A message to the money-worriers

Peter Warburton - 05 April 2018

An unremarkable slowing in various measures of US money supply growth, coupled with concerns that the shrinkage of the Fed’s vast balance sheet and the impending termination of Eurozone QE will aggravate the monetary deceleration, has prompted various economists and commentators to raise a red flag. Its strongest adherents advise (variously) that monetary deceleration threatens the global economic expansion, ushers in a deflationary bust, signals generalised financial asset price collapse and heralds a dramatic appreciation of the US Dollar. Not bad for a day’s work!

For those of us who remember the feverish debates about the significance of different measures of the money supply in the 1970s, there is an element of nostalgia in the revival of these ancient concerns. However, nostalgia should not cloud our thinking about credit and money matters. A profound re-ordering of the financial world has taken place over the past 30 years which has robbed the monetary aggregates of their usefulness.

Fundamentally, credit markets, credit variables and credit signals rule the roost. Money-worriers are marooned on the wrong side of the balance sheet, and not even, necessarily, the right balance sheet. It’s the repo, not the depo, that matters in our brave new world. The creation of mountains of central bank collateral alongside drastically higher liquidity requirements in the global banking system is an important structural change. However, bank credit no longer occupies the central position in the financial system and the stock of bank deposits is recursive to other asset allocation decisions.

Privately-owned financial institutions and non-financial corporations borrow at will (see figures 1 and 2, sourced from the latest BIS Quarterly Review) on their own account in the wholesale money and capital markets. They are constrained by the secondary market value of their quoted debt instruments, by their credit ratings and by the external structure of interest rates. But they are largely independent of commercial banks and have a tenuous relationship with monetary policy.

In today’s medicated (permanently sedated) financial markets, the incidence of loan and bond default – even from speculative grade issuers – is extremely low. Almost all entities can obtain financing and many have over-financed such that they have no need to return to the markets for years to come. Until there is a crack in the credit edifice, the capacity of the global private sector to finance faster nominal growth in the global economy and sustain elevated equity market valuations is unchallenged. The money-ness of non-bank credit is currently very high and the incentive to own bank deposits is correspondingly low. Worry about a long-overdue turn in the credit cycle, not about the slowing of the monetary aggregates.

Figure 1

Figure 2

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