The real money machine in our economy is credit. We deposit money, the bank keeps a small percentage of it around to cover withdrawals and the rest is lent out. This double counting doesn’t stop with the first loan. That money gets deposited somewhere and the process starts all over again.
Eventually, $1,000 of new money deposited in a bank will grow to represent $10,000 in deposits elsewhere through credit creation. What happens when people stop, or even significantly slow, their borrowing? The economy fails to grow, inflation falls, and wages flat-line…
Does this sound familiar?
To be sure, some forms of consumer credit are expanding, as every parent with a kid in college knows. Student loan debt grew 57% from 2009 through October 2014, while car loans increased by 31% over the same time frame.
Cars and student loans can almost be viewed as necessities of life in America, so growth in these areas is not surprising. However, credit card debt is still 8% lower than it was at the end of 2009 and mortgage debt is growing at a snail’s pace.
Then there’s the small business side…
The National Federation of Independent Business reports that only 28% of their survey respondents use credit on a regular basis, which is a record low. They also report that only 4% said that all their credit needs were not met and that is another historic low.
Meanwhile, the Federal Reserve’s third-quarter survey of senior loan officers reflected that banks are on average keeping their lending standards the same, or slightly easing them, which makes credit easier to get. Among the reasons for easing lending standards, 80% of respondents cited increased competition from other banks or non-banks as a very important reason for the change.
So people are not borrowing as much to fund daily purchases, small businesses aren’t using as much credit as they have in the past and don’t want more and banks are starting to fight over clients.
All of this falls in line with our view of where we are today — basically the midway point of the economic winter season.
We’re in a sluggish period marked by moderate consumption as we live through the transition of the boomers from big spenders to savers. While the savings rate of the country doesn’t reflect a tremendous shift, the first step in this direction is to quit spending on credit.
Of course, one man’s spending is another man’s income. As we’ve ratcheted down our spending a bit, overall economic growth has slowed which decreased job opportunities and led to flat wages.
The path forward relies on the next generation of big spenders — the millennials — to ramp up their own spending on credit for homes, more cars and daily living as they establish households and start their families.
This trend should already be established and starting to ramp up but this process is currently held back. Millennials are struggling to make a good living and yet many already have a mountain of (student loan) debt.
This isn’t the type of borrowing and spending that leads to a sustained recovery.
Eventually the Federal Reserve will try to slowly allow excess bank reserves to flow into the economy, which will only increase the competition among banks to get more clients (our upcoming December Boom & Bust covers excess reserves in depth). Many people expect this move to unleash the inflation genie that has been kept in the bottle, even while the Fed printed trillions of new dollars.
But what happens if, instead of being lent out, the extra money just sits there for lack of demand for loans?
Our estimate is that the economy will remain slow for several more years and interest rates will continue to freefall.