| Dear fellow macroeconomists and monetary analysts, Developments so far in the 2020s confirm the importance of money growth trends to inflation. The current video therefore approaches the subject in the same way as our regular monthly survey, by looking at the latest news on banking and money in the world’s six largest economies. The word “challenging” has been used frequently by businesses when asked about current market conditions in their economies. That seems logical and unsurprising given the monetary background. If India is put to one side because of the supply-side dynamism (and approximate double-digit annual money growth) it now enjoys, every other country/jurisdiction in the list we track reports an annual rate of money growth in the single digits. Indeed, all the developed countries – the USA, the Eurozone, Japan and the UK – have an annual rate of money growth in the low single digits. China still has annual money growth of about 7½%. But the Chinese number compares sharply with that typical in the past four decades, when the annual rate of money growth was consistently in the double digits and often over 20%. The implication is that 2025 will be a slow year for the world economy, with beneath-trend growth more likely than trend or above-trend growth, and further downward pressure on inflation. On the other hand, outright recessions are implausible because central banks have ample room to reduce interest rates. The obvious question is, “why is money growth so low?”. Part of the answer is that central banks raised their interest rates in 2022, and the increase in rates deterred some kinds of bank credit, notably residential mortgages. But perhaps more fundamental is that commercial banks are anxious about their capital positions. This anxiety takes different forms in different places. In the USA bank capital was badly hit in 2022 and 2023 by the effect of the rise in bond yields on the values of their available-for-sale securities and some other assets. The chart below shows % changes in US commercial banks’ equity capital on a year earlier, going back to the 1980s. The salient feature is that the reduction in such capital in the year to the third quarter (Q3) of 2022 was larger than in the two other periods of stress in the 40-year period.  Specifically, the reduction in equity capital in that three-quarter period – of $195.3b. or 8.3% on an equity capital base of $2,357.4b. at end-2021 – was larger than in the last three quarters of 2008 – of $65.2b. or 4.8% on an capital of $1,360.8b. at end-Q1 2008, or than in Q2 1987 – of $10.3b. or 4.2% of capital of $244.5b. at end-Q1 1987. (The first three quarters of 2008 were during the Great Financial Crisis, and the second quarter of 1987 was the quarter most affected by banks’ recognition of losses on sovereign loans to Latin America and elsewhere.)The facts here require further discussion. Anyhow the US authorities – including the Fed – deserve some applause for minimizing both public concern about and the macroeconomic impact of the losses responsible for 2022’s reduction in bank capital. But it does seem likely that the capital hit is one reason for the slow growth of US banks’ risk assets – and hence of broad money – in recent quarters. In qualification, US banks were profitable in 2023 and 2024, and in Q3 2023 their equity capital was almost 13% higher than two years earlier. What about banking system capital elsewhere? Official data published by the European Central Bank (for so-called “significant institutions”, where these are subject to the Single Supervisory Mechanism) indicate robust health. According to the data, these institutions had no quarter of loss in the 2020s, and their return on equity has been above 9% for every quarter since the start of 2023. At least arguably, there is a puzzle about the apparent discrepancy between the US and European banks. However, analysts are not supposed to quarrel with published data, and the message is that – if interest rates come down – Eurozone banks would be expanding loan books and adding to their deposit liabilities, and doing so at a brisk rate. As always, the money growth figures need to be watched. In the three months to November Eurozone M3 went up by just above 1.5%, or at an annualised rate of 6.2%. The UK is in a more difficult position. The problem is symptomized by the announcement that Santander Bank is disappointed by the returns on its British operations, which are mostly in mortgage lending and retail deposit-taking. They seem to be weary with the cost of excessive regulation and the business environment more generally. The UK banking system has been hit, for example, by the recent legal decision – widely viewed as arbitrary and against precedent – on incentive payments for car loans. The cost to the system of this decision has been variously estimated at between £8b. and £30b. The figures may seem modest compared to total capital, since the Q3 2024 number for UK Common Equity Tier 1 capital was £460b., but some banks were particularly active in car finance and the damage to their balance sheets is severe. The usual assumption in this area of public policy is that banks’ return on capital is so ample that they will want to retain from profits and grow their businesses, and in the process they will grow loan portfolios and their deposits (which are money). But that is not necessarily so. If returns to equity are inadequate, shareholders will want to deploy capital elsewhere. (HBSC may prefer to grow its Asian businesses and to neglect the UK; Lloyd’s may decide to become a major institutional landlord, taking capital away from lending; and so on.) At any rate, Santander’s loss of faith in the future profitability of its UK investments is a negative for the rate of money growth. Before I close the discussion, I would like to point out that no widely-recognized school of current macroeconomic thought pays attention, in an organized way, to the impact of banks’ capital positions to broad money growth and, hence, to the determination of national income and wealth. In traditional monetarism, the quantity of money is seen as a multiple of the monetary base and banks’ capital is ignored. My approach to these matters is very different. Both banks’ capital and broad money growth play vital roles in macroeconomic analysis in the broad-money monetarism I favour. I have just completed my book on Money and Inflation at the Time of Covid, and it has been sent to the publishers. Chapter 2 details my differences from Friedman and Chicago, and may be of interest. Comments and criticisms are very welcome. The chapter is not for quotation at this stage. .………  Here again is the usual chart on imbalances in the Eurozone’s Target2 settlement system, with November 2024 the final month. Developments in October and November were not dramatic, with little change in the different central banks’ balances with the settlement system. Germany’s positive balance has been stable since spring 2023. Best wishes,  Professor Tim Congdon CBE Chair of the Institute of International Monetary Research, at the University of Buckingham |