Juggling Dynamite

As we discussed in our July client letter “Tapped Out”, and here in Slowing Growth is Natural Product of Debt Hangover, a weakening credit impulse globally continues to bode poorly for economic momentum for the foreseeable future.

As shown below since 2016, the change in the flow of credit (commercial loans taken) has stalled over the last year notwithstanding trillions in cash injected into the lending system through central bank bond-buying.  Quantitative easing can flood banks with liquid reserves but it cannot make the private sector use it.

When corporations are debt-heavy and lacking in compelling domestic investment opportunities they have little incentive to seek new bank loans.

For their part, banks are in the business of only making loans that have a high probability of being repaid in full with interest.

As Richard C. Koo,  explains in The Other Half of Macroeconomics (2018):

“Once the bubble bursts and households and businesses are left facing debt overhangs, no amount of monetary easing by the central bank will persuade them to resume borrowing until their balance sheets are fully repaired. Some are badly traumatized by the years of painful deleveraging experience and may never borrow again—even after they restore their balance sheets…The fact that a number of central bank governors continue to insist that further monetary easing will enable them to meet their inflation targets suggests that they still do not understand why their models and forecasts have failed.”

As many are vaccinated and a significant portion are determined not to be, the virus is taking every opportunity to morph.  Dreams of COVID-19’s mayhem ending any time soon look unrealistic, see Delta Seen to Push Herd Immunity Threshold above 90%.

The spread of the delta coronavirus variant has pushed the threshold for herd immunity to well over 80% and potentially approaching 90%, according to an Infectious Diseases Society of America briefing on Tuesday.

That represents a “much higher” bar than previous estimates of 60% to 70%, because delta is twice as transmissible, said Ricardo Franco, an assistant professor at the University of Alabama at Birmingham.

“It is becoming clear that this is a very dangerous, way more dangerous virus than the original one,” Franco said.

In 1933, Irving Fisher, one of America’s most influential economists, noted that economic growth declines in highly indebted economies because debt increases current spending in exchange for a decline in future expenditures unless the debt is self-financing, i.e., helping to generate an income stream that repays the principal and interest.  Thus, debt borrowed for personal consumption, including housing, reduces savings for investment and future growth. The accelerated consumer spending over the past year was always to be short-lived as households now spend years paying down the additional debt.  For a good update on the latest data, see Disappointing Growth Shows Stimulus Diminishing Returns.

‘Credit impulse’ is a 2008 term coined by Michael Biggs, then an economist at Deutsche Bank, when he noted that the most critical variable in terms of forecasting GDP growth is not the change in the availability of credit but rather the change in the flow of credit (loans taken) as a percentage of GDP.  As shown on the left in blue, the credit impulse peaked globally last June and has plunged since. Inflation expectations (in orange) are set to follow.

No one should be surprised that economic growth is quickly cooling and treasury yields slumping once more.  Irrationally inflated equity and corporate debt prices are next to get the memo.