January 25, 2015
The Fed – Lucky or Smart?
Given the rapid growth in total thin-air credit, i.e., the credit created by the Fed and depository institutions, during most of 2014, the Fed was correct in phasing down the amount of securities it was purchasing if it wanted to avoid creating another asset bubble and/or an acceleration in price increases of goods and services. But when the Fed ended its securities-purchase program in October 2014, it appeared as though growth in total thin-air credit would slow precipitously in 2015 without some contribution from the Fed. This projected 2015 precipitous slowing in total thin-air credit prompted me to write a commentary entitled “2015 Is Shaping Up to Be a ‘Turkey’ of a Year for the U.S. Economy and Stock Market” on November 17, 2014. But, alas, something has changed since mid November. Namely, commercial banks have stepped up their thin-air credit creation markedly, partially compensating for the sharply-reduced Fed thin-air credit creation. As a result, if current trends persist, a big “if”, 2015 is beginning to look better in terms of the performance of the U.S. economy and risk assets than I anticipated in mid November of last year.
Chart 1 is reproduced from my November 17 commentary. The data at that time showed that year-over-year growth in the sum of bank credit and depository institution reserves at the Fed had slowed to 6.8% in October 2014 after having been in the range of 8.4% to 9.8% earlier in 2014. Assuming that bank credit would continue to grow at its October 2014 year-over-year rate of 6.5% and assuming that reserves at the Fed would remain constant at their October level, by December 2015, year-over-year growth in total thin-air credit would have slowed to 5.0%. If bank credit were to increase at a compound annual growth rate (CAGR) of 4.8%, its CAGR for the three months ended October 2014, then, assuming no growth in reserves at the Fed, total thin-air credit would have ended 2015 with year-over-year growth of just 3.9%. Either way, back in mid November 2014, it looked as though 2015 was shaping up to be a year of a sharp deceleration in the growth of thin-air credit.
But, a funny thing happened thereafter. Growth in bank credit accelerated. As shown in Chart 2, for the week ended January 14, 2015, year-over-year growth in bank credit has moved up to 8.3%. For the 13-weeks ended January 14, 2015, the CAGR in bank credit was 11.2%!
Even with the sharp deceleration in the growth of depository institution reserves at the Fed, growth in total thin-air credit is once again ascending, as shown in Chart 3. In the week ended January 14, year-over-year growth in total thin-air credit stood at 8.2%.
If growth in bank credit were to persist at its current year-over-year pace of 8.3% and reserves at the Fed were to remain at their current level, then a year from now, total thin-air credit will have increased by 6.6%. This compares with 8.2% growth in total thin-air credit in the 52 weeks ended January 14, 2015 and long-term median annual growth in total thin-air credit of about 7-1/2%. If total thin-air credit growth were to repeat in the next 52 weeks at the 8.2% it registered in the past 52 weeks, there would be increased risk of inflating an asset-price bubble and/or sowing the seeds of undesirably-high goods/services price inflation. So, bringing down the growth in total thin-air credit by about 150 basis points from it prior 52 weeks’ growth and to a rate about 100 basis points below its long-run normal growth seems to me to be a “smart” policy move on the part of the Fed.
When the Fed ceased its active program of securities purchases last October, did the Fed anticipate that growth in commercial bank credit would soon accelerate, partially offsetting the extreme depressing effect on total thin-air credit growth emanating from the Fed’s cessation of securities purchases? Given that to my knowledge the Fed has never publicly rationalized its securities-purchase program in terms of augmenting the supply of credit in the economy nor has the Fed publicly commented on the quantity of depository institution credit being created, there is little reason to believe that the recent fortuitous acceleration in commercial bank credit, fortuitous for the economy and the stock market, was anticipated by the Fed. But if the Fed isn’t smart, being lucky is a good substitute. By either intelligence or luck, if the Fed has engineered growth in total thin-air credit of about 6-1/2% 52 weeks from now, 2015 will likely to have been a year of reasonably good economic growth and reasonably good stock market performance – not as good as 2014, but better than what things were shaping up to be in mid-November, 2014. But what if bank credit growth were to suddenly plunge? What luck could we count on for the Fed to resume securities purchases in order to prevent a sharp deceleration in the growth of total thin-air credit as was imminent back in mid-November, 2014?
Paul L. Kasriel
Founder & Musical Director, Econtrarian, LLC
Sr. Economic & Investment Advisor, Legacy Private Trust Co., Neenah, WI