Deflation Watch pt 152

Generali

The new bank lending figures from the BoE are released today:

http://www.bankofengland.co.uk/publications/other/monetary/TrendsAugust10.pdf

The short version is lending to consumers for mortgages and consumption was about flat.

Lending to businesses was down 8.1% on the year or £3,500,000,000 on the month (seasonally adjusted).

That compares to business lending increasing by 16.7% in 2007 and 17.5% in 2008.

michaels

I think we have seen a shift in the shares of economic output away from labour and towards capital (eg much higher levels of profitability with stagnant / falling real wages). Business are therefore flush with cash and thus less in need of bank credit, and simultaneously seeing a bleak future for consumption and so wary of using capital to invest - hence instead paying down debt.

Be interesting to see how this rich world 'problem' is balanced by the inflationary pressure of raw material price increases and wage pressure in the developing world. I guess classical theory would suggest a shift in terms of trade will bring equilibrium which will be at the cost of real incomes in the 'rich' world.

Generali

michaels wrote: »

I think we have seen a shift in the shares of economic output away from labour and towards capital (eg much higher levels of profitability with stagnant / falling real wages). Business are therefore flush with cash and thus less in need of bank credit, and simultaneously seeing a bleak future for consumption and so wary of using capital to invest - hence instead paying down debt.

Be interesting to see how this rich world 'problem' is balanced by the inflationary pressure of raw material price increases and wage pressure in the developing world. I guess classical theory would suggest a shift in terms of trade will bring equilibrium which will be at the cost of real incomes in the 'rich' world.

Don't forget that money is basically free right now, in fact once you take inflation into account banks can be paying you to borrow.

I think there is a shift in the terms of trade going on away from the West to the East. A big part of that are the massive non-wage costs that Western economies are saddled with. The money the workers in my other thread are asking for wouldn't cover the cost of the NHS to the average British worker I wouldn't think, let alone the rest of the welfare state and infrastructure that Western workers and companies have to pay for before they make a profit.

Generali

M4 money supply figures are out again. There is a tiny glimmer of hope in there, although year-on-year numbers are down again, almost to zero:

http://www.bankofengland.co.uk/statistics/m4/2010/jul/provm4.pdf

Seasonally adjusted provisional figures for July are as follows: M4 increased by £9.4 billion (0.4%), compared with an average monthly increase for the previous six months of £2.0 billion. The twelve-month growth rate fell to 2.3% from 3.1% in June.

M4 lending decreased by £11.6 billion (0.4%) in July. The twelve-month growth rate fell to 1.6% from 2.3% in June.

M4 lending (excluding the effects of securitisations etc.) decreased by £11.5 billion (0.4%) in July. The twelve-month growth rate fell to 0.5% from 1.3% in June.

(my bold). More QE? Perhaps however don't forget there are limits to the effectiveness of QE.

The way QE works is that by taking debt out of circulation and replacing it with cash it reduces the cost of money by increasing its supply. However, the cost of money can only fall so far because banks need to make a profit and they have certain costs to cover on top of that. Once banks are lending as cheaply as they can, a point I think we've reached hence M4 growth falling, then QE stops working as the extra money isn't lent out so it doesn't enter the money supply.

To use an anology I read recently, imagine the Government giving greengrocers some apples to sell. At first, the price of apples will fall as all the grocer has to do is set a price to turn a profit. The falling price means sales will increase. However you will reach a point where people are buying all the apples they want at the reduced price so if the Government delivers increasing numbers of apples to the grocers, they will just sit on the shelf slowly rotting.

The same happens with QE in the end; people and businesses will be borrowing all that they want at low rates so extra QE just sits in bank vaults, not adding to the money supply.

tomterm8

The next move would be operation twist, where you target long term interest rates rather than short term interest rates. Which is what I guess will be announced soon. Either way, I am surprised the bank of england is talking about inflation being a problem, when the money supply data looks like disinflation is in the future.

michaels

Interestingly despite no further QE in the last few months tracker mortgage rate spreads and instant access savings spreads over base have drifted down from about 2.5% to about 2% - may be people's tastes are changing and they are willing to eat more apples after all?

Generali wrote: »

However, the cost of money can only fall so far because banks need to make a profit and they have certain costs to cover on top of that. Once banks are lending as cheaply as they can, a point I think we've reached hence M4 growth falling, then QE stops working as the extra money isn't lent out so it doesn't enter the money supply.

michaels

If you managed to push 10 year money down from 3% to 2% would business really decide to invest more?

tomterm8 wrote: »

The next move would be operation twist, where you target long term interest rates rather than short term interest rates. Which is what I guess will be announced soon. Either way, I am surprised the bank of england is talking about inflation being a problem, when the money supply data looks like disinflation is in the future.

Generali

michaels wrote: »

Interestingly despite no further QE in the last few months tracker mortgage rate spreads and instant access savings spreads over base have drifted down from about 2.5% to about 2% - may be people's tastes are changing and they are willing to eat more apples after all?

Maybe. I think that reflects increasing competition as lenders that had all but shut down look to gain some market share.

Presumably, a taste for more apples would be reflected in people borrowing more money.

tomterm8

michaels wrote: »

If you managed to push 10 year money down from 3% to 2% would business really decide to invest more?

Well, with the inflation rate where it is, at a 2% long term interest rate, if you simply take the money and put it into a business that produces a nominal return, you would still make money. So, frankly, if moving from 3% to 2% over 10 years doesn't kick start corporate investment, then it is hard to see what else can.

Generali

tomterm8 wrote: »

So, frankly, if moving from 3% to 2% over 10 years doesn't kick start corporate investment, then it is hard to see what else can.

My fear is that is the problem. If you can borrow money secured as a consumer for 4.89% fixed for 7 years from HSBC (link) and still have 2,500,000 unemployed then what is going to get the country moving again?