“From a technical perspective, the recession is very likely over at this point, but it’s still going to feel like a very weak economy for some time.” Ben Bernanke, September 2009
Â Green shoots. What green shoots? Even Chairman Bernanke admits that signs that the North American economy has resumed growing are modest at best. And in the US, the bleak jobs picture shows that job hunters now outnumber openings six to one, the worst ratio since the government began tracking open job postings.
Â A key feature of the Postwar North American economy has been the intimate relationship between credit growth and economic activity. It takes money to finance economic growth. Indeed, by late 2006 the available statistics showed that approximately six dollars of debt was needed to finance every one dollar of expansion in the US GNP. The lesson is this:Â withoutÂ growth in private sector credit demand,Â sustainableÂ growth in the real economy cannot be maintained.
The reality so far in 2009 is that no one is borrowing and the banks are not lending. The chart above shows that the amount of consumer credit outstanding in the US economyÂ nosedived in 2009, dropping at an annual rate of over 7%. Not only is this a fairly torrid pace of decline, it is the first time this has occurred since the data began being recorded in the late 1940’s. However, this retrenchment is necessary for households to replenish savings and restructure stretched balance sheets
Similarly, US corporate loan growth has stalled and gone into reverse, in part because businesses are working off inventories and are not investing in new capacity, but also because bankers are becoming more tightfisted and discerning as to who they choose to lend their money to. More creditworthy borrowers (representing less than 0.5% of all businesses) have also been tapping the bond markets feverishly to lock in low rates. Quarterly Loan growth in the US was tumbling at an annualized rate of 12%% in the latest reporting period.
US banks are increasingly concerned with mounting loan losses and the implications that these will have for earnings, capital and their future ability to fund new activity. Loan losses are at the highest levels since these series were first compiled and the pace ofÂ deterioration shows no signs of slackening.
In Canada the situation seems much the same. Credit growth has faltered. Bank loans at weekly reporting Chartered Banks were falling at an annualized quaterly rate of around 10% in the late summer, and consumer credit growth has been leveling off. Loan loss provisions at all of the banks are up sharply, reflecting restraint in lending practices and a focus on managing their way out of existing problems.
Â The bottom line is that the North American “recovery” is largely technical. Balance sheets need to be rebuilt, jobs are very scarce, many problems remain, not in the least the “re-entry” issues that the Fed is facing after the massive injections of high powered money and fiscal expansion of the past year, and what appears to be a growing mutiny against the continued use of the US Dollar as the global currency of account. TheÂ decline inÂ credit this year portendsÂ anemic real activity next year.
Â Through all of this the modus operandi of the US authorities has been to attempt a slow, controlled deflation of what is left of the “bad asset balloon”, allowing zombie banks and businesses to continue operating on the one hand, while attempting to re-flate markets such that asset positions that were underwater can be re-priced at higher levels;Â balance sheet problems can be cured, and access to capital markets can be restored for public companies whose shares were only a short time agoÂ trading in the bargain aisles. This effort has been accompanied by an aggressive campaign of moral suasion (”spin” some might call it) aimed a fostering a rosy view ofÂ present policyÂ and of future developments.
Â We see many risks with this approach as we have stated in the past. At this juncture one of the key risks we see is that developments in the US stock market are significantly out of step with developments in the real economy, prospects for corporate profits going forward, and the massive reversal in credit growth (without new credit formation the “recovery” will go nowhere).Â Â We have three observations here:
Â Without a meaningful and strongly-based recovery in the US, the Canadian economy will also face significant and growing headwinds. ThereÂ is no “magical” de-coupling in store. In combination with a resurgent Loonie, this portends continued tough times for domestic manufacturers, exporters, and growers. The Bank of Canada faces a daunting task.
Â We are again approaching an inflexion point where outsized downside risks in the US sharemarket have accumulated and there is a growing likelihood of another painful rout. What the spark will be is unclear, but with so much dry tinder around it does not take much imagination to see this rally ending in flames in the not too distant future. This would put the Fed in a smaller box.
Once the realization that times are going to remain tough sets in, many banks will be forced to deal with their zombie borrowers. If banks are not proactive in dealing with the rot in their portfolios now, they will face a much more complicated and expensive task in the near future.