Business credit slowdown is probably not itself an issue

People continue to fret about the slowdown of bank C&I loan growth.  I have a few quick thoughts on this plus an update of a set of charts I have been following:

  • Measured credit growth does not lead spending, although credit availability or abrupt shifts of credit demand may.  Looking at inherently-trailing credit aggregates will not usually help forecast spending growth, particularly if taken directionally.  When credit growth has boomed, it is often time to get worried. And recoveries often come in the wake of big declines of borrowing. Relative to the size of the nominal economy, the flow of credit to the household and business sectors was strongest ever just before the recent depression.
  • The logic behind this is a corollary of Jason Benderly’s  automatic deleveraging / re-leveraging hypothesis.  Benderly views credit growth as largely a function of spending growth, with the relationship itself varying through the cycle, depending on the position of credit-sensitive spending relative to its own history.  Another way to express this same thought, the corollary, is that some points of the economic cycle require more support from credit expansion than others.  You don’t want to be in a position where normal spending growth requires excessive credit growth.
  • The bear case, now, from a credit perspective is that domestic private sector is no longer running a large financial surplus, which had inclined the expansion not to be particularly sensitive to credit.  The domestic private sector’s surplus or deficit can be imputed from the public and foreign sector financial balances, as in the chart at top left, or measured directly (and noisily) as the sum of the sub-sectors that are most interesting: household and nonfinancial corporate, as in the chart top right.
  • Earlier this cycle, there was a large surplus there, which was bullish, and put the lie to the notion that 2% growth would be a “stall speed.” (The economy grew at this “stall speed for 8 years in a row, which to me had some humor value.)  Economies are prone to stalling when a prior period of rapid demand growth results in destabilizing imbalances. And recently, imbalances have been rare,  including in credit, with the energy patch being perhaps one exception.  The issue now is that the balances have begun to deteriorate again, although not yet alarmingly, at least on this aggregate level.  In other words, things are not quite so safe as they were, but the folks worrying about recently-slower credit growth probably have it backwards.
  • I am not worried that business credit growth is too weak, because – as mentioned – there is little reason to believe it leads, unless taken contrarily at extremes. But – and this will require more digging – I suspect there is something going on with the mix shift, as the flow of overall credit to the business sector has slowed much less than bank lending (C&I)..Maybe the public capital markets have re-opened for business in energy and that is part of it. I have seen that discussed elsewhere. If that were the case, then it would be evidence that credit supply has eased, which would be bullish growth, although probably already in the data.
  • Given that the credit story itself, including balances, is not really saying anything interesting, I think the real story is best looked at through a different prism. There was a stock adjustment in the oil patch and in inventories, both of which heavily implicate credit. I would watch that stock adjustment, which I would judge complete, rather than its noisy reflection in credit.

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In the middle row of charts, I show the household and nonfinancial corporate sectors on a scale with similar ranges, in each case 14% of GDP.  I do this to facilitate an easy comparison of the magnitude of the swings involved there. In recent years, the action has been in the household sector.