The Credit Machine

Bank credit is a key issue. When policy makers consider it necessary to stimulate the economy, and they decide to generate inflation, what they are actually aiming at is injecting liquidity into the market.

One of the main ways to inject liquidity is by lowering interest rates. What makes such rates to fall is that the price of money becomes cheaper, credit becomes more accessible and by this way individuals have a greater stimulus to take credits and consume, while businesses have a greater incentive to take credits and invest.

Due to the crisis lived in these last years, credit, consumption and also prices have contracted. As a result, Bernanke decided to lower the economy reference rate to a minimum, with the intention of injecting liquidity into the market and thus stimulate the economy: reactivate consumption, investment and prices. The means to achieve this was credit! ... But something is happening.

Bank credit in the United States is in constant crunch. This scenario involves commercial and industrial loans, as well as real estate and individual consumption loans.

We can say that it is ‘normal’ for credit policy to contract in times of crisis because individuals and business paralyse for a moment their usual cycle of taking credit.

Today, when we find ourselves on the road to recovery, credit policy is still paralysed not only due to lack of trust, but also because the average level of credit quality has been severely damaged.

What the economists take into account when analyzing the expansion (or contraction) of the monetary supply is the monetary multiplier. This same multiplier has experienced over a 50 per cent contraction during the 2007-2009 crisis. We can read between these lines that what has decreased is actually the capacity of the financial system to generate money and credit. The money multiplier was therefore functioning like a deflationary engine. Today that engine remains low, maintaining extant deflationary pressures. This is a variable that policy makers are paying attention to.

Around 60 per cent of the entire American credit market comes from debt instruments (known as direct credit), while the remaining 40 per cent comes from loans (known as indirect credit). Nowadays, most companies’ first choice is direct credit, avoiding bank loans. As the financial multiplier remains low, this tendency of finding financing through debt instruments is most likely to increase, resulting in the reduction of bank loans. As a result, we run into an equity market increasingly attached to the debt market.

The phenomenon we are experiencing is highly interesting. Although liquidity is actually growing, short-term availability of credit is still contracting.

Banks are just not lending money. They seem to have abandoned that business for the moment; and to be honest it is understandable. The global context has created a terrific scenario for them: borrowing money at almost 0 per cent rates and buying Treasury bonds at 3.5 per cent.

Banks have absorbed most of the monetary stimulus. Commercial Bank cash assets went from 340 billion in September 2008 to 1,2 trillion dollars at present. Around that same time the Federal Reserve balance sheet went from 900 billion to 2,2 trillion dollars.

A very recent and highly important indicator is credit card loans, which have plummeted by 17 billions during December 2009, Christmas’ month with the highest stationary consumption levels.

Why is it that the extraordinary monetary stimulus from the Federal Reserve has not reached bank loans yet? The answer is that banks are devoting their time to recovering their balances, and carrying out this extraordinary spread rate business mentioned above.

In the meantime, those American states, which are in crisis, spend all their time and funding in recovering their balances and emerging from stressful situations.

The good news is that the market has claimed that the worst is over. It is possible that, through this path of pricing and valuation recovery, banks may be gaining solidity to get back to business, so that credit may begin to expand.

Nowadays, one of the main goals of the Federal Reserve is to create inflation. In order to accomplish this, they have to get banks to inject liquidity into the economy. One way to do this is by the expansion of credits. Hopefully, that is where we are heading for.

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