I usually do the “QE2 Watch” post in the first week of the new month, but in this coming month I will be a little tied up. I am having hip replacement surgery on June 28 and will be a little preoccupied for a few days. I will also write a post on the condition of the banking system that I will post tomorrow. Then I go “on vacation” for a while.
Chairman Bernanke and the Federal Reserve have signaled that QE2 will definitely end on June 30 and they have indicated that QE3 is not in the works…at least at the present time.
The stated plans for QE2 included the new purchase of $600 billion in Treasury securities and the purchase of a possible $300 billion more in Treasury securities to replace securities maturing in the Fed’s portfolio of Federal Agency issues and the Fed’s portfolio of mortgage-backed securities.
From Wednesday, September 1, 2010 to Wednesday, June 22, 2011, the Federal Reserve’s holdings of United States Treasury issues have risen by roughly $816 billion. During this time period, the dollar volume of Federal Agency issues on the Fed’s balance sheet has dropped by $38 billion and the dollar volume of mortgage-backed securities has declined by $189 billion…a combined total of $227 billion.
The “net” increase in securities held outright by the Federal Reserve has been $589 billion, pretty close to the $600 billion “net” increase promised.
Reserve balances at Federal Reserve banks, a proxy for excess reserves in the banking system, have increased by $584 billion to $1,594 billion over this time period. Actual excess reserves in the banking system averaged $1,610 billion for the two-week period ending June 15, 2011.
Almost all the increase in excess reserves can be attributed to the Fed’s purchase of United States Treasury securities.
Other factors affected reserve balances within this time period but they tended to be minimized over the period as a whole. For example, in the first quarter of 2011, the United States Treasury Department reduce its “Supplemental Financing Account” at the Fed by $195 billion, a not inconsequential amount of funds. This reduction added reserves to the banking system. However, over time, this movement was offset by other factors and hardly had any net effect on the total amount of reserves being supplied to the banking system.
And, what was the total impact of QE2 on the commercial banking system?
All the reserves the Fed crammed into the banking system went into excess reserves!
Yet deposits in the banking system continued to increase.
Demand deposits in particular rose at a very rapid pace. From the second quarter of 2010 when demand deposits at commercial banks increased at a 6.3 percent rate year-over-year, these accounts rose by 8.5 percent in the third quarter and 14.3 percent in the fourth quarter. But this rate of acceleration jumped to 20.4 percent year-over-year in the first quarter of 2011 and in the month of May was showing a rate of increase of almost 27 percent!
What is happening here?
Demand deposits at commercial banks are increasing at a very, very rapid pace, yet commercial banks do not seem to be lending much at all (more on this tomorrow) and everything the Federal Reserve is pushing into the system seems to be going into excess reserves. What’s going on?
Basically, what’s going on is the same thing that has been going on for the last 18 months or so. Because of the poor economic climate and because of the excessively low interest rates people and businesses are moving funds out of interest bearing accounts and into transactions accounts. These latter accounts are where people are locating their “liquidity” these days so as to pay for necessities and other important things to keep on living.
For example, Institutional money funds are still losing money…perhaps not as fast as they were a year ago, but they are still contracting by more than 5 percent, year-over-year. Retail money funds are still declining at a rate in excess of 8 percent year-over-year and small time accounts are declining by more than 20 percent, year-over-year.
All non-M1 money stock money included in the M2 money stock measure has risen only modestly over the past 12 months and most of this has come in the money market deposit account s included in the aggregate category titled savings deposits.
The result is that the M1 money stock measure is increasing rather rapidly at around a 12 percent year-over-year rate in the last three months. The M2 money stock measure is increasing by less than 5 percent over the same time period. The rate of growth of the M2 money stock measure has only increased modestly over the last four quarters.
People are putting their money into accounts from which they can transact. They are moving their money into these accounts because they need to stay liquid in order to pay for their daily needs.
The other indicator of this behavior is the rapid increases that have been made in the demand for coin and currency. In the second quarter of 2010, the currency in circulation was rising by only about 3.5 percent, year-over-year. This steadily increased through 2010 until it reached a total of over 7.0 percent in the first quarter of 2011. That is, the coin and currency in circulation more than doubled its growth rate over this time period. In May 2011, the year-over-year rate of increase in the currency component of the money stock was rising at almost 9.0 percent year-over-year.
In the slow economic growth climate we are in, people do not increase their holdings of coin and currency in order to generate new spending. They increase their holdings because they need these funds to buy necessities in the face of unemployment, foreclosure, and bankruptcy!
The information from the financial system is not very encouraging. The Fed has tried to push all the funds it can into the banking system. The banking system is not lending it…both because the banking system is still not in that good of a shape…and because people are not in very good financial condition and are not borrowing. Thus, reserves pile up at commercial banks.
If QE2 was supposed to get the economy growing faster, it has failed miserably. If QE2 served other purposes, like allowing the FDIC to close banks in an orderly fashion, then it has succeeded. If the Fed used the economy as an excuse to explain QE2 while it was assisting the FDIC in its efforts to close banks in an orderly fashion then it was duplicitous. It might have done this to avoid people getting overly worried about the condition of the banking system.
But, the more I think about this last statement the more I chuckle because I don’t think that the Fed is that good.