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What happened to the US economy? - Banking system, money supply, and policy challenges
I. The Core Role of Commercial Banks and the Dilemma of Credit Contraction
Commercial banks, as the backbone of the U.S. economy, play a core role in money creation. Data shows that U.S. commercial banks contribute 80% of the broad money supply (M2), and their lending behavior directly determines economic vitality. However, current commercial banks are trapped in a vicious cycle of "cautious lending - monetary stagnation:"
The annual growth rate of commercial bank loans in 2024 is only 3.2%, far lower than the 5.8% in 2018-2019 (Federal Reserve data). Among them, the growth rate of commercial real estate loans has dropped from 6.5% in 2022 to 1.1% in 2024, reflecting a lack of corporate investment willingness.
As of Q4 2024, the proportion of loans overdue by more than 90 days in the United States reached 1.8%, an increase of 0.7 percentage points from the low point in 2022. The credit card default rate rose from 2.4% in 2021 to 3.9% in 2024, and the auto loan default rate exceeded 4.5% (New York Fed data).
Commercial banks hold approximately $520 billion in unrealized securities investment losses (mainly from government bonds and MBS), accounting for 12% of tier 1 capital (FDIC data). If long-term interest rates remain high, it may trigger large-scale asset impairments.
While the U.S. banking system's capital adequacy ratio remains at 12.5% (higher than the Basel requirement of 8%), credit standards continue to tighten. The Federal Reserve's Q4 2024 survey showed that 68% of banks have "significantly increased" their requirements for corporate loans, the highest level since 2008. This "shrinking" behavior leads to the attenuation of the momentum of money creation, which directly threatens economic growth.
II. Stagnation of Money Supply: The Core Factor of Economic Slowdown
The growth rate of money supply has a strong correlation with economic growth. From June 2022 to December 2024, the year-on-year growth rate of the US M2 is only 1.1%, which is far below the average of 3.8% from 1960 to 2020 (FRED data). The "golden growth rate" (6%) proposed by Hankey aims to balance the 2% inflation target with actual growth demands, and the current growth rate has been below this threshold for 28 consecutive months.
The transmission mechanism of currency supply contraction
The corporate loan demand index has dropped from 72 in 2021 to 58 in 2024 (Federal Reserve survey), reflecting a pessimistic outlook on future profitability. 2. Supply-side constraints
The loan scale supported by each $1 of capital in commercial banks has decreased from 10.5 times in 2021 to 9.2 times in 2024, indicating a weakening of the money multiplier effect. 3. Policy Cumulative Effect
The Federal Reserve's Quantitative Tightening (QT) reduces its holdings of $95 billion in Treasuries and MBS each month, cumulatively withdrawing $2.1 trillion in liquidity from 2022 to 2024, further suppressing monetary expansion.
The lagging effect of economic impact
Changes in the money supply typically lag behind the economy by 12-18 months. The sharp decline in M2 growth rate in 2022 (from 15.6% to 6.1%) has led to a slowdown in actual GDP growth to 1.5% in 2024, below the average of 5.9% in 2021-2022. The inflation rate has decreased from 9.1% in 2022 to 2.3% in 2024, with the core PCE price index growth approaching 1.8%, indicating that insufficient demand has become the main contradiction (BEA data).
The Federal Reserve's excessive reliance on interest rate tools while neglecting money supply may exacerbate the risk of policy lag. Currently, the federal funds rate remains at 5.25%-5.5%, with the real interest rate (adjusted for inflation) reaching 3%, the highest level since 2008, creating a dual pressure on consumption and investment.
III. Systemic Uncertainty: The Chain Reaction of Policy Shocks
(1) Misleading Focus of Trade Policy
The essence of the U.S. trade deficit is a mirror reflection of insufficient domestic savings. In 2024, the U.S. GDP is projected to be $27.4 trillion, with private consumption ($17 trillion), investment ($4.8 trillion), and government spending ($6.2 trillion) totaling $38 trillion, exceeding the GDP by $10.6 trillion, which constitutes a trade deficit (accounting for 3.9% of GDP). This deficit is balanced by a surplus in the capital account (foreign purchases of U.S. Treasury bonds, stocks, and other assets) and is unrelated to "foreign exploitation" (BEA data).
Tariff policies not only fail to address structural issues but may also exacerbate cost pressures:
(2) The Unsustainability of Fiscal Policy
The current federal government debt stands at $37 trillion (135% of GDP), and interest expenditures for the fiscal year 2024 will reach $1.2 trillion (15% of the budget). The "$4 trillion tax cut bill" being debated in Congress essentially extends the current tax rates, but the additional $1.2 trillion increase in defense spending will further worsen fiscal discipline:
Historical comparisons show that the Reagan administration reduced the federal expenditure/GDP ratio from 22.7% to 21.2% over 8 years, while during the Clinton era, budget surpluses were achieved with the "peace dividend" (the fiscal surplus in 2000 accounted for 2.4% of GDP). Currently, both parties lack fiscal constraints, and the CBO projects that federal debt will exceed $57 trillion by 2034, with interest payments accounting for 4.5% of GDP (surpassing Social Security expenditures).
(3) The cumulative impact of regulatory policies
After the 2008 financial crisis, the Dodd-Frank Act raised the leverage requirement for large banks from 4% to 5%, and Basel III required a common equity tier 1 capital adequacy ratio of at least 4.5%. These policies have raised banks' cost of capital by 150-200 basis points and reduced the supply of loans by about $3.2 trillion (NYU study). The final Basel III to be implemented in 2025 will further tighten capital requirements, which is expected to reduce banks' lending capacity by 5%-8%. Hankey proposes to remove redundant regulations such as "supplemental leverage ratios" and free up about $2.1 trillion in credit space (equivalent to 9% of current M2).
IV. Risk Transmission and Historical Reflection of Financial Markets
(1) The Pricing Contradictions in the National Debt Market
In October 2024, the yield on 10-year government bonds briefly exceeded 5%, reflecting market concerns about fiscal risk. This pricing ignores the deflationary pressures brought about by the stagnation of money supply:
(2) Lessons and Insights from the Great Depression
In 1930-1933, the U.S. money supply fell by 30 percent, business investment plummeted by 60 percent, and unemployment rose to 25 percent. Policy uncertainty in the early years of Roosevelt's New Deal (such as frequent adjustments to the National Industrial Recovery Act) prolonged the recession, and it was not until 1936 that capital formation returned to 1929 levels. The current corporate earnings guidance cancellation rate of 45% (up from 28% in 2008) shows a similar wait-and-see sentiment (S&P data).
(3) Japan's "balance sheet recession" warning
After the collapse of the Japanese real estate bubble in the 1990s, companies and households turned to debt repayment, with commercial bank loan growth remaining below 1% for a long time, and M2 growth maintaining below 2%, creating a "low growth - low inflation - low interest rate" trap. The current household debt repayment rate in the U.S. is 13.2% (higher than Japan's 11.8% in 1998), and caution is needed to avoid falling into a similar cycle (data from the New York Fed).
5. Policy Path Selection and Future Outlook
(1) Short-term response: Activate currency creation
The Federal Reserve should incorporate M2 growth rate into its policy objectives, using operation twists (OT) to suppress long-term interest rates and alleviate the pressure from banks' securities investment losses; 2. Regulatory Tightening on Hold
Postpone the implementation of the "Basel III Final Version", cancel the supplementary leverage ratio, and release credit supply; 3. Reshaping Fiscal Discipline
Link tax cuts to spending cuts, for example, for every $1 in tax cuts, there is a corresponding $1.50 reduction in spending, prioritizing the protection of rigid expenditures such as social security.
(2) Long-term reforms: Rebuilding growth momentum
Reduce protection for traditional manufacturing and increase investment in basic research in fields such as AI and new energy (current federal R&D spending accounts for only 0.7% of GDP, lower than China's 1.6%); 2. Immigration Policy Optimization
Supplementing the labor force through technical immigration to alleviate the decline in labor participation rate (the labor participation rate in 2024 is 62.8%, which is 1.2 percentage points lower than in 2019); 3. Debt Monetization Constraints
Establish "fiscal rules" to limit the deficit ratio to within 3% of GDP, and automatically trigger spending cuts when the debt/GDP ratio exceeds 120%.
(3) Risk Scenario Simulation
The Federal Reserve will cut interest rates by 50 basis points in 2025, M2 growth will rebound to 4%, GDP will maintain a growth of 1.2%, and inflation will stabilize at 2%;
From Q2 2025, consecutive two quarters of negative GDP growth, unemployment rate rises to 5.5%, 10-year yield drops to 3.8%, and the Federal Reserve launches QE5;
The escalation of trade conflicts combined with bank asset impairments has led to a GDP decline of over 2%, an unemployment rate exceeding 7%, and the risk of a repeat of the 1970s "stagflation."
Conclusion: Structural Changes Beyond Short-term Speculation
The core contradiction of the American economy is not a single policy mistake, but rather the resonance of a rigid monetary supply mechanism, lax fiscal discipline, and excessive regulatory burdens. The contraction of credit by commercial banks is a superficial issue; the deeper problem lies in the uncertainty of the system that stifles the risk appetite of market participants. Only by breaking the inertia of "treating the headache by treating the head" policies and activating monetary creation through market-oriented reforms, and reshaping fiscal sustainability, can we avoid falling into long-term growth stagnation. For investors, it is essential to closely monitor M2 growth rates, the progress of commercial banks' securities loss recognition, and signals of policy shifts, in order to seize structural opportunities in a complex environment.