Bankers Betting on Recovery?
The 'it's all good' meme got another boost at Reuters, which has published an article entitled “Looking up! Top bankers see rosier view of economy”. The biggest too-big-to-fail whale of them all chimed in as follows:
Loans to businesses have risen to a record high and bank executives say they are increasingly optimistic about the U.S. economy.
Increasing demand for bank loans often is a prelude to higher economic growth. With the U.S. government budget crisis fixed for now and Europe showing signs of economic recovery, companies feel more comfortable borrowing to invest in machinery, factories, and buildings.
JPMorgan Chase Chief Executive Jamie Dimon, who has long described himself as "cautiously optimistic" about the economy, recently dropped the modifier "cautiously," he said on a conference call with investors last week.
"We're using the word optimistic because we are actually optimistic," he added. "The sun and moon and stars are lined up for a very successful year" in the U.S., he said the next day at a conference in San Francisco.
The sun, the moon and the stars are aligned! What could possibly go wrong? The article goes on to list a plethora of lesser bankers expressing similar feelings. However, things are not always what they seem.
So allegedly bankers think everything is looking up and their opinion is even supported by the proper alignment of various celestial bodies – and presumably, a favorable reading from the Tarot deck (we end the year on a magical high note!). If that's the case, one might be wondering about certain statistics. For instance, how come that total bank credit growth is exhibiting the lowest year-on-year rate of change of at least the past four decades, with the sole exception of the period immediately following the 2008-2009 financial system crash?
So the banks are not lending, but everything is going swimmingly? Something doesn't compute here. We should also point out that it is true that corporations are more indebted than ever before, but that is a reason for grave concern rather than a reason to be optimistic (and it partly reflects that fact that many big corporations drew down promised credit lines after the crash because they feared they might be cut off if they didn't act fast).
In the German language the statements of the bankers interviewed in the article would be referred to as 'gesundbeten' – which means literally 'to pray for the health of something'. However, the term conveys much more than that, namely that 1. it won't work, because the something that is being prayed for has actually long transmogrified into an irretrievable state close to or akin to death, and 2. that the act of 'gesundbeten' is a senseless act of motivational self-deception, precisely because there is obviously no point to it.
Anyway, it seems to us this is a case where it might be better to watch what they are doing instead of listening to what they are saying.
Hoping for a Capital Expenditure Boom?
Zerohedge recently reported on an analysis by SocGen that should be required reading for all economic faith healers.
A summary of the important points: 1. corporate cash piles may be high, but debt has been piled even higher – the result: unprecedented leverage (i.e., a record high in net corporate debt).
2. operational profit growth has completely stalled out over the past year (listed corporations are boosting EPS with share buybacks – which are partly funded with the growing debt pile mentioned in point 1), while sales growth has been in decline since 2010.
3. while growth in capital expenditures has been in a sharply declining trend for more than two years and looks like it may dip into negative territory soon, it has recently reached almost a historic high relative to sales and has exceeded free cash flow growth for three years running.
None of this is particularly surprising if one is convinced – as we are – that monetary pumping and the artificially low interest rates it produces falsifies economic calculation and spurs malinvestment. There may be little 'inflation' reflected in aggregate prices indexes such as CPI or PPI, but there can be no doubt that the valuation of capital goods changes relative to that of consumer goods when interest rates decline. This distortion in relative prices is the most harmful effect on the economy at large created by inflationary monetary policy. For instance, the depreciation of capital goods is still based on the prices that obtained prior to the distortion in prices, which makes profits appear larger than they really are (in other words, accounting profits do not reflect the price revolution and are therefore illusory). When the time comes to maintain worn out capital it turns out it costs more than expected and it would have been more accurate to depreciate it at different rates. By that time, the illusory profits may already have been distributed, i.e., capital will actually have been consumed.
In addition, contrary to a decline in interest rates based on a genuine increase in savings, the artificially lowered rate transmits the distorted information that savings are larger than they really are. Longer and theoretically more profitable production processes appear feasible, and investment activities are set into motion that later turn out to have been misguided because consumer time preferences have actually not changed. As Mises put it in a famous conceptual analogy:
“The whole entrepreneurial class is, as it were, in the position of a master-builder whose task it is to erect a building out of a limited supply of building materials. If this man overestimates the quantity of the available supply, he drafts a plan for the execution of which the means at his disposal are not sufficient. He oversizes the groundwork and the foundations and only discovers later in the progress of the construction that he lacks the material needed for the completion of the structure.”
The 'later discovery' expresses itself as an economic bust. As our regular readers know, we like to keep an eye on changes in the capital structure via a ratio of production indexes, as imprecise as they probably are. Note here that the long term trend partly reflects the increase in global trade and the growing global division of labor, but the noticeable medium term volatility in the ratio suggest that the approach is sound:
While we cannot state with certainty when and where exactly the recent trend will turn, the current height of the ratio suggests that a negative inflection point is probably fairly close (or may have occurred already). If so, then the record high in net corporate indebtedness is likely to end up creating great difficulties – not only for the debtors, but also their recently officially optimistic creditors.
Charts by: St. Louis Federal Reserve Research
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