Living with contracting bank credit, by Alasdair Macleod

A credit contraction means a debt contraction which in turn means an economic contraction—at least a recession and probably a depression. From Alasdair Macleod at goldmoney.com:

In this article we look at the consequences of contracting bank credit on the economy, financial markets, and commodities. It is a developing global condition.

Why is bank credit on the verge of a substantial contraction? The starting point is record bank balance sheet leverage in the Eurozone and Japan, high bank leverage rates elsewhere, and a sea-change in the interest rate environment. In short, instead of being greedy for profits, senior bankers are now growing scared of risk and of their exposure to it.

The effect on the non-financial economy will be to cause nominal GDP to slump because every transaction that makes up GDP is settled through credit — nearly all of it is bank credit. Contracting bank credit will simply drive GDP into the ground.

But bank credit also drives financial activities, its long-term expansion having driven bond yields down, equities up, and expanding derivative markets to a $700 trillion monster. A credit contraction undermines financial asset values and associated derivative markets. This article looks at the inadequacies of Basel III regulations in this context.

Every ten years or so there is a banking crisis due to bankers attempting to reduce lending risk. Fourteen years since the Lehman failure, this cycle’s downturn is now overdue. The indications are that the cycle of bank credit contraction is just beginning…

Introduction

When Jamie Dimon spoke at a banking conference in New York and warned us that he was upgrading his economic outlook from stormy to hurricane conditions, we should have taken notice. It was probably the most important warning since Michael Burry shorted the 2007 mortgage bond market, and it came from not from an obscure trader, but the world’s most important commercial banker.

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