Cash and money: conclusions (part 4 of 4)

Part 4 of 4

If we consider the nominal growth rate of credit in the USA against the growth in nominal GDP, it is apparent that we have re-entered a credit bubble style process, which this time round relates to intra-financial system credit flows and corporate decision-taking.

Thus, in 2006, credit creation was associated with CDOs but today it is the repo markets that seem to be at the root of the credit creation process, and it is these markets that are recycling the central banks’ various liquidity injections on into the asset markets.

Unfortunately, the repo credit system is almost as opaque and under recorded as was the case with mortgage-related products in the mid 2000s and hence it is difficult to discern the true extent of this latest credit boom.

It is however important because just as has been the case on previous occasions in many countries, intra-financial system credit booms and the mis-allocations of capital and labour resources that these create are likely be to the detriment of the underlying fundamentals of both the global economy and those companies that over-focus on the pursuit of near term stock price gains at the expense of long term business prospects.

History suggests that while a credit driven asset price boom process is in place, longer term considerations are usually ignored, with the result that markets can rally even as the state of the underlying economies remains risky and uncertain.

An interesting feature of the current global credit-driven asset price boom is that there appears to be a relatively small number of major players providing the necessary credit.

While this concentration of power in the hands of the relatively few may create more intense week to week levels of volatility as the emotional and practical positioning of these bankers shift, we may also suspect that the key decision takers are likely to be extremely well connected to today’s policymakers.

Indeed, if we assume that Mr Bernanke is the key influencer, then it may follow that investors should not be overly negative in the immediate future in response to any poor economic data or bad news from Europe, unless the news flow is really so terrible that it outweighs even Mr Bernanke’s ability to encourage the key banks to continue aggressively recycling the funds that he has created via QE into more financial sector credit growth. It follows that we must continue to monitor carefully these types of credit flow.

For the longer term, we must worry that the financial system is building more trouble ahead, but for now it is likely that as with Japan in the mid 1990s, the major asset classes will fluctuate in broad trading ranges, albeit ranges that could be broken to the downside if or when the credit booms finally dissipate. We therefore must remain focused on quality and exposure to reliable stable business and assets. As for a possible catalyst for any break downwards, the fate of the Euro is the most obvious candidate, but we must also monitor for the risks of a protracted slowdown in China which would affect global growth trends, particularly whilst de-leveraging developed economies remain weak.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla