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Adrian Ash

Adrian Ash

Formerly City correspondent for The Daily Reckoning in London and head of editorial at the UK's leading financial advisory for private investors, Adrian Ash is…

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Credit Deflation Lands in Britain

Credit deflation just hit the UK for the first time on post-war records...

HMMMM... This looks telling.

UK banks will soon be able to post raw loans - rather than securitized loans that have been bundled into asset-backed bonds - as collateral against short-term liquidity aid from the Bank of England.

This will mean lending central-bank cash against the commercial banks' major assets, as the Old Lady of Threadneedle Street puts it, rather than against that sliver of their balance-sheets held as securitized loans. Which seems prescient, for two reasons.

UK Debt Securitization

First, securitization of UK consumer, mortgage and business debt has all but collapsed. Net-net, there haven't been any sizeable securitizations of UK bank lending for six months running - the longest period since 1998.

The two months before that actually saw securitizations paid back, and at the fastest pace on record, down by £26 billion. Which is a pity for the UK's formerly go-go-crazy-bones credit bonanza.

In the 10 years ending Dec. 2009, securitization added £325 billion to the growth in UK bank lending, expanding new credit by more than 20%. And why not? Securitizing bank loans, by parceling them up and then selling the debt to investors both foreign and domestic, gave banks the chance to lend the same Pound twice, skimming a profit both times. It also gave insurance and pension funds the chance to invest in Britain's record debt bubble...a boom which ended with more people working more hours to service more debt than ever before in history.

That bout of collective insanity has now got the DTs. Because second, and as a result of securitization's collapse (or so we guess here at BullionVault), private-sector UK loan growth overall last quarter did what it's never done before (not since records began in June 1963, at least) and actually turned negative.

Quarterly Change in UK Bank Lending

The Bank of England's decision thus looks timely, if ineffective against the credit deflation already underway.

To repeat: UK bank lending to the private sector has never previously shrunk, not in the 47 years of available data. And lending cash to commercial banks Walter Bagehot-style - albeit by accepting their debtors in turn as collateral, and not charging that "high rate" the 19th-century economist recommended either - is what central bankers are for, after all.

Concluding her 3-month consultation with the banking sector, the Old Lady said Monday that she'll start accepting "raw loans" as collateral for short-term liquidity, dispensed via the Discount Window Facility, in 2011. That expands the list of eligible collateral which banks can post from securitized debt (those asset-backed bonds accepted since Dec. 2007 on top of government gilts), just so long as the loans are residential or commercial real-estate mortgages, consumer loans (but not including credit cards), or corporate loans to non-bank borrowers.

Unlike the Bank's failed attempt to inject cash into the UK economy via Quantitative Easing, this latest wheeze to underwrite the credit-supply will at least keep the Old Lady's cash onshore. Because the raw loan's end-borrower "must be UK-based." Which should stop the tabloids screaming about "foreigners stealing" this particular chunk of Britain's monetary easing when it begins.

Whether it stems the UK's credit deflation remains to be seen. And whether that deflation ever gets to stem the ongoing inflation in prices still awaits history's verdict, too. Because while private net lending shrank between April and July, quarterly consumer-price inflation meantime rose to 1.3%, knocking 3.3 pence off the purchasing power of each Pound Sterling compared with 12 months prior.

Deflation in credit but inflation in prices? With the fastest GDP growth in four years coming in at 1.1% at market (i.e. unadjusted) prices across the quarter? Economists from Mervyn "monetarist" King to Paul "Keynes re-born" Krugman say this confluence of pain can never happen. So best wheel out the Bank of England's printing press yet again, just to get reality back on track with theory.


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