This post was shared with newsletter subscribers last week (August 25th):
I am about to board a plane back to Singapore… something like 20+ hours in transit.
It’s a long flight – good thing I have a flat-bed and a Kindle!
It’s been a few days since I have been able to put digital pen to paper. I have been traveling across the heartland of the US… with meetings morning, noon and night.
Great fun and very interesting discussions.
If there is one thing about working in tech – it moves fast.
And whilst finding time to write is difficult – late each evening I keep abreast of economic, financial and political developments.
And I am stating the obvious when I say the latter dominates the news.
As an aside, it’s funny toggling between CNN (the left) and FOX (the right) and their clear bias. CNN is relentless in their criticism of Trump… and FOX very rarely (if ever) says anything negative. Both sides could take a more balanced view.
And of course Trump doesn’t help things by refusing to let go of the media war.
I will come back to this as I think it’s causing him to lose focus.
There’s a bigger (and more important) fish to fry… and CNN is not one.
But outside all things Trump — from my lens things seem to ticking along fine.
Take the world’s largest economy, the United States.
It’s still growing around 2% for the most part (and I think the current quarter will exceed 3%). And if we look at financial markets — there are very little signs of stress.
But it’s Washington DC which is providing the largest headwinds.
What’s new you say!
I say that because it’s simply too large – and far too overbearing.
Big government is a handicap… not an enabler. Therefore the bigger government gets… the slower economic growth will be.
The private sector are the producers of real wealth… the government’s function is to confiscate and redistribute it. The larger the public sector – the more they look to try and confiscate.
Some of course want to see government control increase (ie the left) and there are those that would like to see all levels of government cut in half (or more).
Trump’s agenda is to reduce government. Cut spend. And make the economy more productive.
For example, he has stated he wants to reduce regulatory reform… slash taxes… and in turn enable the private sector via investment and hiring.
But he is having a hard time convincing both the Republicans and Democrats.
As I say, his choice of language and overly abrasive style is not helping him (on either side). And he needs the full support of Congress to get any form of reform through.
Let’s check in with a few charts to get a pulse on the economy… and why there is no looming “debt crisis” mainstream loves to warn us about.
Commercial and Industrial Loans
The first chart I want to share is the growth in commercial and industrial loans.
The growth in lending shows us what we see in the small and medium-sized business sectors (the heart of the economy).
And whilst lending has slowed in recent times to around 2.5% year on year – another way to view this is a function of output (or GDP):
For the past four consecutive quarters – this has remained between 12% and 13% of GDP – a level the sector seems comfortable managing.
The question will be asked is whether the Fed’s “tightening” measures are now starting to put the squeeze on these debt loads?
The answer is no.
Thanks to QE – Fed tightening has a different ‘shape’.
Let me explain…
Before 2007 – when the Fed raised short-term rates by reducing bank reserves – this reduced liquidity and in turn higher rates. This typically resulted in a lending squeeze (and a recession).
Whilst the Fed has raised their short-term rates — banking reserves are pretty much unchanged.
Furthermore rates are extremely accommodative in real terms.
Today bank reserves are something like $2.3 trillion. Now in 2007, bank reserves were just $9 billion. Check this chart out:
There’s your market’s oxygen right there…
So do you think there is a shortage of liquidity in the system?
To give you an idea of how many small to medium sized business are being “squeezed” by so-called Fed tightening… take a look at this chart for loan delinquencies:
Loan delinquencies remain extremely low at just 1.35%.
Again, there is ample liquidity in the system and rates remain at historical lows in real terms.
Put another way – there is no imminent squeeze or credit crisis happening here folks.
Yellen: “System is Safer Now”
Earlier today we heard from Fed Chair Janet Yellen at Jackson Hole on the state of credit and financial safety:
The central bank chief spoke at the Fed’s annual conference in Jackson Hole, Wyoming.
Though the speech is closely watched in financial markets, Yellen offered no clues about the future of monetary policy, instead focusing on the history of the crisis and what regulators have done in response. She warned that future crises are inevitable but said the housing meltdown taught valuable lessons.
“The events of the crisis demanded action, needed reforms were implemented, and these reforms have made the system safer,” she said in prepared remarks.
Yellen rejected arguments that regulation had stifled banking activity, insisting that higher capital requirements actually promoted loan growth.
I agree with her sentiment…
For example, the system is now extremely well captialised (evidenced by banking reserves) and if you look at loan growth – it has continued to remain at healthy levels (especially as function of GDP).
She is also correct that financial crises are inevitable.
No-one will argue with this.
We will have another one. And odds are it will be big. But we are not having one in the near-term. And this is important.
Too many go on about an impending debt crisis and an imminent repeat of 2008… but they are misguided and clearly do not understand how credit functions (nor how central banks are managing this).
We know what risk factors to watch. We chart them regularly.
For example, we look at credit default spreads… yields on bonds… the yield curve and its shape… TIPS… and lending growth etc.
We will know when it’s time to raise a yellow flag. Now is not that time… not from my lens.
Putting it All Together…
Regular readers will know I have been bullish this market (and economy) for sometime.
My commentary and observations have been consistent.
I have relentlessly highlighted “gaping holes” in the (perma) bears arguments. And so far, we have been on the right side of the trade.
But it won’t stop them call for an imminent crash.
I get that. It’s the oldest selling trick in the book. And sadly, too many people buy it.
But don’t be fooled. There is no looming debt crisis today.
… trade the tape
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