Commercial Loan Growth Signals at U.S. Economic Recession 2017 Ahead
U.S. Economic Recession 2017 Is Hard to Predict, But This Indicator Is Right Every Time
Trying to predict the likelihood of “U.S. Economic Recession 2017” with traditional indicators is notoriously difficult. The data ebbs and flows in a way that makes false positives inevitable. The U.S. economy is so diverse that even five or 10 important indicators all pointing in the same direction can still lead to false hope (or fear). Using Federal Reserve parlance, economic data is often “transient” and can shift direction quickly.
But this key indicator, commercial and industrial (C&I) loans growth, is different. It has flawlessly predicted the last eight U.S. recessions since 1960, with Swiss-watch-like precision. If this indicator is right yet again, an upcoming U.S. economic recession 2017 could pop the stock market valuation bubble in ear-splitting fashion.
You may be asking yourself: “What makes stalling C&I loans a sign of recession in 2017? Why is this data more predictive than, say, U.S. employment or consumer price index (CPI) data? In my opinion, the answer is twofold. First, it’s not subject to data chicanery and manipulation seen in U.S. Employment data (i.e. the birth/death model, not counting people who have given up looking for a job) or CPI data (what really counts in inflation statistics anymore?). Second, it’s unadulterated confirmation that, without constant credit expansion, the economy will implode. Plain and simple.
That’s precisely why the Federal Reserve has been so reluctant to raise interest rates. They understand that, once borrowing costs increase, borrowing demand wanes and then it’s game over for the business cycle.
The quagmire of “pushing on a string economics” comes full circle when the bill gets presented. Nine years after the U.S. housing bubble, the Federal Reserve has only started to tighten its fiscal policy. The Fed has been doing it reluctantly, having more to do with paring its huge Treasury Security balance sheet than with quelling an overheating economy (which is still not meeting its inflation mandates).
It doesn’t matter why. The fact is, meaningful commercial and industrial loans growth hasn’t happened in more than 30 weeks, which is probably long enough to surmise that growth has stalled. At the very least, we’ve hit an inflection point where, if no major demand surfaces, odds of contraction or stagnation are inevitable. C&I growth was down to 1.6% for April, which is down from seven percent month-over-month growth at the beginning of 2017. If the current rate of deceleration holds, loan growth contraction will soon be negative. (Source: “U.S. Weeks Away From A Recession According To Latest Loan Data,” Zero Hedge, June 11, 2017.)
They say a picture is worth a thousand words, so here’s visual proof of how predictive the C&I loan metric has been throughout the years.
The scary part about the above chart is that it shows that the issue is not if contraction will happen, but how far it can go.
In each recession leading up to 2008, C&I growth has contracted by greater amounts, compensating for the imbalances of larger credit growth from the preceding expansions. For example, in the 1990 recession, total peak-to-trough C&I growth fell around 9.02%; in the 2001 Tech Bubble recession, total peak-to-trough C&I declined 21.14%; in the 2008 U.S. Housing bubble, total peak-to-trough C&I cratered 25.31%.
See the trend here? The rollback in loan growth gets sharper with each passing recession, as the credit bubble keeps expanding. Not only is more credit being force-fed into the system, persistently-low interest rates are providing a push for demand, which is no doubt fueling large misallocations of capital. Things that shouldn’t be getting built are getting built; companies that should go bankrupt are staying alive. It’s making the economy less productive and efficient over time.
Declining C&I Loan Value a Sign of U.S. Economic Recession 2017
Nowhere has C&I loan expansion in America been more evident than in the retail sector. Many of the real estate loans doled out to build retail space are on a one-way ticket to failure. What’s happening is an apt template of what other sectors will face if “U.S. Economic Recession 2017” comes true.
Credit Suisse AG predicts that store closures in 2017 will surpass anything in recent memory. Urban Outfitters, Inc. (NASDAQ:URBN) CEO Richard Hayne acknowledges that the U.S. has several times more retail space per capita than Europe and Japan. The reason: Low cost of capital allowed retailers to build tens of millions of excess square footage before companies like Amazon.com, Inc. (NASDAQ:AMZN) started stealing their market share. (Source: “CEO: ‘The Retail Bubble Has Now Burst’. Which Retailers Are In The Most Trouble?,” PrivCo, April 18, 2017.)
In related fashion, commercial real estate loans are taking a hit. Both mortgage-backed securities (MBS) and commercial mortgage-backed securities (MCBS) rates have reached their highest level since 2015. This is starting to trigger payment delinquencies. The average asking rent has fallen to the lowest levels since 2011, reflecting the weak negotiating position that commercial property managers face. Stagnant demand combined with pervasive overcapacity make poor bedfellows.
In any event, ultra-low interest rates for almost a decade have allowed this to unfold. As previous recessions have ended artificially early due to government stimulus programs and cheap credit, the problem keeps getting worse.
Even worse, the government is not in a position to bail out the system this time around. The U.S. deficit is more than $20.0 trillion and counting. Government partisanship is getting increasingly bitter. The Federal Reserve is holding $4.46 trillion in balance sheet reserves, which is five times higher than before the 2008 recession. It seems unlikely that the Fed has the ammunition to launch an additional Treasury security buying spree (aka quantitative easing) to keep interest rates down. Public support for yet another perceived Wall Street bailout is extremely low.
These are just a few reasons why the next contraction is worrisome. The government will surely use the same playbook to divert the next U.S. recession. It’s doubtful that they will allow widespread foreclosures, commercial bond defaults, bankruptcies, spillover consumer delinquencies, et al. to rule the day.
But when they attempt to rescue they economy again with larger iterations of quantitative easing or the Trouble Asset Relief Program (TARP), how will it affect the U.S. dollar? Will the credit crisis downgrade of 2011 re-emerge? Remember, the S&P’s credit downgrade was debt-related, and the U.S. is about $6.0 trillion more in the hole than before, with more political turmoil and a raging stock market bubble.
To say the situation is troubling is an understatement.
Why the Next Recession Will Be Worse
Not only does the low amount of commercial bank loan creation accurately signal that a recession is coming, it accurately signals the recession’s severity. America’s last three recessions (1990, 2000, 2008) are a testament to this, because they were largely fueled by debt. Each successive recession has been more severe and has required more government intervention to stave off collapse.
In response to the 1990 recession, the government didn’t have to do anything at all. It was among the shortest and least severe recessions on record. There were some notable pockets of construction overcapacity that needed to be cleared, but clear they did. By 1993, the growth had returned to 1980s levels and continued unabated for the rest of the decade. As stated previously, peak-to-trough C&I growth contracted by just over nine percent; a total that was effortlessly absorbed by the economy.
The Tech Bubble recession of the early 2000s was also quickly brought to heal. But it took 11 Federal Reserve interest rate cuts to do it. C&I loans peak-to-trough more than doubled to 21.14%. Fed interest rates were brought to their lowest levels of the post-gold standard era, in a desperate attempt to stimulate new demand to counteract defaulting commercial credit excesses in the system. They succeeded, but it was also the advent of “bubble economics” as we know it today. Interest rates must be maneuvered lower in order to stimulate demand and keep debt service payments low, or it all blows up.
The U.S. housing market-related recession was the next bubble that was fueled by easy credit and financial gimmickry. Consumer and commercial credit growth exploded on the back of easy lending standards and rates which took years to normalize. Loans were given to anybody who could fog a mirror. When it all blew up, this recession was the longest on record. It took a $2.0-trillion-plus TARP bailout and emergency-level interest rates (still in place today), to stop it. At its lowest point, total peak-to-trough C&I cratered 25.31%.
Where are we going with all this? While correlation is not causation, the trend is unmistakable. The boom/bust cycles are getting more extreme, caused by copious amounts of credit growth. Then there’s a fall in credit growth demand once a recession hits.
Under such circumstances, one would expect credit expansion to level off. But that’s not happening. Loans are still being given out, misallocated to non-productive investments. In other words, the debt monster needs to be fed, no matter what it takes. This will obviously end badly once the bill is due.
Ultimately, should C&I loan growth contract by 30% or more in the inevitable financial crisis 2017 (or beyond), the business landscape in America is going to get downright scary. It won’t be simply excess retail space purged from the system. Factories will close by the thousands; dozens of banks will fail; established, recognizable companies will go belly-up.
It’s really just simple mathematics at this point. The effects of U.S. economic recession 2017 will really hit home. Even if the government is able to muster another historic stimulus program to stabilize things, adverse consequences will occur. Many private-sector jobs will get destroyed, or perhaps the dollar or U.S. credit rating will get hammered. With equity market valuations through the roof, it’s doubtful that this will end in anything but misery for U.S. stocks.
As the old Chinese proverb goes: May you live in interesting times. Obviously, these wise men never worked in retail.