For those wondering whether there really has been a significant cut-back in bank lending, one need not look any further than the present relationship between the financial industry’s “monetary base” and the “money multiplier”. Since neither of these are household terms, let me explain… As the Central Bank pumps money into the banking system, as they’ve done since the economy jumped off the cliff, it increases the monetary base. Since banks are allowed to loan out up to nine times their reserves, the loaned out money “multiplies” through the economy as it gets used to run businesses, buy inventory, hire workers, etc. This is the “money multiplier” measure. The chart below clearly shows where the money is:
- The Monetary Base is UP, and the Money Multiplier is DOWN
According to Liz Ann Sonders, Chief Investment Strategist for Charles Schwab:
- “Increases in central bank money do not necessarily result in commercial bank money because the money is not required to be lent. Whereby the withdrawal of central bank liquidity necessarily compels commercial banks to pare back lending, the provision of central bank liquidity does not necessarily compel commercial banks to lend. If indeed it isn’t lent, it can result in the growth of excess reserves—characteristic of the present environment.” In other words, just because we have propped up the banking system to keep it afloat doesn’t mean that they now need to lend out the money.”
In all fairness, high bank reserves is characteristic behavior following a deep recession. The good news is that as long as the Money Multiplier is low, there is little risk of high inflation. As long as inflation remains low, interest rates should also see little upward pressure.
As I said in my last post, the ultimate performance of this year’s Lamorinda real estate market will be highly dependent upon bank liquidity and their willingness to loan money for consumer home purchases. This isn’t just an “upper market” problem, rather an issue for buyers across all price points.
When trying to forecast the coming year for Lafayette real estate, or anywhere else in Lamorinda, the journey starts with the beginning of the money trail… our financial system.
