You Might Like To Watch This Picture As Asset Prices Fall

“It is high time we rediscovered the role of the financial cycle in macroeconomics.”
Claudio Borio, Bank for International Settlements

In May, we queued up the b-side of a record describing America’s balance sheet—we looked at the mix of lenders instead of the usual “a-side” analysis of the borrowers.

We showed that the balance sheet includes four types of lenders—banks, the Fed, foreigners and prior domestic saving—as in the updated chart below. And the “prior domestic saving” category, since you asked, is mostly households, pension funds and insurance companies investing in bonds and bond funds.

watch this picture one

Then we showed why the b-side is so important, even as it gets little attention. That is, the four types of lenders are fundamentally different from one another—lending by banks is highly correlated to spending (same-period and next-period spending), whereas the other lenders show no such correlation.

watch this picture two

But economic theory says all lending is the same—how can banks be different?

Finally, we shared a diagram that explains the previous result.

econ indicator 1

The diagram shows that bank lending is unique because it creates fresh spending power from “thin air.” We’ll leave further explanations aside for now, but you might check our articles here or here to review how banks create spending power from nothing, and why that process invalidates entire libraries full of mainstream thinking. (Or see our book for more detail.)

Bank balance sheets are also highly predictive, as we showed when we used bank credit to construct a business-cycle indicator. (Again, see the b-side article linked above.) Considering the connections—empirical and conceptual—between bank credit and the business cycle, our indicator might be the best first step to business-cycle forecasting.

Okay so banks conjure spending from thin air—does anything else do the same?

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To demonstrate the fourth point, in particular, we’ve published a chartbook with more ...

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