Written by Nathan White, Chief Investment Officer of Paragon Wealth Management
Bloomberg reported today that the biggest U.S. banks are lending the smallest portion of their deposits in five years. The banks have been flooded with cash since the financial crisis of 2008 as people have sought to conserve cash and not borrow. Due to tighter lending standards, less credit worthy borrowers, increased regulation and capital requirements loans have not been exactly flying out the door. This doesn’t mean banks haven’t been lending but more that they are a lot more cautious and that demand isn’t what it once was.
The economy, while growing, hasn’t felt strong enough for robust lending to reignite…yet. Could this change? The economic
numbers, while not great, have been getting better and banks have significantly cleaned up their balance sheets and raised capital. The potential is there. While lending will probably not return to the levels of the past (at least for a while), it wouldn’t take much releasing of the spigots to keep the economy moving along and get better. It’s like a virtuous cycle where once confidence and conditions improve it creates a sort of self-reinforcing momentum.
Dare I say we could be entering a sort of boom or “normal” period? I know that sounds like heresy to so many and contrary to the gloom scenarios that having ruled the day since 2008 but I agree with James Paulsen of Wells Capital Management who says that the economy is now “gearing”.
As I have talked about before, the fly in the ointment is the Fed. As the economy strengthens it will have to reverse its easy money policy and shrink its tremendous balance sheet and these actions act as a drag on the economy. This is one of the reasons why I never liked so much QE and have always said that the Fed’s big test comes when they have to start reversing policy and whether they will have the guts to do it. For now the Fed is in no hurry to reverse course and with their stated target of 6.5% unemployment they could be very slow in the process of reversing course when that time comes.
Politically it will be difficult. That means we could enter a period where, with the aid of increased lending, the economy picks up for some years before the Fed finally takes away the punch bowl. That means that stocks and the economy could do well for a while before inflation forces action.