Econ Category #5: Money & Credit

 

“It takes considerable knowledge just to realize the extent of your own ignorance.”  

– Thomas Sowell

Howdy, gang!  Welcome back to another installment of Know Good Things!  I trust that all is well with you and yours and that you’re anxiously engaged in good causes.  Whether or not the markets are engaged in a good cause certainly depends on your individual trading strategies…and that’s for sure!  With the recent consolidation that seems to be developing it is beginning to remind me of the market climate prior to significant changes.  Case in point: take a look at the nine-month period just before the big selloff in 2008.  You’ll likely notice a nine-month period of consolidation followed by a rather tumultuous selloff, which was obviously spurred by several factors, but I digress.  The reason I mention this is because of historical precedents.  Prior to any major market reversal, there is usually an extended period of consolidation.  Go ahead and read that sentence again.  This is actually a good thing for individual traders/investors like ourselves because it gives us time to adjust and prepare accordingly. 

The previous five installments of Know Good Things have been an adventure in modern macroeconomics.  For those of you who have been following, I have been attempting to categorize and label the major economic reports in an effort to make this part of trading (economic analysis) more palatable and utilitarian.  This week will be spent on the fifth economic category, which is MONEY and CREDIT.

Money is the engine that drives the markets and it’s essentially the only reason anyone decides to get involved.  There are certainly cheaper hobbies than trading, but I’d also venture to say that if you’re treating trading as a hobby then the odds of your long-term success are likely going to be much lower than you’d like.  This is a business and (most) successful traders across the globe are pretty talented at treating their trading endeavors as a business. 

There are several ways to gauge the level of money, but the American way is to take a look at credit.  Consumer credit in the United States is something that is unparalleled by any other country.  What can I say?  We love to spend!  There happens to be a report that we can take a look at which will give us an idea of the monthly changes in the level of consumer credit and it’s usually released on the first Friday of each month (along with the Employment Situation report).  There are both positive and negative implications of an increase in consumer credit (an increase in the level of debt held by consumers) and I’m willing to bet that you can probably think of those implications on your own because they are kind of obvious.  Economic activity is stimulated when we borrow money (within our means) to buy cars, homes, and other significant purchases.  However, if we end up borrowing too much money (more than we can afford) relative to our income level then we’ll likely have to stop spending on new goods/services so we can focus on paying off the initial debts.  This decrease in economic activity usually leads to things cooling off in regards to our economy.

Interest rates are a major component of credit as it’s the primary method of income for lending institutions AND it helps regulate the overall money supply (which is a report issued on Thursdays).  Simply put, if demand for credit increases above the supply of willing lenders then interest rates rise.  If demand for credit decreases and the usual lenders are now fighting for customers then they usually try to attract those customers by lowering interest rates.  It’s a “teeter-totter” relationship, which…if you think about it will hopefully make sense.  On one end of the “teeter-totter” (also known as a “see-saw”) is demand for credit.  On the other end, we have interest rates.  When one end increases the other side decreases.

Consumer credit and bank credit reports are typically focused on by large financial institutions, but investors like to pay attention because it helps them have a greater understanding of consumer spending ability, thus giving them a lead on investment alternatives.  There is usually a significant lag between changes in consumer/bank credit reports as it relates to the markets, which obviously gives these reports the classification of a lagging indicator.

Bond prices are another form of debt that the markets pay attention to.  For the most part, bonds are the “safest” form of investment available because of their classification as a secured creditor.  The investment returns on bonds are usually rather low, which is a result of the relatively low level of risk involved.  Bond information (announcements) is distributed weekly with short-term bonds slated for Mondays and long-term bonds slated for Thursdays.  Again, the “teeter-totter” plays a role in helping with our understanding if we put bond prices on one end and bond yields on the other.  When one end increases the other decreases; when one end decreases the other increases.

All of the reports contained in this economic category (consumer credit, bank credit, bond announcements, bond yields, etc…) can be classified as being lagging and procyclical.  Bottom line, the information provided by most of these reports helps banks decide how scarce to make their available funds towards borrowers.  The market/economic implications are then derived from those lending decisions.

Be good.  Do good.  Know good.

Kleiny (@KnowGoodThings)

Columbus, Indiana