Saturday, February 6, 2010

Loan Demand Falls

A report in the Financial Times (FT) this past week tells us that a Federal Reserve’s survey of financial activity stated the following: “banks reported that loan demand from both businesses and households weakened further…”

Let’s see if this is accurate based on the latest data available. This is a graph that demonstrates the YOY change in weekly commercial and industrial loans at large banks.

For a larger graph see here.

As you can see, the fall since its peak has been precipitous. The trend has stabilized recently but growth is still exceedingly negative. This implies that loan demand from businesses continues to be weak, as the survey suggested.

Looking at the household sector, we simply have to look at the level of financial debt exposure and burden. With regards to total consumer credit, it decreased at a rate of 4.7% during the fourth Quarter of 2009. In fact, the quarterly trend was down for the entire 2009 period. See here.

Moreover, to estimate the financial burden we look at the household debt service ratio, which considers how much of what it is earned gets spend to cover debt payments. See here. There are no data for the fourth quarter 2009, but if the trend is any indicator, it should be down. This, along with the previous household statistic, gives us confidence that the second part of the survey—namely weak consumer credit—is probably accurate.

In addition, the FT article mentions that the economists’ consensus is that a “lackluster loan demand would hamper the economic recover.” Indeed, our fractional reserve banking system, whereby a portion of all bank deposits are held on a vault and the rest lent out, ensures that money is multiplied many times over. Assuming a reserve requirement—that is, the percentage required to be held by the bank to meet expected customer demand for cash—is 10%, for every $100 dollars that is injected into the banking system an additional $900 dollar gets created out of thin air. This extra digital “liquidity” can cause a false boom, which can be mistaken as a genuine economic recovery.

It is obvious banks are not lending. The trouble is that currently they are storing most of the excess digital “liquidity” at the FED. See here. Should this money ever make it into the economy, mass price inflation is inevitable. Policymakers are clearly stuck between a rock and a hard place. The best of both worlds is one where we find ourselves now. Push too tight, we get an economic depression. Push too loose, we get mass (and potentially hyper) inflation, ultimately killing the dollar and impoverishing everyone. Maintain the status quo, we get a stagnant economy.

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