Credit where credit is due

A switch from liquidity to credit is under way in the US. The rest of us are not so lucky.

The chart below encapsulates the dichotomy between credit and liquidity which I’ve been thinking about for some time. I won’t go into the details but the key take-away here is that the more the Fed intervened with QE, which supported financial assets, the less room on bank balance sheets for real credit (loans). This is now reversing with QT. 

This has application in the geopolitical sphere. The rebalance of funding from liquidity to credit which is currently underway is the key driver of the strong dollar, and is the cause of the massive monetary tightening which is under way outside the US, caused by dollar strength. The US has the ability to ameliorate the switch away from liquidity through expansion of credit. This is a function of accounting identities – if Cash/Securities decline on bank balance sheets, then true credit (loans) must expand. Even though this is largely an identity issue, it does act as a (partial) offset to acute monetary tightening for domestic US borrowers.

The rest of the world may not have access to this offset, at least not in dollars. If you cannot control the US monetary balance sheet then any monetary expansion will weaken local currency against the dollar and undermine their ability to service dollar debt, or engage in dollar trade activity. Look at China, where the authorities have had to ease monetary policy in the face of Fed tightening but this flows through to the Renminbi, and suggests it may have a way further to fall. 

This line of thinking ties in with Biden’s recent further restrictions on chip technology to China. The USTR/State department actions and the Fed tightening are not overtly co-ordinated. The combined effect, however, is a massive reassertion of US dominance – and incidentally is terrible news for financial assets, but not necessarily so bad for the US economy. That means it is also terrible news for non-dollar economies, at least in the next few months – unless something breaks in the US monetary system. That’s another matter.