The key chart
Visual summary of the CMMP Analysis framework linking all economic sectors together (Source: CMMP)
The key message
The key message from CMMP Analysis is that the true value in analysing developments in global finance lies less in considering investments in banks’ equity and more in understanding the implications of the relationship between the money sector and the wider economy for macro policy, corporate strategy, investment decisions and asset allocation.
The 2023 “messages from the money sector” included the importance of post-GFC debt dynamics, the risks of policy errors, the failure of banks to support productive economic activities, and the increasing abuse of macro statistics.
The seven key lessons were:
- The risk of a Chinese balance sheet recession dominated 2023 and will DOMINATE 2024 too
- “US bears” ignored structural shifts in US debt dynamics post-GFC and underestimated the RESILIENCE OF THE CONSUMER as a result
- Aggregate demand in credit-driven economies is equal to income (GDP) PLUS THE CHANGE IN DEBT. Policy makers continue to ignore this truism at OUR peril
- The ECB’s policy celebrations may prove PREMATURE
- UK policy making is still based on UNBELIEVABLE forecasts and FLAWED macro thinking
- Banks are failing to support PRODUCTIVE ACTIVITY and the SME sector in particular
- The ABUSE of macro statistics is rife – beware of “panic charts” and their accompanying narratives
Seven lessons from the money sector in 2023
The importance of post-GFC debt dynamics
Lesson #1: the risk of a Chinese balance sheet recession dominated 2023 and will dominate 2024 too
January 2023: Trends in Japanese, Spanish and Chinese private sector debt ratios (% GDP) (Source: BIS; CMMP)
CMMP Analysis began 2023 by questioning the popular, “China-opening story“. We highlighted three structural risks to this narrative – (1) the level of private sector debt, (2) the rate of growth of household debt, and (3) the affordability of private sector debt. We asked two questions.
First, what happens if rather than seeking to maximise profit/utility as traditional economics assumes, the Chinese private sector turns to minimising debt or maximising savings instead?
Second, and following on from this, what if China experiences a balance sheet recession instead?
December 2023: Trends in “excess credit growth” in China since June 2013 (Source: BIS; CMMP)
The balance sheet narrative remained on hold during 2023, but risks remain as we enter 2024. All sectors of the Chinese economy are increasing leverage still. The Chinese government is the main driver here, rather than the private sector, however. Crucially, the dynamics of Chinese money creation and potential growth are shifting. Credit agencies may (mistakenly) wish for lower levels of government debt in China, but given current debt dynamics it will be fiscal policy/government spending that will have to do the heavy lifting in 2024 if China’s growth is to recover.
Lesson #2: “US bears” ignored structural shifts in US debt dynamics post-GFC and underestimated the resilience of the consumer as a result
January 2023: Trends in the stock of US consumer credit ($tr) and the consumer credit to DPI ratio (%) (Source: FRED; CMMP)
CMMP Analysis also began 2023 by questioning the equally popular, “US consumer slowdown narrative”. We argued that “US bears” were ignoring the key structural shifts in US debt dynamics that saw the US leading the advanced world in the structural shift away from high-risk HH debt towards relatively low risk public debt in the post-GFC period. In September 2023, we noted greater affordability risks in other developed economies such as Canada, Switzerland, Sweden, France and Finland and in emerging markets such as Brazil, China and Korea instead.
December 2023: Trends in monthly flows of US consumer credit (Source: FRED; CMMP)
That said, we also noted signs that the US consumer was starting to crack as the year progressed. Quarterly consumer credit flows in the 3Q23 ($4bn) were the weakest since 2Q20, and only a very small fraction of the pre-pandemic average quarterly flow of $45bn. Monthly flow data for October 2023, also suggested that momentum weakened further at the start of 4Q23.
Note the key differences between China and the US here – China’s challenges are more structural in nature, while the US’s challenges are more cyclical.
The risks of policy errors
Lesson #3: Aggregate demand in credit-driven economies is equal to income (GDP) PLUS THE CHANGE IN DEBT. Policy makers continue to ignore this truism at OUR peril.
In September 2023, CMMP Analysis argued that central bank decision making that appears largely “data independent” in relation to private sector credit dynamics is unlikely to produce positive economic outcomes. Instead, it increases the likelihood of policy errors, especially in credit-driven economies.
September 2023: Trends in the UK PS debt ratio (RHS) and PSC relative growth factor (LHS) (Source: BIS; CMMP)
The fundamental error is to ignore that aggregate demand in a credit-driven economy is equal to income (GDP) PLUS THE CHANGE IN DEBT. The addition of the change in debt means that, in reality, aggregate demand is far more volatile than it would be if income alone was its source (as typically assumed). This is especially true for highly indebted economies.
If Schumpeter could understand this in 1934, why can’t policy makers understand it in 2024?
Lesson #4: The ECB’s celebrations may prove to be premature
ECB officials spent much of 2023 arguing that the transmission of monetary policy was working. The tone became almost celebratory by the end of the year, with Board members arguing that not only was the transmission working but also that it was delivering results that were EXACTLY what the ECB wanted to see.
December 2023: Trends in PS financing flows (EUR bn, 12m cum flows) and nominal NFC and HH borrowing costs (%, RHS) (Source: ECB; CMMP)
The risks that these celebrations may prove to be premature are obvious, however, or at least they should be. While monetary policy transmission in the euro area is working as textbooks suggest, both the pace and scale of current tightening is unprecedented. The ECB lacks a playbook for such a scenario and EA economies now find themselves in uncharted territory. Policy tightening continued even as the EA money sector was indicating increases stresses for banks, households and corporates. The end result – a combination of NEGATIVE financing flows to the private sector, historically high policy rates and elevated costs of borrowing – is unlikely to be sustainable in 2024.
Lesson #5: UK policy making is based on unbelievable forecasts and flawed macro thinking
November 2023: Historic and forecast trends in sectoral balances for the UK private and public sectors and the RoW expressed as % GDP (Source: OBR; CMMP)
Official OBR forecasts for the UK economy remain unbelievable when viewed through CMMP Analysis’ preferred sector balances perspective. The March 2023 version suggested a return to the pre-pandemic world of economic imbalances and an economy forecast to remain heavily dependent on net borrowing from abroad – the irony of post-Brexit Britain. The November 2023 version presented a more balanced outlook and a more realistic forecast for private sector dynamics but was simply too dull to be true.
December 2023: Trends in UK PS debt ratio (% GDP, RHS) and relative growth versus nominal GDP (3Y CAGR %, LHS) (Source: BIS; CMMP)
The UK private sector debt ratio fell back to its March 2022 level at the end of 2Q23. This matters because neither Jeremy Hunt (the current UK Chancellor) nor Rachel Reeves (his likely successor) appear to recognise the folly of combining austerity with private sector deleveraging (“pre-COVID Britain”). The next general election will be fought on the wrong macro battleground as a result. Both parties will repeat the flawed narrative that governments (that enjoy monetary sovereignty) face the same financial constraints as households and that public debt is a problem while largely ignoring private debt. A depressing thought for the year ahead.
The failure of banks
Lesson #6: Banks are failing to support productive activity and the SME sector in particular
February 2023: Trends and breakdown of UK FIRE-based (red and pink) and COCO-bases (blue) lending (£bn) (Source: BoE; CMMP)
A more appropriate macro policy debate in the run-up to the next election would focus on the role of banks. UK banking, for example, is heavily geared towards less-productive FIRE-based lending that supports capital gains rather than productive COCO-based lending that supports investment, production and income formation.
October 2023: Trend in the outstanding stock of SME loans since 2013 (£bn) (Source: BoE; CMMP)
UK banking also fails SMEs, the lifeblood of the UK economy. Only 22 pence in every pound lent in the UK is for productive purposes and only c.7pence is lent to SMEs. This is despite the fact that SMEs account for 50% of private sector turnover and 60% of employment. SMEs cannot invest fully in growth, job creation, innovation and equality if and when: (1) their access to external capital is constrained by LT structural factors; (2) flows of financing (both loans and overdrafts) are negative; and (3) their cost of borrowing is rising so rapidly.
The abuse of macro statistics
Lesson #7: The abuse of macro statistics is rife – beware of “panic charts” and their accompanying narratives.
CMMP Analysis suggests that US public sector debt and trends in narrow money (M1) are the most widely abused macro statistics of the year.
May 2023: 50 years of US public sector debt dynamics – plotted differently! (Source: FRED; CMMP)
The abuse of US public sector debt data involves five elements. First, ignoring the fact that public debt is both a liability for the government sector and an asset of the non-government sector. Second, making no comparison with GDP. Third, ignoring inflation. Fourth, presenting long time series data using linear scales. Fifth and finally, ignoring private sector debt dynamics completely (see also lesson #2 above).
November 2023: Growth trends (% YoY) in narrow money (M1) and other short term deposits (M2-M1) (Source: ECB; CMMP)
The abuse of monetary aggregate statistics is more understandable given that growth in narrow money is falling rapidly, and that real growth rates in M1 typically display leading indicator properties with real GDP. This means that M1 dynamics make great headlines for sure, but they only tell one part of the macro and banking stories. The rising opportunity cost of holding money, on-going portfolio rebalancing and the mechanics of money creation are important too. Policy normalisation leads to natural re-adjustments in the structure of MFI consolidated balance sheets. This can and does create dramatic movements in individual items and monetary variables such as M1 and increases the risk of misinterpretation.
In short, monetary aggregates still matter. To return to the key message from CMMP Analysis, they tell us a great deal about the interaction of the banking sector and the wider economy, but they need interpreting with due care and attention…
Thank you for reading and very best wishes for a very happy and healthy new year.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.