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Deleveraging is history





These two charts may look pretty similar, but they represent two very different things. The top chart shows total outstanding Commercial & Industrial Loans (a proxy for bank lending to small and intermediate-sized businesses), while the bottom chart shows total outstanding consumer credit. Both started to decline in late 2008 as the economy cratered, the financial system was virtually paralyzed, and consumers were clobbered by collapsing home and equity prices. Consumers and businesses struggled valiantly to deleverage and de-risk, and banks were happy to oblige, not anxious at all to increase their lending at a time when every borrower was suspect and most banks were teetering on the verge of insolvency.

Things started to change about a year ago. C&I Loans are now rising at an 11% annual rate, and although consumer credit is up only 3.7% in the past year, it was up at an annualized rate of 7.8% in the final three months of last year. (Both series are seasonally adjusted)

One important thing about the releveraging activity that we see here is not that it will directly boost the economy, because more credit does not necessarily equate to more growth. More credit today means that everyone—businesses, consumers, and banks—feels more comfortable about taking on additional risk. It's a measure of rising confidence, and that bodes well for future growth. It's also important because it means that financial markets are functioning more normally. Credit expansion can't create growth per se, but it can facilitate growth by more efficiently distributing the economy's resources from savers to investors.

Of course, credit expansion in the context of the banking system's $1.5 trillion in excess reserves could also be the canary in the inflation coal mine—the first sign that banks are starting to use their reserves to create new deposits and thus expand the money supply. M2 has increased by $568 billion in the past seven months, for an annualized growth rate of 11%, which is about double the rate that M2 has averaged over the past 15 years. Too much of this sort of credit expansion could eventually be a bad thing. So far, however, we are only in the early stages, and I see it more as a harbinger of a healthier economy than of any significant near-term rise in inflation.

For now, these charts are additions to the long and growing list of signs that the U.S. economy is slowly and gradually improving.

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