Mind the Gaps


It sometimes is useful to comb through data – not to cherry pick and not to confirm one’s beliefs, but to uncover things that might jar interest. The Bank for International Settlements (BIS) is a rich repository for such data, and ideally suited to be, given its role as “the central bank to central banks”, sitting in traditionally impartial Switzerland.

A useful measure the BIS compiles is its credit-to-GDP gap calculation, which looks at the “difference between the credit-to-GDP ratio and its long run trend”. The gap calculation is a useful measure to ascertain whether an economy is vulnerable to an “over-heating” in domestic credit growth, and a possible bubble expansion.

The measure, by itself, is limited, and offers no direct insights into the health or vulnerability of the existing credit aggregates. This is an important distinction. Yet, the credit-to-GDP gap measure offers a proactive, if not always predictive, read on a country’s trends in credit growth.

So much so, that the BIS extols the measure, “as a common reference point under Basel III to guide the build-up of countercyclical capital buffers.” Or, when to gross up capital in anticipation of bad times.

The chart below offers a snap shot in the credit growth trends among the world’s four largest economies from QIV 1995 thru QII 2019.

Taking a look at credit-to-GDP gap calculations over the roughly past twenty years tells an interesting story – one about credit extremes and vulnerability.

We can see the fever and trauma of the US financial crisis where credit growth far exceeded its trend line prior to 2007-2008, then crashed abruptly. The pace of credit expansion still remains below the established US trend.

We can also see a similar but still distinctive path traced in China.

There, one can see an earlier downward slide during the early 2000’s, followed by recovery, then a downslide again with the onset of the Global Financial Crisis (GFC). Official priming of the credit pump became more manifest in the wake of the GFC, but the Chinese authorities began tapping the brakes on credit expansion during these past few years, bringing a slowdown and below trend performance.

What’s also interesting to note are how credit-to-GDP gap measures have been unfolding for both Germany and Japan. Both countries show evidence of a steady secular expansion in domestic credit during the past decade – not too fast, but an ongoing increase, perhaps. It’s something to watch.

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