The Economic Consequences Of Bank Credit Contraction

As well as financing escalating government deficits, central banks face an additional problem of replacing contracting bank credit to the non-financial private sector if a slump is to be avoided. The problem comes at the worst possible time in the bank credit cycle, with commercial banks’ balance sheets as highly leveraged as they have ever been.

Banks are already reducing their credit allocations to the non-financial private sector. Yet, as this article points out, it is virtually impossible for central banks to persuade commercial banks to increase their financing of genuine production. This is because they must protect themselves from increasing bankruptcies as pandemic-related support is withdrawn at a time of maximum balance sheet gearing.

The withdrawal of bank credit when post-lockdown consumer demand is unleashed will hamper the production and supply of goods to consumers, driving up high street prices which are already subject to rising commodity prices and other costs. Further monetary inflation will only make the problem worse as the purchasing power of fiat currencies is undermined. But for central banks and governments expanding the quantity of money is the only recourse they have left if they are to defer a full-scale slump.


Everywhere, the story is of a sharp economic recovery following the end of lockdowns. The tide of unspent stimulus is expected to flood all major western economies when normal business resumes.

Furthermore, governments and central banks are going to continue stimulating us back towards economic health. The most extreme version is President Biden’s plans, involving a $1.9 trillion covid relief plan, a $1.8 trillion American Families Plan and a further $2.3 trillion infrastructure plan so far. That’s $6 trillion additional spending to normal mandated spending of about $4 trillion annually on a tax base of only $3.5 trillion. Biden says he will tax the rich to pay for some of it. That has never raised much additional revenue in the past, so it is reasonable to assume it will be all borrowed — nearly all involving inflated dollars.

Other advanced economies are following a similar if less egregious path. Measuring it all will be GDP, certain to rise substantially later this year. “Growth” will be back. This column has frequently warned readers not to be misled by GDP, which is simply a money total. With all the monetary stimulus everywhere, money totals will obviously increase substantially, rendering the term “growth” in the true economic sense meaningless. If GDP had been invented in the 1920s, the European bloc comprising Germany, Austria, Hungary, and Poland would have demonstrated spectacular growth, and a contemporary CPI would have seen “real GDP” more than doubling — even quadrupling or more. A post-WW1 economic miracle would be declared, though the reality was sadly very different.

That’s the problem with macroeconomics and its statistics. It’s non-science, which in GDP describes an evenly rotating economy, confusing an economy which is assumed to be unchanging with a dynamic one that advances the human condition. GDP matters to governments because it quantifies their revenue base, which justifies its statist popularity, but it is useless for independent forecasters. Instead, a rationalist approach to economics, understanding that economic laws exist and that they are aprioristic, is the only way to understand the current condition and the dangers from total inflationism.

The analysis spewing out of investment banks and investment management operations, being entirely macroeconomic, is flawed for these and other reasons and must be ignored in the diligent search for economic and monetary outcomes. It deflects from the real problems: the underlying factors which determine life after the lockdowns end and the role of banks supplying credit.

Life after lockdowns

When lockdowns end, we can expect those who have accumulated unspent funds will be likely to reduce their cash balances to their more customary levels. But the ending of lockdowns is not a black and white issue. Some countries and regions will emerge later. Others, notably India, are still seeing tragic surges in covid-19. Others in the underdeveloped world are unreported. Many countries are likely to have new travel restrictions imposed upon them, and there is no guarantee that countries that have been slow to roll out vaccinations will not see new waves of new variants.

We also know that individuals whose bank balances have increased in lockdowns are predominantly members of the middle classes, the cohort which has access to mortgage and consumer finance. And it is its members who are buying houses in the country, building extensions, buying yachts and recreational vehicles. They are the target for advertisers and the mainstay of the mainstream media. With this readership informing it, the MSM trumpets the recovery prospects. Ignored are the low paid, dependent on government support, having either lost their jobs or likely to do so as the pandemic drags on. Before the pandemic, it was frequently reported that some 70% of Americans and Brits on salaries lived from paycheck to paycheck, representing a threatening black hole for the post-lockdown economy.

With supply chains still in chaos, it is unlikely that goods and to a lesser extent services will be able to supply the predicted unleashed demand. Today, motor manufacturers are being forced to suspend production due to microchip shortages. Manufacturers of all goods and assemblers of components are similarly threatened with supply dislocations. Containers are wrongly positioned to deal with any surge in consumer demand and some industry experts think global logistics won’t be sorted out before the year-end.

Prices in the high street are already rising more rapidly than before.

Probably the most important issue dismissed by macroeconomists is the state of the bank credit cycle, which combined with increased trade tariffs against China rhymes with the global economy when it faced similar conditions to those that collapsed Wall Street between 1929-1932. More recently, the US banking system visibly ran out of balance sheet space in September 2019, signaled by a crisis in the repo market. Shortly afterward from February 2020, liquidity constraints crashed the US stock market, echoing the September-October 1929 phase ninety years before. Figure 1 shows that cycle compared with today, the difference being that in the earlier cycle prices were in gold through the dollar at $20.67 to the ounce, while today’s dollars are pure fiat.

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Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not reflect those of Goldmoney, unless expressly stated. The article is for general information ...

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