Last month we took sides in the ongoing debate about the Great Yield Curve Scare—we argued that the curve hasn’t flattened enough to deliver a strong recession signal at this point in time. We showed that the recent flattening is similar to those that occurred at various stages of the last nine business-cycle expansions, but usually before the midpoints. In other words, history places today’s curve in an early- or mid-cycle position, not late-cycle as commonly believed. We concluded that the recent flattening isn’t all that interesting as far as the business cycle is concerned.
Now we’ll broaden the discussion to consider a related indicator, one that we like because it looks directly at the bank credit cycle. Our bank credit indicator is worth watching, for two reasons. First, the latest readings are more interesting than the latest yield curve readings, as you’ll see in Part 2. Second, bank credit is arguably more fundamental to the business cycle than any other measurable piece of the economy.
If you’ve followed our recent work, neither of our two claims should surprise you. This isn’t the first time we’ve written about bank credit—we’ve occasionally tried to popularize a way of thinking about banks that’s distinctly unpopular, albeit consistent with certain heterodox schools of macro. In fact, this article is a companion piece to “An Inflation Indicator to Watch,” a follow-up to “Learning from the 1980s,” and we’re also drawing from our book Economic for Independent Thinkers. We’ll recap a few points from that earlier work here, but to make our repetition seem a little less repetitive, this time we’ll explain the points differently. Namely, we’ll ask you to picture yourself as part of the story.
See the Banker, Be the Banker
Imagine you’re an experienced banker who understands both the legalities of bank charters and the mechanics of loans, and you’ve been asked to prepare for a new assignment by refreshing your understanding of two big, broad and overlapping topics—the economy and the business cycle. You’ve cleared your schedule and holed up in a quiet room with only a stack of relevant books and papers, a thick pad of paper and your deep thoughts. I’ll call you IT, short for Independent Thinker.
Now imagine a second character, the CEO of your bank, whom I’ll call him BBM for Big Boss Man. BBM is the one who handed down your assignment and hopes to benefit from your preparations. One day, he knocks on the door of your room and asks if you wouldn’t mind fielding a few questions about how your bank fits into the big picture. Happy for the chance to put your growing pile of notes to good use, you hand him your latest sketch: