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.
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  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 . 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.