Thursday, 12 December 2013

81% of all the QE is sitting in a vault and stagnant!

Source: Business Insider

Ever since the financial crisis in 2008, the Federal Reserve has employed extremely loose monetary policy in its effort to stimulate the economy in the right direction.
This included keeping short-term interest rates near zero and keeping long-term interest rates low through bond purchases.
Some warned that this would lead to rampant inflation. But inflation has stayed extremely low.
One of the reasons for this is because the velocity of money has been low. In other words, all of the additional money in the system hasn’t changed hands as frequently as some would’ve expected.
Art Cashin, the veteran trader from UBS, discusses this in his note this morning. Specifically, he talks about how he and his “friends of fermentation” were in a “frenzy” over it.
From Cashin:
Failure To Achieve Escape Velocity – The FoF Trading Division (Local 410) was in a bit of a frenzy yesterday as they circulated a chart from the St. Louis Fed showing that monetary velocity continued to fall and had slipped to a level lower than at the depths of the recession in 2009. I have been greatly concerned about this lack of velocity for years. Here’s what I wrote back in 2010:
Pushing On A String – The Fed’s Frustration – Chairman Bernanke may not be sleeping well. In 2002, he famously said that to stave off inflation, the Fed could even drop tons of money from helicopters. That was hyperbole, of course, but the Fed’s version of the helicopter plan has not been working out very well. It’s as though they dropped the money on the lawn and the homeowner raked it up and put it all in a garage – and then went back to bed.
The Fed has tripled its balance sheet. Banks are sitting on nearly a trillion dollars of excess reserves. Corporations are sitting on over a trillion dollars in cash. Yet, the monetary base has remained stagnant for months. The broad money supply (M3) has actually fallen significantly this year.
Money has no velocity today. The money supply can only grow if you spend it or lend it. Instead, it sits idle in that garage.
Here’s what that chart looks like via the St. Louis Fed:

Cashin also references the comments of Barry Ritholtz of the Big Picture:
Recently, my friend, Barry Ritholtz, did an extensive and enlightening review of those stagnant free reserves in his terrific blog – The Big Picture. Here is a bit from the opening:
Robert D. Auerbach – an economist with the U.S. House of Representatives Financial Services Committee for eleven years, assisting with oversight of the Federal Reserve, and now Professor of Public Affairs at the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin – notes [1] today:
There is a massive misconception about where the Bernanke Fed’s stimulus landed. Although the Bernanke Fed has disbursed $2.284 trillion in new money (the monetary base) since August 1, 2008, one month before the 2008 financial crisis, 81.5 per cent now sits idle as excess reserves in private banks. The banks are not required to hold excess reserves. The excess reserves exploded from $831 billion in August 2008 to $1.863 trillion on June 14, 2013. The excess reserves of the nation’s private banks had previously stayed at nearly zero since 1959 as seen on the St. Louis Fed’s chart [2]. The banks did not leave money idle in excess reserves at zero interest because they were investing in income earning assets, including loans to consumers and businesses.
This 81.5 per cent explosion in idle excess reserves means that the Bernanke Fed’s new money issues of $85 billion each month have never been a big stimulus. Approximately 81.5 per cent (or $69.27 billion) is either bought by banks or deposited into banks where it sits idle as excess reserves. The rest of the $85 billion, approximately 18.5 per cent (or $15.72 billion) continues to circulate or is held as required reserves on banks’ deposit accounts (unlike unrequired excess reserves).
Wow! 81% of all the QE is sitting in a vault as stagnant as if it were in that proverbial garage. (It’s a terrific review and if you can access it, read it thoroughly over the holiday or on the weekend.)
Sort of puts “tapering” in a slightly different perspective doesn’t. Velocity is essential in a fractional banking system.
Interesting how things work.

A heterodox lesson about money and debt from Thomas Edison

Here's what Thomas Edison had to say about bonds and currency. Though the guy treated his employees badly, the man understood how money works.

In December 1921, the American industrialist Henry Ford and the inventor Thomas Edison visited the Muscle Shoals nitrate and water power projects near Florence, Alabama. They used the opportunity to articulate at length upon their alternative money theories, which were published in 2 reports which appeared in The New York Times on December 4, 1921 and December 6, 1921.

Here, the reporter is quoting Edison:

“That is to say, under the old way any time we wish to add to the national wealth we are compelled to add to the national debt.
“Now, that is what Henry Ford wants to prevent. He thinks it is stupid, and so do I, that for the loan of $30,000,000 of their own money the people of the United States should be compelled to pay $66,000,000 — that is what it amounts to, with interest. People who will not turn a shovelful of dirt nor contribute a pound of material will collect more money from the United States than will the people who supply the material and do the work. That is the terrible thing about interest. In all our great bond issues the interest is always greater than the principal. All of the great public works cost more than twice the actual cost, on that account. Under the present system of doing business we simply add 120 to 150 per cent, to the stated cost.
“But here is the point: If our nation can issue a dollar bond, it can issue a dollar bill. The element that makes the bond good makes the bill good. The difference between the bond and the bill is that the bond lets the money brokers collect twice the amount of the bond and an additional 20 per cent, whereas the currency pays nobody but those who directly contribute to Muscle Shoals in some useful way.
” … if the Government issues currency, it provides itself with enough money to increase the national wealth at Muscles Shoals without disturbing the business of the rest of the country. And in doing this it increases its income without adding a penny to its debt.
“It is absurd to say that our country can issue $30,000,000 in bonds and not $30,000,000 in currency. Both are promises to pay; but one promise fattens the usurer, and the other helps the people. If the currency issued by the Government were no good, then the bonds issued would be no good either. It is a terrible situation when the Government, to increase the national wealth, must go into debt and submit to ruinous interest charges at the hands of men who control the fictitious values of gold.
“Look at it another way. If the Government issues bonds, the brokers will sell them. The bonds will be negotiable; they will be considered as gilt edged paper. Why? Because the government is behind them, but who is behind the Government? The people. Therefore it is the people who constitute the basis of Government credit. Why then cannot the people have the benefit of their own gilt-edged credit by receiving non-interest bearing currency on Muscle Shoals, instead of the bankers receiving the benefit of the people’s credit in interest-bearing bonds?”