The Real Monetary Policy is Extremely Expansive

While economists on Wall Street are whining about fed tightening, the REAL monetary polcy is extremely expansive. As you can see in the chart below, from the current issue of US Financial Data, commercial and industrial loans are soaring, reaching $939.1 billion last week. That’s up $70 billion from their lows last May.

A good friend, who is also about the smartest man there is on the leveraged lending market, tells me this is the tip of the iceberg. Banks now make up only 25% of the business loan market. The other 75% of business loans is provided by non-bank leveraged lenders, who ultimately package and sell their product to mutual funds, hedge funds, and insurance companies. These buyers are so hungry for yield they will eat anything today, so much so that big lenders have changed their internal operating procedures to all but ignore credit risk. Stay tuned for the back side of this story in about 2 years. Not going to be pretty.

This is important because most people think of Fed policy as the Fed funds rate through a sort of loan market equilibrium. It is not. Monetary policy works primarily by creating periodic disequilibria in the credit markets, which causes fits and starts in credit availability.

Wicksell, Keynes, and Fisher all knew this. Non-price rationing, not price, is what clears the market. These episodes are examples of the system failure behaviors encountered in nonlinear dynamical systems, which draws on the far-from-equilibrium physics work of Ilya Prigogine.

The Fed lowered the funds rate all through 2001 and 2003, to a chorus of analysts writing about Fed easing. All the while Banks were restricting credit, which drove business loans on bank books down by $230 billion through last May. That’s why the ‘jobless’ recovery was so slow.

Now they are talking about Fed tightening. Since May, however, when the mortgge refi boom ended, banks are lending again, up $70 billion so far.

That’s why the economy, jobs, profits, and stock prices in 2005 will grow more than analysts think.

JR