Monday, 26 May 2008

Where is the crunch?

I sense that readers of this blog are desperate to get into a serious discussion about money. Since it is a quiet bank holiday and the rain has ruined my plans for today, I thought I should start today.

The chart above highlights two key indicators. The first is M4 growth, which is a broad measure of monetary growth comprising of cash, retail and wholesale bank deposits. This data largely comes from the liabilities side of bank balance sheets. However, M4 has a counterpart on the asset side of bank balance sheets, which is called M4 lending.

Here are two quick observations from me. First, I can't see any slowdown in either indicator. The data goes right up to March 2007, and both indicators are growing at double digit rates. Second, take a look at the period when we last had a housing crash - the early 1990s. Prior to the crash, both indicators were growing extremely rapidly. Then comes the crash and monetary growth slips down in to the low single digits.

So, where is the credit crunch? On the face of it, it is hard to see it in the broad money growth numbers.


VADO said...

The inflationists take an early lead over the deflationists.

Swartz said...

Inflation is always and everywhere a monetary phenomenon.

M. Friedman

aSteve said...

There simply isn't a credit crunch in the M4 figures... and with recent rights issues etc. I can easily see M4 continuing to grow at rates comparable to the the last decade.

M4, however, is not where the action is. The real action is with securitisation. In the late 80s, it was M4 lending that stoked the housing bubble. This time it is different - it has been foreign finance via securitisation that has driven down the price of money and driven up the price of real-estate.

With M4 expanding at ~12% - that's, ball-park £150bn for last year... slightly less than was securitised. (€170bn - down on ~€200bn the year before...) From this, we can conclude, if we had a graph of M4 lending + securitised lending, we'd have recently seen a 'growth' of ~25% - i.e. at or above the 1989 high.

The difference, as I see it, is that Securitised debt is not part of the money supply, per se, so can't be 'earned'. Today, private debt is even less affordable than it was in 1989.

The credit crunch is about an abrupt end to securitisation, not an abrupt end to fractional reserve lending. This also indicates why, while central bank rates have fallen, mortgage rates have not. Mortgages are only partly financed by M4 lending.

Anonymous said...

"comprising of..." should be replaced by "comprising... "

Ed H said...

I'd say the crunch comes not in money supply but in money velocity. With all the bead debt and loans, the Bank of England could inject as much money as they want into the system. But if people aren't lending or people aren't borrowing, then that money supply increase is for nought.

So M4 (cash, retail and wholesale bank deposit) may be growing but credit is not and that's the difference. I see it as a velocity problem just like in Japan in the 1990s.

Mark Wadsworth said...

Hmmm. asteve makes a good point. That aside, how would M4 growth look if you minus off inflation? Wouldn't it be fairly flat?

J said...
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J said...
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aSteve said...

Thanks, Mark-W... I firmly believe that securitisation is the "elephant in the room."

If you're going to talk about subtracting inflation from M4 growth, then you need to say, specifically which inflation. If we take a very broad view, I'd be happy to say that M4 growth has been approximately 10% since the mid 1990s. RPIX has been between 2% and 4%; RPI between 3% and 6% - and HPI about 10% too. Some hard-core Austrian economists might choose to define inflation as being M4 growth... though I think that a somewhat cyclic argument with little merit.

One of my early ideas about M4 growth was that it might be driving property prices - because there certainly seems to be a correlation. On further investigation, while prior to the 90s it may well have been M4 expansion that drove real estate prices, but over the past 10 to 20 years, securitisation has been the alternative. I think that mortgages have driven M4 expansion rather than the other way around. M4 expansion reflects that those who take out mortgages to buy property ultimately financially compensate previous asset owners with hard currency. This is new Sterling currency acquired via foreign exchange rather than by Sterling denominated fractional reserve lending. The sting in the tail has been that the 'new currency' was not 'created' but loaned on strict short terms (which protect investor interests) and leaves lenders like Northern Rock with spectacular funding crises the moment that the foreign investors decide that they no-longer wish to invest. I think that the continued M4 growth in the face of the credit crunch represents that domestic banks are now being relied upon to finance the mortgages previously financed by foreign investment. I think that, recently, higher than expected M4 growth can be put down to fractional reserve lending trying to take up the slack where money market investors have withdrawn their funding.

If, like me, you have some level of confidence in markets to appropriately allocate resources (except when something 'new' comes onto the scene – Transatlantic trade; Railways; the Telegraph; the Web – etc.) then the puzzle is to ask why did international investors see Britain, of all the European countries, as being such a desirable place to invest. I have a suspicion. Since inception, until very recently, the Euro has had a remarkably stable exchange rate with Sterling... helped no-doubt by economic harmonisation – adopting European laws; European inflation measures – etc. With a stable exchange rate, but different central bank rates... it suggests to me that foreign money market finance may have been predominantly Euro denominated. If so, that may well explain why Sterling has weakened significantly against the Euro. It is with this in mind that I'm especially interested to establish a geographic breakdown of foreign portfolio investment in debt secured against UK assets.

Anonymous said...

I was going to ask why the two measures haven't disconnected, but I think you mean that securitised debt simply isn't recorded. As in debtor owes the bank, bank owes foreign investor, so the bank is neutral. Until the bank has to come up with funds to replace the foreign investment because they withdraw. In which case the graph goes sharply up. The graph certainly doesn't look as though it represents some of the highest earning multiples ever borrowed. If the BoE step in to replace the foreign funds the two measure still don't change. So this graph is flawed because it does not include government borrowing OR foreign funds and so does not represent M4 as it would be understood, i.e. how much money is floating around.

aSteve said...

Securitised debt is recorded, but is - by definition - not part of M4. The details available on securitised debt are separate:

M4 isn't flawed - as such - it merely tells us only a small part of the story.

From where I am now with research, I want to establish the geographic breakdown of investment in UK securitised debt and to establish why this huge capital flow appears not to have adversely affected our exchange rate. It is obvious how the USA kept its currency elevated in value - it is the world's reserve currency and is the denomination of the vast majority of international trade. It is less clear why Sterling fared so well for so long.

Mark Wadsworth said...

@ asteve, good answer but a tad detailed. When I say 'inflation' I mean price inflation rather than expansion of money supply, because it'd be daft to adjust M4 growth down for growth in M4, obviously.

aSteve said...

If you're going to talk about "price inflation" you need to ask which prices you intend to consider... and in what proportions. Prices do not rise uniformly.

Is it reasonable to suggest that the price of houses are irrelevant? What proportional representation should fine art have on the metric? Do you expect substitution? How do you compare products where technological innovation increases, say, capacity every year? Should supercars or diamond tiaras feature? Should we concern ourselves with the basic essentials for survival or should we aspire to manage a better quality of life? Should we consider prices before or after duty and taxes have been applied? Where do you draw the line between investment and consumption (which spending is on capital goods)?

It matters greatly what constitutes your shopping basket - and how you gauge quality and substitutions.

Inflation is a nightmare... if you consider all spending to be relevant, however - and consider saving to be a special kind of 'spending'... and refuse to be politically swayed... then inflation can be defined as being the expansion of the money supply.

The difference between RPI; RPIX and CPI underline the wild differences that can be recorded with only slightly different metrics.

Russell said...

@asteve - interesting and thought provoking posts here. Do you have a website/blog yourself, perhaps you could post a link?

Regarding foreign investment to the UK, the other factor is that sterling rates were/are just a little bit higher than euro rates throughout the period and so long as you beleived that Eur/Gbp would be stable you might enjoy the higher returns available in Gbp over Eur. Of course that party came to a nasty end over the last 6 months as Gbp has weakened across the board.

It seems like a long time ago since we would be "treated" to Brown dishing out patronising advice to the other European finance ministers regarding their economies.

aSteve said...

I'm glad my ideas were thought provoking... I don't have a blog or (relevant) website myself. I'm pursing my interests rather than publishing/promoting them.

We saw the same end to the Euro/BGP carry trade - though, assuming the exchange rate was suitably hedged, I suspect that leveraged funds in the Eurozone investing in AAA-rated UK mortgage backed securities may have proven lucrative right up until then.

I'm finding Brown hard to fathom... last year I paid him attention for the first time in my life. It quickly became evident that he was either intellectually sub-normal, or a (possibly malevolent) genius. As time has gone on, I've become far more inclined towards the former than the latter.

aSteve said...


powerman said...

I think Gordon Brown's main problem is that he's completely wedded to centre-left macroeconomic theories.

I think he really did believe he was doing a great job as the country slid deeper and deeper into debt over the last decade because the favoured blurry metrics like GDP growth and 'consumer demand' seemed to be going up not down.

I've always had a slightly cranky semi-serious theory that Blair was aware quite some time before Gordon through well-placed banking contacts that there was a real problem building up and he timed the handover to Gordon Brown so it was just before his most highly-placed contacts told him it was likely to pop, as a parting snub.

aSteve said...

While Blair was PM, I always thought there was something fishy about the Blair-Brown pact, and something decidedly odd that no-one would oppose Brown in a party-election for leadership. It felt almost as if, as people murmured that they might stand... that someone better informed went and whispered in their ear. The pinnacle was the day Blair left... his triumphant speech... followed by walking out of the House of Commons to find that no-one had thought to ensure that he had dignified transport under the watchful gaze of the press... leaving him bumbling... while trivial, it gave the clear impression that he only commanded respect from MPs while he was PM - and as soon as that had passed to Gordon, he was yesterday's offal.

I believe that all senior Labour MPs are now well briefed on what to expect from this crisis. I think Blair left because he saw his position as being untenable and Brown is PM because there was no-one else stupid enough to take the fall. I suspect that Brown was a reluctant Chancellor - and that, as a consequence, he delegated (or accepted advice as policy) without looking for clearly vested interests. I think the tri-partite agreement was a wet-dream for unscrupulous bankers... and I suspect it was presented to him by the equally unscrupulous (and now disgraced) management consultants Arthur Anderson. From 1997, a combination of an incompetent self-serving treasury and an uncommitted regulator, where even senior figures were keen to garner favour with the industries they were regulating, has lead to a financial free-for-all with a few spectacular bonuses and misery (yet to be felt, in many cases) for others.

[N.B. This isn't intended to be political - except that it concerns our government of the last decade, so necessarily addresses Labour politicians exclusively.]

powerman said...

"I believe that all senior Labour MPs are now well briefed on what to expect from this crisis."

You're more optimistic about governmental competence than me. The only thing that shocked me about the 'leaked' cabinet report which the young minister let face the cameras was how shallow and undetailed the economic 'analysis' was, and how peppered with 'touchy feely' suggestions on how to 'connect with people's pain'.

I would be very, very surprised if many senior civil servants or labour ministers have as much insight into what is happening than yourself or Alice.

The only politicians who I would expect to be better informed will be the ones with strong, high level investment banking contacts (like we now know Blair to have had from all the lucrative appointments he's gone on to pick up).

aSteve said...

Actually, Powerman, you misinterpret what I say as confidence in the competence of politicians. When I say "well briefed" - I mean only that I believe that they do know that the UK is scuppered by consumer debt - probably because they've been told in no uncertain terms by research carried out by professionals at the public expense. I doubt they understand why; how; what should be done to correct this; etc. I think we're seeing the last grasp at cronyist deals for a decade or more without political influence. I think they've known since early 2006 (at the latest) that the British economy is all but sunk - and, with that, their government. I think this prompted bold and obviously unpopular legislation (among the core Labour vote) such as the smoking ban, for example. The 10p tax is another that no government looking for re-election would attempt. (Ironically, I think that abolishing the 10p tax will be good for low earners in the medium and long term... but it definitely isn't a vote winner. I believe opposition came from ideologically inclined populist politicians with only a scant understanding of the mechanics of remuneration. I doubt I'd have the courage to make the change unless I knew my time was almost up anyway.)

Anonymous said...

Politicians have no engine to be competent. They rise into positions of power based on the following factors:

1) Backroom politiking with other apparatchiks to get nominations
2) Persuading stupid people to vote for them
3) Spinning everything to stay in power

None of those require competence in the job you hold, and (2) actively prevents competent people holding office.

I genuinely believe Gordon Brown does not understand how to do his job and has been winging it since 1997


aSteve said...

Nick, I'm inclined to agree... I started to research Brown in 2007 - and from having no opinion, aware that he had a popular reputation with the media... I quickly came to the conclusion that he was either an imbecile or a secretive malevolent genius. I hesitated for a while unsure which... now, I think, odds-on he is a moron.