today is perceived as complex and uncertain - that makes extending credit is a risky business.
2s10s Yield Cruve
The yield curve forces a bank to answer the following proposition:
Assume 2yr rate is 3.10%
Assume 10yr rate is 2.70%
Do I make a 10yr loan at 3.80% (2.70% + 1.00% credit premium) where I have to reserve 0.10% for a net 3.10% return
Or do I just hold 'riskless' cash and make 3.10%
Inverted yield curves don't destroy lending but impact the rate of change.
If anything banks will have to push higher credit premiums which clearly impact borrowing demand and thus credit creation.
Inverted yield curves make banks wary of the business environment as the market is speaking loudly about the present and future economic conditions.
It makes sense for banks to be risk averse in this enviornment given unfunded loan comittments.
There is a thin discussion on Wall Street of just how large the uncommited lines of credit are at banks
There is a lemon problem where bank loans increase via revolver draws as bad performing companies draw capital.
This type of credit creation is not organic and has systemic read through given bank leverage.
In 2008-09 we saw a rapid draw down in unused comittments across all channels as consumers / corporates drew on cash.
Right now there is $9.5trn of committed lines of credit across US banks --- this represents 40% of bank assets
Credit is the focal point of money creation in any economy.
M2 is a mirror image of changes in credit conditions.
Year-to-date M2 has underperformed versus prior pre-covid years.
Every indicator we look at (stock mkt / economic data / yield curve) suggest lending will get worse.
Less lending means less transactions and less money — this is highly disinflationary.
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Great work sir!
What do you think about the theories pushed forward by Jeffrey Snider and Steven van Metre. They are both structurally disinflationist. However, it seems that in the short term, mainly due to energy, inflation is the way to go.