A Global Dearth Of Liquidity

Worldwide Liquidity Drought – Money Supply Growth Slows Everywhere

This is a brief update on money supply growth trends in the most important currency areas outside the US (namely the euro area, Japan and China)as announced in in our recent update on US money supply growth (see “Federal Punch Bowl Removal Agency” for the details).

Nobody likes a drought. This collage illustrates why.

The liquidity drought is not confined to the US – it is fair to say that it is a global phenomenon, even though money supply growth rates in the euro area and Japan superficially still look fairly brisk. However, they are in the process of slowing down quite rapidly from much higher levels – and this trend seems set to continue.

Euro Area – Money Supply Growth Still High, But Slowing Fast

The chart below shows the euro area’s narrow money supply aggregate M1 (stock) and its year-on-year growth rate. M1 in the euro area is almost equivalent to US TMS-2, which makes it a good enough stand-in (it includes savings deposits that are in practice payable on demand; however, it lacks euro deposits belonging to foreign residents and central government deposits).

It is worth noting that a slowdown to a 0% growth rate triggered crisis conditions in 2008. After a sharp, but short term spike in money supply growth after the ECB made emergency liquidity facilities available to European banks to mitigate the fallout from the US housing bubble implosion, crisis conditions promptly returned when these facilities expired and money supply growth fell to around 1% in 2011.

(Click on image to enlarge)

Euro area, M1 (~TMS-2): Total in millions of EUR (blue line) and y/y rate of change (orange line). We have highlighted the three most recent slowdowns in money supply growth associated with economic crises and declining asset prices. In 2000, a slowdown to 5% annualized growth was sufficient to trigger an economic downturn in concert with a recession in the US after the technology mania ended. It not certain yet where the threshold will be this time, but there are already some indications that it may be at a higher level than in 2008 and 2011. The current growth rate of 6.8% is still quite brisk, but it is down from more than 14% at the peak in 2015 and this downtrend is almost certain to continue.

Although recent surveys show that lending standards in the euro area have eased considerably, bank lending growth remains quite anemic. Lending to non-financial corporations recently grew at just 1.75% y/y, while lending to households grew at approx. 2.6% y/y. Total bank credit growth (incl. lending to governments and other loans) amounted to 3.5% y/y, which is quite similar to recent bank credit growth in the US (3.4%).

In other words, most of the expansion of the money supply in recent years can be ascribed to QE – and the ECB has halved the size of its asset purchase program again to EUR 15 billion per month as of October and plans to discontinue new purchases entirely at the end of this year (at the peak, it bought EUR 80 billion in securities per month).

Reinvestment of the proceeds from maturing bonds will continue so as to prevent the ECB’s balance sheet from shrinking, but a stagnating balance sheet is materially different from an expanding one. Based on the growth in bank loans and the concomitant slowdown in QE, we concluded a few months ago based on a rough estimate that TMS growth in the euro area was likely to fall to less than 5% y/y by the end of the year. We still believe this is likely to happen sometime between December and February.

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