'Let's go'
'Yes, let's'
They do not move as the curtain falls.
It is nearly midsummer, so time for taking stock of how the first half of the year has developed. Musing over this, it struck me that the hopes and expectations commonly held at the end of 2013 have receded so rapidly that even recalling them requires an imaginative effort.
Do you remember when China's Third Plenum was going to usher in a new and energetic phase of reform in which an improved capital allocation would lay the foundations for a shift towards consumption-led demand and rising return on capital? What we have got is a tremendous amount of political energy diverted into an anti-corruption campaign and a host of mini-measures aiming to fine-tune the economy to ensure that the same old broad GDP targets are met . . . anyhow, it seems. That Xi Jinping may turn out to be China's Brezhnev remains an awful possibility.
Do you remember when Abenomics was going to rejuvenate Japan? The core of that strategy was a hope that sufficiently dramatic policy initiatives from both the central bank and the government could fundamentally re-order Japanese expectations – which is to say household and corporate financial and economic behaviour. So far the devaluation of the yen has produced a mild and belated upturn, but close examination of corporate behaviour shows no deviation whatsoever from the tactics and strategies hard-learned during deflation. It is still not clear that what 'third arrow' policies will be adopted, but currently it seems that the most that can be hoped for is a snail's pace scaling down of corporate tax rates paid for by closing other tax breaks. It seems unlikely to fundamentally change corporate expectations or behaviour.
There were, perhaps, no great expectations of the Eurozone, except that a pickup in the rest of the global economy might mitigate the damage done by policies aimed only at extending the Euro's half-life as a viable currency. Nothing has changed there, except a quiet backsliding on measures to underpin a banking union, and a quiet backsliding on some of the excesses of the destructive fiscal compact. Voters turned in unprecedented numbers to elect members of the European Parliament opposed in a variety of ways to the EU institutions' agenda. But it seems likely the new head of the European Commission will be a man who's main qualification is a lifetime's unthinking and unbending devotion to 'the project'.
So our anticipation of reforms which might help re-boot the global economy were ill-founded and are probably best forgotten. Despite all that, the outlook for the world economy has actually improved, and will probably continue to improve during 2H, even if the reasons are altogether more mundane (see previous comments on prospects for G3 imports and NE Asian exports).
At the centre of this is the US recovery, which continues to accelerate without really threatening to reach escape velocity. Two indicators give a pretty clear visual idea of where we are: employees' willingness to quit their jobs; and small businesses' intention to expand capex. Both are grinding higher, but at such a slow pace that there's no short or even medium term likelihood of reaching their pre-crisis cruising altitudes any time soon. The quit rate is a good indicator of how employees think about the state of labour markets – the higher the quit rate, the greater the quitting employee's confidence that an alternative job awaits. Latest data shows it has risen to 1.8%, which is up from the 2009 lows of 1.3%, but still far off from the 2.2%-2.3% sustained pre-crisis. In other words, we're halfway there. The small business capex intentions rate is self-explanatory: pre-crisis it typically ran at about 31%-32%; during the crisis it bottomed out at around 17.5% and has since recovered to 24%. In other words, just as with the quit rate, we're about halfway there.
And there is an unexpected second factor allowing encouragement: it seems that Britain has stumbled on a form of recovery driven by a rise in employment which probably reflects human ingenuity responding to dire necessity. It seems wrong to credit any of Britain's policymakers with discovering this course – indeed, there is little sign they understand how and why it is happening. And since such a supply-led recovery is a genuine novelty to Britain's policymakers, there's still every chance that they will snuff it out by tightening monetary policy in order to head off a 'overheating' which exists nowhere outside London's property market. Nevertheless, if it is allowed to live, a supply-led recovery can be extremely durable, and it has been born and already reached its early years without the benefit of productivity-enhancing investment spending or any significant supply of credit.
It is also possible that Britain's labour-led recovery may be replicated elsewhere in parts of Europe where there are few other grounds for hope – Spain for example.
But the problem is that almost everywhere the world's cycle remains hostage to a financial system which, for varying reasons, remains profoundly dysfunctional. The key measurement here is monetary velocity – or GDP / M2. It is worth taking a moment to imagine what this measures. M2 can be seen as the cash and bank deposits of households and corporations. A new deposit can be created essentially in only two ways: either they represent the balance sheet result of a new bank loan; or alternatively, it can represent what happens when you liquidate a real asset (a house, a diamond necklace) for cash. The bank's function is to act as an intermediary to allocate those deposits to a purpose sufficiently productive to allow it to pay interest. If monetary velocity is falling whilst M2 is growing, it means either that the banks are not distributing the savings at all, or they are allocating them extremely badly.
It's still happening virtually everywhere. In the US, monetary velocity has sunk to lows not seen since at least 1959 (when my data starts), even as M2 rises to around 6.5%. The reason; in the 12m to May, deposits in US banks have risen by $783bn, but their loan books have risen only $324bn, which has cut the loan/deposit rate by 2.5pps to 75.6%.
In the Eurozone, the decline in monetary velocity has slowed, but only because M2 growth has slowed so fast that nominal GDP has yet to catch up: by April M2 growth had slowed to just 1.9% yoy, and unless positive momentum is restored, it will sink below 1% by the end of the year. Deposits in Eurozone banks fell by 0.8% yoy in April, or by Eu 95bn, whilst banks' loans books shrank by 3.3% yoy, or Eu402bn during the same period. Such contraction managed to cut 2.7pps off the loan/deposit ratio, but it still stands at 104.7%.
Where will it stop? US banks' pre-crisis loan/deposit ratio topped out in early 2008 at just over 102% - they are now 75.6% and are still falling. UK banks' ratio peaked out in late 2007 at 117.9% and have fallen to 92.6% and are still falling. Eurozone banks' stood at around 123% in early 2008, and have come down only to 104.7%. They have a very long way to go. The Eurozone has a very long way to go.
Britain's monetary velocity also continues to fall as banks continue to deleverage: in the year to April, banks' loans to the private sector fell £68bn whilst deposits rose £14.5bn, cutting banks' LDR by 3.4pps yoy to 92.6%.
Where else are monetary velocities falling? Practically everywhere one looks: Japan, China, S Korea, Taiwan,Hong Kong etc. Perhaps the baleful truth is that in a global economy which is dominated by global capital flows, no economy entirely escapes unscathed when the developed world's banking systems are dysfunctional.
Ever since encountering the idea in John Greenwood's Asian Monetary Monitor (then of GT) in the late 1980s that a universally-distributed system of money market mutuals might allocated capital more effectively than commercial banks, it has seemed to me that commercial banks are a fundamentally unnecessary form of commercial activity. It has also been my belief that something like that must arise out of the ashes of this crisis. We are waiting.
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