I have argued that whilst the destruction of wealth represented by the falling stockmarkets will surely have malign economic consequences, they were not themselves responding to problems or excesses in the global economy which would be predictably resolved by a business cycle downturn. Rather, those falls were generated by a contraction of cross-border bank lending which ultimately had its roots in the surge in the dollar during 2Q14. The fall in cross-border financing acts on reserve money in just the same way a contraction in central bank lending to the financial system does. It is this unrecognized monetary crunch which toppled stockmarkets, with the worst impacts being felt precisely in those economies (and stockmarkets) which had previously benefitted most from the previous rise in cross-border lending. In practice that meant emerging markets, and China in particular.
The Bank for International Settlements data has the widest record of this, and it shows net cross-border claims on banks dropping by US$748bn to just $496bn between 3Q14 and 3Q15.
The impact was muted for developed country banks, net claims fell by only $185bn to $1.243tr, but for others, net claims dropped $563bn to result in a net liability of $747bn. This hit to ex-developed country banks was only partly offset by a continued rise (of US$190bn) in net claims on non-bank borrowers in the same period. Overall, however, net claims on countries outside the ‘developed’ definition fell by US$373bn - or by just over half - to US$371bn at the end of 3Q15.
A couple of things strike me visually concurrent and also what you’d expect: the direction of the flows mirrors the strength and weakness of the dollar/SDR. When the dollar strengthens mid-2011 to mid-2012, and again mid-2014 to early 2015) cross-border claims tend to diminish; when the dollar stabilizes or weakens, cross-borders lending picks up once again.
Because my global Monetary Conditions Indicator (excluding China) includes direction and volatility measures of movements of the US dollar (as well as monetary aggregates, real interest rates and yield curve measures), it is not surprising that there seems to be a good relationship then, between that and the movement of total international bank net claims on the the world (ex-developed countries).
The BIS’s data is invaluable in tracking this fundamental stress which finds expression in financial markets, but it is slow arriving - the latest data runs only to September 2015. To work out the degree to which those stresses are persisting, intensifying or retreating we need faster data. I have three suggestions:
- direct observation of foreign assets and liabilities of developed-country bank balance sheets;
- movements in my global monetary conditions indicator;
- activity in credit default swap markets.
1. Developed Economy Bank’s Foreign Assets/Liabilities
The most direct indicator of the trends in cross border lending are, of course, movements in the net foreign assets or liabilities of developed economy banks. Although obviously less complete than the BIS’s survey, they are updated far more quickly. Looking at these balance sheets, we find two main sources for the drain in cross-border lending: the Eurozone, and, specifically, Hong Kong’s lending to China.
Eurozone Stress, the Big Unfinished Factor
As the chart shows, the net foreign asset position of the Eurozone’s banks has been in sharp and almost continuous contraction since the middle of 2014. In July 2014, the Eurozone banking system’s net foreign asset position hit a peak of US$1.917tr, but by January 2016 this had shrunk by US$481bn to US$1.437bn. There is no sign that this contraction has yet come to an end. Moreover, it is a mistake to view this contraction purely as a function of the 19.8% fall in the Euro against the dollar during this period: first, because it is a net figure and the fall in the currency affects both foreign assets and liabilities similarly; second, although Sterling has suffered a similar fall during the same period (down 15.5%), there has been no similar sustained run-down in foreign assets from London’s banks. Rather, this sustained fall in Eurozone banks’ net foreign assets represents a genuine disentanglement of Eurozone banks from ex-Eurozone finance. The data up to January contains no suggestion that this withdrawal has been completed. Anecdotal evidence and the demonstrated travails of the Eurozone banking system (loan growth of 0.1% yoy in Jan 2016) also give no obvious reason to expect an early reversal.
Hong Kong & China Finance. The second source of stress is the way in which Hong Kong’s financial system has pulled in credit lines to China - a contraction which has been far stronger than the overall fall in its net foreign asset position. I have written about this previously, but to summarise: between June 2014 and NOvember 2015, Hong Kong banks’ net foreign asset position fell US$47bn to US$253bn. This was a relatively modest reversal in trend, but hides a much more extreme reversal in its China position: between June 2014 and November 2015, the banking system’s net China assets fell US$247bn to just US$90bn. I expect by now that net total has already fallen to zero, or possibly less.
By contrast, the US banking system shows a fall in net foreign liabilities which is the counterparty of the fall in other banking system’s net foreign assets. Between July 2014 and December 2015 US banks’ net foreign liabilities fell by US$338bn to US$1.93tr, as gross foreign assets fell by US$27.6bn, but foreign liabilities fell by $395.6bn. We have data up to the end of 2015, and there is no obvious change in the trend.
Finally, we come to Japan, for which we have the data up to the end of 2015. This shows the familiar run down in net foreign assets between July 2014 and June 2015, although it was a relatively small affair - the contraction was only US$42.9bn. However, uniquely, that was subsequently reversed, and the current US$269bn in net foreign assets held at end-2015 is almost identical to the total held in July 2014. Small though the movement is, this is the only banking system I can find where foreign asset holdings are actually now rising.
2. Global Monetary Conditions Indicator
As we saw in the chart above, inflection points in my global monetary conditions indicator do seem to have coincided with similar inflection points in total cross-border financing flows. It is therefore worth noting that the decline seen between summer 2014 and sustained throughout 2015 does appear at least to have bottomed out - although it is too early to be certain it is inflecting upwards.
3. Credit Default Swaps - Weekly to end-Feb
The final indicator which may be worth watching is movements in the notional amount of credit default swaps outstanding. The data is timely and delivered weekly from the International Swap Dealers Assn, but has its own difficulties: responding to regulations which demand increased capital accounting for these products, the industry has adopted various ways of ‘compressing’ the notional outstanding balances, essentially by writing down the notional amount of matching or offsetting swaps outstanding in tranches as the cashflows materialize. As this has progressed, since the overall trend has been for the notional outstanding to fall by approximately 17% a year.
However, when detrended, the movements against trend shows the characteristic movement seen in cross-border lending, and in particular, the sharp fall against trend since the middle of 2014, which has been sustained until now.
After a particularly harsh fall at the end of the year - almost certainly in response to the approach of the end of year balance sheet - there has been something of a recovery in January and February. In fact, the middle of February saw the break above trend since December2014. Probably not too much should be read into that just yet: it may well just represent a rebound
infrom the unusually sharp falls of December. Nevertheless, I think this total is worth watching, since a sustained rise vs trend is a plausible early-indicator for a broader recovery in cross-border finance.
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