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[CARLHAYDEN]

US credit shrinks at Great Depression rate prompting fears of double-dip recession
Both bank credit and the M3 money supply in the United States have been contracting at rates comparable to the onset of the Great Depression since early summer, raising fears of a double-dip recession in 2010 and a slide into debt-deflation.
 
By Ambrose Evans-Pritchard, International Business Editor
Published: 11:59PM BST 14 Sep 2009


Professor Tim Congdon from International Monetary Research said US bank loans have fallen at an annual pace of almost 14pc in the three months to August (from $7,147bn to $6,886bn).

"There has been nothing like this in the USA since the 1930s," he said. "The rapid destruction of money balances is madness."

Similar concerns have been raised by David Rosenberg, chief strategist at Gluskin Sheff, who said that over the four weeks up to August 24, bank credit shrank at an "epic" 9pc annual pace, the M2 money supply shrank at 12.2pc and M1 shrank at 6.5pc.

"For the first time in the post-WW2 [Second World War] era, we have deflation in credit, wages and rents and, from our lens, this is a toxic brew," he said.

It is unclear why the US Federal Reserve has allowed this to occur.

Chairman Ben Bernanke is an expert on the "credit channel" causes of depressions and has given eloquent speeches about the risks of deflation in the past.

He is not a monetary economist, however, and there are indications that the Fed has had to pare back its policy of quantitative easing (buying bonds) in order to reassure China and other foreign creditors that the US is not trying to devalue its debts by stealth monetisation.

Mr Congdon said a key reason for credit contraction is pressure on banks to raise their capital ratios. While this is well-advised in boom times, it makes matters worse in a downturn.

"The current drive to make banks less leveraged and safer is having the perverse consequence of destroying money balances," he said. "It strengthens the deflationary forces in the world economy. That increases the risks of a double-dip recession in 2010."

Referring to the debt-purge policy of US Treasury Secretary Andrew Mellon in the early 1930s, he added: "The pressure on banks to de-risk and to de-leverage is the modern version of liquidationism: it is potentially just as dangerous."

US banks are cutting lending by around 1pc a month. A similar process is occurring in the eurozone, where private sector credit has been contracting and M3 has been flat for almost a year.

Mr Congdon said IMF chief Dominique Strauss-Kahn is wrong to argue that the history of financial crises shows that "speedy recovery" depends on "cleansing banks' balance sheets of toxic assets". "The message of all financial crises is that policy-makers' priority must be to stop the quantity of money falling and, ideally, to get it rising again," he said.

He predicted that the Federal Reserve and other central banks will be forced to engage in outright monetisation of government debt by next year, whatever they say now.

[Swing low, sweet chariot. Comin' for to carry me home.]

now, this is an interesting article, Carl.

I have been concerned by the stress test's shift towards focusing on the Tier 1 capital ratios of banks.  Basically, I think the banks are now overcapitalized.

But, I am not at all sure how this has restrained credit

[CARLHAYDEN]

now, this is an interesting article, Carl.

I have been concerned by the stress test's shift towards focusing on the Tier 1 capital ratios of banks.  Basically, I think the banks are now overcapitalized.

But, I am not at all sure how this has restrained credit

Without getting into all the factors, the central problem is emotional irrationality.  Essentially its the flip side of the emotional irrationality that has caused chumps to bid up prices on the stock market the past couple of months.

Now, there are real problems with commercial real estate loans at many banks, which have paralyzed many bankers who aren't "to big to fail," and therefor do not have a blank check from the fed.

[Swing low, sweet chariot. Comin' for to carry me home.]

now, this is an interesting article, Carl.

I have been concerned by the stress test's shift towards focusing on the Tier 1 capital ratios of banks.  Basically, I think the banks are now overcapitalized.

But, I am not at all sure how this has restrained credit

Without getting into all the factors, the central problem is emotional irrationality.  Essentially its the flip side of the emotional irrationality that has caused chumps to bid up prices on the stock market the past couple of months.

Now, there are real problems with commercial real estate loans at many banks, which have paralyzed many bankers who aren't "to big to fail," and therefor do not have a blank check from the fed.

well, that gets to a central question...Because the money supply by itself means very little if not taken together with the velocity of money (doesn’t matter if the money supply increase by 1000% if the velocity of money is zero – which would mean banks are simply hoarding the extra supply).  Therefore, it is ok if the Fed to be withdrawing money from the system if the velocity of money is increasing enough to make up the difference.  That’s the challenge the Fed faces.

So, we need the other piece of info – the velocity of money – to complete the picture of where the economy is headed.  If the velocity of money is not increasing and the Fed is withdrawing funds, then that’s a HUGE problem and we would expect to see problems with economic growth in about six months (and that would explain the recent rally in the bond market.  YIKES!)

The ECRI Long Leading Index (LLI) is a great measure of this supply/velocity mix, but unfortunately it is NOT released to the public like the Weekly Leading Index (WLI) is…though, from time to time, you can glean references about the direction of the LLI by listening to ECRI interviews.