One week ago, we reported that UBS has some “very bad news for the global economy”, when we showed that according to the Swiss bank’s calculations, the global credit impulse showed a historic collapse, one which matched the magnitude of the impulse plunge in the immediate aftermath of the financial crisis.
But why is the credit impulse so critical?
To answer this question Citi’s Matt King has published a slideshow titled, appropriately enough, “Why buying on impulse is soon regretted”, in which he explains why this largely ignored second derivative of global credit growth is really all that matters for the global economy (as well as markets, as we will explain in a follow up post).
King first focuses on the one thing that is “wrong” with this recovery: the pervasive lack of global inflation, so desired by DM central banks.
As he notes in the first slide below, “the inflation shortfall isn’t new” and yet the current “level of credit growth would traditionally have seen inflation >5%”
To be sure central banks always respond to this lack of inflation by injecting massive ammounts of liquidity, i.e., credit, in the system: according to Citi, the credit addiction started in 1982 in the UK, while in 2009 it was in China. However, there was a difference: while in the 1982 episode, it took 3 credit units to grow GDP by 1 unit, by 2009 this rate had grown to 6 to 1. Meanwhile, central bankers “simply stopped worrying about credit.” That also explains the chronic collapse in interest rates starting in 1980 with the “Great Moderation” and their recent record lows: the world simply can not tolerate higher rates.
And while the central bank experiment had limited success in stimulating inflation, there was one obvious consequence: credit fuelled asset bubbles around the world.
This is where the credit impulse comes into play: it allows market participants to track the instantaneous change in central banks’ credit creation, and more importantly, The change in the flow of credit drives GDP growth.
The impulse is also important as it directs investor behavior as well, due to its correlation with asset prices.
Of note: courtesy of fungible money and equivalent, the effects of a credit impulse in one area promptly diffuse around the globe, as “Credit created in one place often drives prices elsewhere.”
Which, simply said, means that instead of looking at central bank, or credit creation, in isolation, it has to be watched in a global context. And here is the important part: as Citi concludes, “we’ve just had the biggest surge in the post-crisis era”…
… and yet the central bankers’ holy grail – inflation – remains low.
In a follow up post we will show momentarily what, according to Citi, happens when the credit impulse turns negative as it just did.
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