Not a Pretty Picture – Lending to Businesses Down Again…

Today the Bank of England published its trends in lending dataset. Unfortunately it doesn’t make for pleasant viewing.

The chart above outlines the ‘three month annualised growth rate’ of lending to individuals and businesses in the UK – in effect it shows what the yearly growth rate in lending would be if the rate over the last three months remained the same for the rest of the year.

The chart shows that lending to businesses has fallen almost every month since mid 2008. Towards the end of 2011 it looked as though this trend was reversing; however since then bank lending to businesses has dropped dramatically and with it any chance of an economic recovery. Small businesses are particularly hard hit by lower bank lending (if it is a supply rather than demand issue), as they are unable to access capital markets. Even including capital markets (see the chart below) does not change the overall negative outlook – businesses just aren’t investing. Meanwhile banks have continued to increase lending for house purchase and consumption, albeit at reduced rates.

This creates a problem. Economies, like individuals, repay their debts by earning. For example, an individual may borrow from a bank to buy a house. Unlike a business loan (where the debt is paid off by profits from the investment the loan funded) a house does not help you repay your debt – it does not produce additional goods and services which you can sell. This is the reason purchases of pre-existing houses do not contribute to GDP – it does not create new wealth.

Because it does not earn an income itself, the house must be paid for by some other activity (renting a house out just shifts the problem of the debt onto someone else). For most people this means having a job or owning a business. This is why the drop in lending to businesses is so worrying. While the debt of the economy continues to increase (through both home and consumer credit purchases) the ability to pay off those debts is decreasing: Firms are investing less, which leads to lower profits, job creation and growth. Lower income for the economy as a whole means less money with which to pay off debts, and a greater proportion of income spent on debt repayment.

The problem of business investment and debt repayment is exacerbated by government austerity measures and the strengthening of the pound vis-à-vis the euro on the forex markets, making British exports more expensive in Europe and European imports cheaper in the UK. (The pound’s strength is incidentally more of a symptom of the problems in Europe as opposed to any strength in the UK economy.)

What this means for the UK economy is uncertain, but eventually something has to give. Increases in ‘unproductive’ debt cannot go on forever: the percentage of income given up to debt repayment can only go so high. Furthermore a proportionally greater percentage of income devoted to debt service means less income spent on goods and services. Lower demand for goods and services means lower employment and lower investment by firms, and even greater difficulties in paying down debt. Eventually in this system defaults become inevitable, and with it debt deflation and recession.

Of course, all this assumes we stick with the current monetary system. The implementation of Positive Money’s reform proposals would instantly allow austerity to end or taxes to be cut, either of which would increase demand for goods and services and so incentivise investment by businesses. What’s more, debt free money would allow the overall debt burden to be decreased without a corresponding shrinking of the money supply.