All across the banking world – from commercial loans to leases and real estate – credit is collapsing. Ambrose Evans-Pritchard writing for British newspaper The Telegraph:
Credit strategists are increasingly disturbed by a sudden and rare contraction of U.S. bank lending, fearing a synchronized slowdown in the U.S. and China this year that could catch euphoric markets badly off guard. Data from the U.S. Federal Reserve shows that the $2 trillion market for commercial and industrial loans peaked in December.
The sector has weakened abruptly as lenders tighten credit, especially for non-residential property. Over the last three months it has dropped at a rate of 5.4% on annual basis, a pace of decline not seen since December 2008.
C & I loans, y/y growth. Readers may recall that we recently showed this chart in “Libor Pains”, in which we discussed corporate debt. Actually, y/y commercial & industrial loan growth peaked in early 2015 already, not just “last December”… but lettuce not quibble (Pritchard likely meant to refer to total commercial bank credit, the growth rate of which reached an interim peak in late 2016 – shown further below). The point remains that credit growth is falling fast – click to enlarge.
If new loans aren’t made, the supply of credit money will contract. That’s the “doomsday device” embedded in our credit money system: It is subject to sharp and disastrous drawdowns in the money supply.
When loans are paid or written off, the outstanding credit (money) ceases to exist. This reduces the money supply and triggers corrections, recessions, or market crashes.
Real money doesn’t disappear in a credit contraction. But our fake “credit money” does. This makes the entire system vulnerable to the credit cycle. Credit increases. Then it decreases. And as credit money vanishes, the recession deepens… causing the credit market to tighten further and causing more money to disappear.
That’s why a credit contraction is so dangerous in today’s world. With more than $200 trillion in outstanding debt, even a soft contraction could lead to a worldwide depression.
That’s why the Fed will not risk jacking up interest rates too far, too fast. Instead, it will follow inflation, and then do an immediate about-face when the credit cycle turns around.
A dear reader helpfully suggested that we put together a “Doom Index” – with indicators of an approaching bust. Our research team in Delray Beach, Florida, is working on it.
In the meantime, as to the doom indicator highlighted above, namely the flow of credit: This is an economy that depends on bank lending. If it slows, so does the economy. And credit growth is falling at a rate not seen since 2008.
Bank credit growth at all commercial banks has begun to decline sharply from an interim peak in September 2016. It should be noted that the current decline in the growth rate is taking place against a very different backdrop compared to the last one between late 2012 and late 2013 – which occurred concurrently with QE3 debt monetization running at full blast ($80 billion in asset purchases per month). Consequently money supply growth remained brisk on the latter occasion, while this time, it is slowing down hard, hand in hand with the decrease in bank credit expansion – click to enlarge.
Another indicator that will surely be a part of our Doom Index is the level of margin debt. When an investor buys stocks on margin, he borrows the bulk of the purchase price from his broker.
Because he only puts up a portion of the total amount – the margin – he stands to gain more if the market goes up. But if the market goes down, he gets a “margin call.”
He has to put up his shares as collateral for his loan. His broker can now sell these shares (without notifying him) if he doesn’t meet his margin requirements.
“Markets make opinions,” say the old-timers. When stocks are near an all-time high, investors imagine they will only go higher. But when they go down, all of a sudden they ask themselves why they ever bought them.
Squeezed and panicked, the margin buyer is forced to sell. And the higher the margin debt, the greater the number of shares that must be liquidated, sending the whole market down even further. Today’s level of margin debt has never been seen before.
Margin debt has reached a new record high of $529 billion, while net cash available to investors has plummeted to a record net negative $ -224 billion (i.e., there is actually “no cash available”). This is an insane amount of leverage, to put it bluntly. Eventually it will result in a cascade of forced selling, as it did on the previous occasions visible on this chart – click to enlarge.
The Trump Factor
Margin debt figures are “hard data.” They show, in exact dollar terms, that investors are optimistic. Consumers are optimistic, too. Consumer sentiment figures are “soft data.” They rely on mushy survey results. But the two line up nicely – hard and soft – at 17-year highs.
On the surface, both types of data are remarkable. Why would investors borrow money to buy shares when stock prices are already as high or higher than ever in history?
The way to make money is to buy low and sell high. These investors seem to have it backward. They are eager to buy shares – on credit – at the highest prices ever seen. Consumers should be gloomy, too. In fact, the hard data says they are gloomy. They’re not spending.
As John Hussman correctly pointed out recently: “Multi-year highs in consumer confidence are less a sign of forthcoming consumer spending as a sign of forthcoming investor losses.” Note also the developing long-term triple divergence between peaks in stock prices and peaks in the consumer confidence index. In our experience such divergences – which usually are hardly noticed by anyone – often prove very meaningful in hindsight – click to enlarge.
Retail stores are closing at a faster rate than any time since the 2008 crisis. Auto sales are slumping (there’s a study from JPMorgan Chase that predicts used car prices will fall by half over the next five years.)
And mortgage payments are now the least affordable, compared to wages, than they have ever been. How to account for such bullishness on the part of consumers and investors? Donald J. Trump.
In spite of being considered a “controversial figure”, the Donald has managed to infect investors, businessmen and consumers alike with his “can do” MAGA optimism. That is not a bad thing in our opinion – but contrary to certain of his predecessors he is sometimes compared to, he has come to power at a time when interest rates have just begun to rise from all time lows, stocks and other assets are at the most egregiously overvalued levels ever and the money supply has grown by more than 140% in a mere eight years. He cannot possibly keep the necessary bust at bay, regardless of which of his economic policies he actually manages to implement. In fact, the earlier the bust happens, the better it will likely be for him.
No Reagan Redux
Consumer confidence and the stock market shot up after Election Day. Apparently, consumers and investors thought that Mr. Trump would make things better. But how, exactly, this was to happen has never been made clear – at least not to us.
The “Trump Trade” depends on so many unlikely and remote things. Even if Team Trump could make fundamental improvements in regulations, taxation, or the deficit, the results wouldn’t show up for years. It takes years for sensible infrastructure spending to get underway, for example.
After President Reagan took office, stocks fell, not rose. They kept going down for the next 17 months, wiping out 20% of the entire market value. And that was when the Deep State insiders were just getting started.
Thirty-seven years ago, a determined majority, with a solid grip on Congress and a clear idea of what it was doing, could still control the government. Now it’s practically impossible.
And back then, the reformers had the wind at their backs. You could buy the Dow for one ounce of gold (now you need 16 ounces). The nation had less than $1 trillion in debt (now it has $20 trillion). The 10-year Treasury yield was over 15% (now it’s under 3%).
In other words, investors and consumers had every reason for optimism in the Reagan Era. Things were almost sure to get better. Now, they had better be careful. The winds have shifted. Things are almost sure to get worse.
Charts by: St. Louis Federal Reserve Research, SentimenTrader, John Hussman
Chart and image captions by PT [ed note: we have slightly edited the original text]
The above article originally appeared as “Doom Index Says Beware!” and “The Credit Money System’s “Doomsday Device”” at the Diary of a Rogue Economist, written for Bonner & Partners. Bill Bonner founded Agora, Inc in 1978. It has since grown into one of the largest independent newsletter publishing companies in the world. He has also written three New York Times bestselling books, Financial Reckoning Day, Empire of Debt and Mobs, Messiahs and Markets.
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