Eurozone Credit Contraction Accelerates
Bank Loans And The M3 Money Supply In The Eurozone Contracted At An Accelerating Pace In November, Raising The Risk That A Lending Squeeze Will Choke The Region's Fragile Recovery Next Year.

By Ambrose Evans-Pritchard, Telegraph,UK | 30 December 2009

The ECB has played down the decline in M3, believing that it reflects 'portfolio shifts' by investors. The European Central Bank said that loans to companies fell by a record 1.9% from a year earlier. The broad M3 money supply— watched closely as a leading indicator for the economy a year ahead— fell by 0.2% and has now been shrinking for several months.

Julian Callow from Barclays Capital said the decline in lending was steeper than expected and will cause the ECB to move with great care before withdrawing emergency stimulus. "This is the weakest data since the statistics began in 1970 and probably in the post-war era. It is a message about what is happening to the banking system, which is the lending nexus for the eurozone economy," he said.

Hans-Peter Keitel, head of Germany's industry federation (BDI), said there was a danger of a credit crunch next year as banks take fright at the ugly state of corporate balance sheets. He accused lenders of returning to their gambling habits— in some cases with state money— while refusing to roll over loans for companies with a good track record that have run into short-term problems. The Bundesbank is bracing for a second wave of the credit crisis as corporate downgrades by rating agencies forces lenders to set aside more money. Big companies in the eurozone have been able to tap the bond and equity markets, raising €130bn of fresh money in the first 10 months of the year.

However, smaller Mittelstand firms that form the backbone of Germany's export industry are often shut out of the credit system. Banks have chosen to restrict lending as they struggle to meet tougher capital rules rather than dilute shares by raising fresh equity or accepting the onerous terms of state support schemes. This has prompted harsh criticism from finance ministers, but Professor Tim Congdon from International Monetary Research said the authorities themselves are to blame.

"This is becoming ridiculous. How can banks raise capital asset ratios and lend more at the same time? These people are barmy," he said, comparing the new rules with policy mistakes in the early 1930s. But the longer the decline in M3 continues, the greater the concern. Mr Congdon said Club Med states will suffer the brunt of the ECB's restrictive policies. "Business surveys in these countries are getting worse, and so are property markets. Fractures in the euro system are becoming clearer by the day".

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Charles Goodhart Warns Of Return To Recession As Bank Lending Falls
The Contraction Of Bank Lending And The M3 Money Supply In The Us And Europe Over Recent Months Has Become A Serious Concern And Raises The Risk Of A Slide Back Into Recession, According To One Of Britain's Most Celebrated Economists.

By Ambrose Evans-Pritchard | 22 December 2009

Professor Charles Goodhart, a former top official at the Bank of England now at the London School of Economics, said policymakers have neglected the flashing danger signal of the monetary data. "What has happened to all the monetarists? Growth in money holdings and lending has plummeted. Thirty, or 40, years ago they would have been forewarning doom and destruction at this juncture, and casting anathemas at the authorities," he wrote in a consultant report for Morgan Stanley.

"There is a danger that markets and authorities become obsessed about the fiscal implications of the crisis at a time when the real worries should still focus on private sector access to credit and money." The exception is China, which has the opposite problem: monetary growth is running at 30% a year. Beijing will have to slam on the brakes soon. "When that happens the locomotive will slow, and probably reveal a string of non-performing loans; it has always been thus," he said. Prof Goodhart said it was too early for the world's central bankers to congratulate themselves for averting a slump.

The US Federal Reserve has stopped publishing M3, which covers a broad range of deposits. This may have been a blunder. The data gave advance warning of bubble trouble in 2006-2007, and again before the US economy crashed in late 2008. Some blame lies with Fed Chair Ben Bernanke, a New Keynesian openly scornful of monetarist thinking.

Reconstructed data shows that M3 shrank at an annual rate of 7.2% in the three months to November. Bank loans have fallen from $7.1 trillion (£4.4 trillion) to $6.75 trillion since the end of May. In the eurozone, M3 has fallen slightly since February. Professor Tim Congdon from International Monetary Research said credit contraction on both sides of the Atlantic has been the steepest since the 1930s, risking a slide into deflation next year.

Banks are tightening credit for two reasons: losses from the crisis, and tougher capital adequacy rules imposed by regulators. Mr Congdon said it is bizarre that the European Central Bank (ECB) seems unwilling to take steps to prevent a monetary implosion in these circumstances. Optimists say that "portfolio shifts" by investors may have distorted the M3 data. If so, there is little evidence in ECB or Fed reports that they have delved deeply into this issue.

They also argue that falling credit is benign because it reflects lower demand by borrowers, not a lending crunch. Professor Goodhart said this line of argument is "not terribly comforting". Businesses stop taking out loans when terms are punitive. The economy is damaged either way.

Mr Goodhart is best known around the world as the author of "Goodhart's Law", which posits that an indicator ceases to be much use once it becomes a target.