Wednesday, August 31, 2011

Struggling With A Great Contraction

Martin Wolf of the Financial Times recently returned from vacation.   It is interesting to see where this “top” economic commentator stands after taking off from his weekly writing for a full month. 

His view on his return: The major economies of the world are “Struggling with a great contraction.” ( His concern is not with the possibility of a “double dip” recession, but with something more sustained.  He asks, “How much deeper and longer this recession or ‘contraction’ might become.  The point is that, by the second quarter of 2011, none of the six largest high-income economies had surpassed output levels reached before the crisis hit, in 2008.”  Hence, the great contraction.

The turmoil in financial markets that was seen in August, he contends, tells us, first, that “the debt-encumbered economies of the high income-countries remain extremely fragile”; second, “investors have next to no confidence in the ability of policymakers to resolve the difficulties”; and third, “in a time of high anxiety, investors prefer what are seen as the least risky assets, namely, the bonds of the most highly-rated governments, regardless of their defects, together with gold.”

A pretty succinct summary…what?

There is too much debt around which means that all the efforts that governments are making to get the economy moving again face the up-hill battle of over-coming the efforts people, businesses, and local and regional governments are making to reduce their debts. (

While national governments deal with their own excessive debt loads and deficits, their central banks have responded with undifferentiated policies to flood banks and financial markets with sufficient liquidity in order to provide time for banks, consumers, businesses, and local and regional governments to “work out” their positions as smoothly as possible. (

The hope seems to be that “time will heal all things.”

Whereas there is too much deb around, there is too little leadership.  I will quote Wolf on this: “In neither the US nor the eurozone, does the politician supposedly in charge—Barack Obama, the US president, and Angela Merkel, Germany’s chancellor—appear to be much more than a bystander of unfolding events.” (

If there are no leaders, then policy decisions tend to be postponed as long possible, and then, when a result is finally forthcoming, the outcome is more like a camel, something that appears to be an inconsistent piecing together of incompatible parts.

And, this is supposed to produce confidence?  To quote Mr. Wolf again: “Those who fear deflation buy bonds; those that fear inflation buy gold; those who cannot decide buy both.” 

The point being that it is not a time to commit to the future, to invest in real assets or investments.  Hence, the economies of the “high-income” nations stagnate, unemployment remains excessive, and public confidence continues to be depressed.   

Such a general condition argues for a continuance of the economic malaise and not a more robust recovery any time soon.  Hence, the great contraction.

Mr. Wolf still has hope: “Yet all is not lost.  In particular the US and German governments retain substantial fiscal room for manoeuvre…the central banks have not used up their ammunition.”  

But, this hope is based on the existence that leadership in these governments will arise.  Policy makers will come to their senses: “The key, surely, is not to approach a situation as dangerous as this one within the boundaries of conventional thinking.”  

Therein lies the problem.  Mr. Wolf is looking for the hero to ride in on her/his white stallion and provide the leadership necessary to clean up the mess and get things going forward on the right path. 

He has just argued, however, that that leadership does not seem to exist.  So, where is the leadership going to come from?

With all the debt loads outstanding, just how much can be done to overcome the drag on the spending and the economy coming from the efforts of many to de-leverage. 

The Federal Reserve and the European Central Bank have flooded the world with liquidity.  Their effort here is to give banks, consumers, businesses, and governments time to work out their bad debts.  This also provides time for banks and others to fail, consolidate, and/or raise capital without causing major disruptions to the whole financial system. Banks in the United States continue to fail, banks in the US and Europe continue to consolidate, and banks in the US and Europe continue to raise capital. 

Since debt seems to be the major problem here, the only other major suggestion that has been made that could relieve the credit crisis is to relieve debtors of some of their debt burden.  This would mean that some parts of the debt would need to be written off.  Whereas many have suggested such a program, the difficulty of creating such a problem is in the details and no one seems to have come up with any acceptable details of such a program.  Some have suggested that inventing such a workable and just program of debt reduction is nearly impossible.

So, we are back to square one…there are no “good” options.  And, when there are no “good” options, potential leaders tend to disappear into the woodwork.  It is easy to “lead” when you can create credit without end and encourage everyone to own a house and attempt to guarantee people jobs for their lifetime.  But, real leaders are the ones that can stand up and lead when there are no good options.

It is just that few want to be “out front” when none of the options are nice and comfortable.      

Monday, August 29, 2011

The Current State of Monetary Policy

At the top of my Financial Times this morning reads the blurb: “Did Ben Bernanke Drop the Ball Over QE3?”  This is reference to an editorial by Clive Cook. (

In examining the speech given by Fed Chairman Bernanke, Cook takes on the Financial Times essays published last week by Michael Woodford ( and Mohamed El-Erian ( that argued against the Fed implementing a QE3.  Cook contends that Bernanke missed a chance…a “chance to jolt ailing America.”

I don’t believe that Bernanke dropped the ball.  I don’t believe that a declared QE3 is necessary.  Whereas Cook believes that a QE3 would “shock” America, I believe that a QE3 would be taken as ho-hum, more of the same. 

In this, I don’t believe that QE1 and QE2 were understood. 

Michael Woodford, the “good” academic states in his essay: “The economic theory behind QE has always been flimsy.”

Get real…this is the “real world”!

QE1 and QE2 were not a result of economic theory.  QE1 and QE2, in my mind, were a response of real people to a desperate real world situation.  In the first case, the financial markets were falling apart.  In the second case, the economy was not growing. 

In both cases, the response of Mr. Bernanke and the Fed’s policy makers were to throw whatever they had against the wall to see what would stick.  There is little in the way of theory behind this.   Some of us believe that in the first case this was not one of Mr. Bernanke’s finest hours. (See my post, “The Bailout Plan: Did Bernanke Panic,”

In my mind, what was behind these actions was not theory…but history. And, Mr. Bernanke is one of the premier students of the history of the Great Depression and the 1930. 

So, what was behind QE1 and QE2?

In the case of QE1, Mr. Bernanke was aware of the massive monetary history written by Milton Freidman and Anna Schwartz.  The famous conclusion drawn from the Friedman/Schwartz history is that the Federal Reserve allowed the money stock of the United States to decline by one third over the 1929-1933 period. 

Mr. Bernanke and the modern Fed was not going to allow this to take place.  As a consequence, they, Bernanke and the Fed, threw everything they had at the wall.  There was no theory in this.  They were just human beings re-acting in a situation in which there was extreme uncertainty and in which things seemed to be falling apart around them. 

In terms of QE2 we can also go back into the history of the 1930s to get some instruction that might help us understand what the Federal Reserve has been attempting to do over the past year.  The specific case here comes from the period 1937-1938.  The United States economy had been modestly recovering since 1933 but bank lending had not really picked up.  Excess reserves at commercial banks became, for the time under review, excessive.  Since the Federal Reserve’s policy makers did not want to have all these excess reserves around because they felt this reduced their control over the banking system they raised reserve requirements so as to get rid of these “superfluous” reserves.

The consequence? 

There was another collapse of the money stock because the commercial banks “wanted” those excess reserves due to the uncertain times and the slow pickup in business activity.  So, when the Fed took away the excess reserves, the banks reduced their lending activity even more to recover their “excess” reserves and the financial system declined once again.  There was another depression following up on the “Great” one!

Mr. Bernanke, the historian, and the Fed did not and does not want a repeat of the 1937-38 depression.  As a consequence, QE2 was created.  The thought behind QE2 was to throw enough against the wall so that something would stick!  Economic growth was sluggish at best; bank lending was still declining in the summer of 2010; debt loads of businesses, and families, and governments were huge; foreclosures and bankruptcies were at record levels; and under-employment were at levels reached only in the 1930s.  Banks had excess reserves, yet, nothing much seemed to be moving.

Mr. Bernanke and the Fed wanted to escape a replay of 1937-38!

There was little or no theory behind QE1 and QE2.  These two programs were put into place by real people facing extreme situations who did not want to err on the side of not doing enough.  They were people that would let history decide whether or not they acted correctly…and let the theorists debate all they wanted to in their own little worlds. 

And, what are we left with right now?

A commercial banking system that has around $1.6 trillion in excess reserves and about $2.0 trillion in cash assets on its balance sheets.  And, we are told that the central bank is poised to act in the future in anyway needed to shore up the banking system and the economy.  Furthermore, we are told that short-term interest rates are to stay around where they are for two more years. 

Mr. Bernanke, who has overseen both QE1 and QE2, is not afraid to throw more “stuff” against the wall if needed.  This, to me, is current state of monetary policy at the present time.        

Wednesday, August 24, 2011

The "New" Liquidity

This is the age of the “New” liquidity.  This new liquidity is driven by two things: first, information technology; and second, by the free flow of capital throughout the world. 

Finance is nothing more than information.  A dollar bill can be exchanged for another dollar bill.  A demand deposit can be exchanged for dollars and is nothing more than 0s and 1s on some bank’s computer.  A bond provides you with a series of cash flows, which are nothing more than electronic blips, 0s and 1s.  Mortgage-backed securities are nothing more than different cash flows cut into streams that suit the needs of whoever buys them…0s and 1s.

Information can be “sliced and diced” any way that you want it and can be stored and transmitted instantaneously almost anywhere in the world.   This latter point is where the free flow of capital throughout the world enters the picture.

This free flow of capital throughout the world is where the “new” liquidity comes in.  Financial assets, in today’s world, are extremely liquid.

 That is, these assets are liquid…until they aren’t liquid!  They remain liquid until something changes, like the price of the real estate behind certain assets ceases to rise continuously. 

And, this is the new world that the Federal Reserve has to operate within. 

The financial innovation of the last fifty years has been truly exceptional.  Information technology has aided this advance.  There are derivative instruments everywhere.  International capital markets have meant that financial assets can be placed all over the world.  The finance industry has become a huge part of the global economy, both in terms of wealth produced and in terms of employment.  Even manufacturing firms like General Motors and General Electric have gotten into the game and in recent years their finance wings have produced a majority of their profits.

The volume of financial assets that have been produced in this environment has relied on the liquidity of international capital markets to facilitate and expand the flow of these assets into every corner of the world.  The ease of the flow has been truly remarkable.

But, it is the very ease of the flow that has created problems here and there.  The problems I am alluding to are called “bubbles.”  Because capital can flow so freely from market to market and this flow can take place almost immediately, capital can move rapidly from various segments of the capital markets into other segments as sentiment or information changes.  And, as long as the markets remain “liquid” the movements can continue until the situation is played out.

This is a different environment from the one that the current model of monetary policy is based upon.  That model, originally created through the Bretton Woods agreement in the 1940s, assumed that there would not be a free flow of capital internationally.  Thus, with a gold standard and fixed exchange rates, the economic policy of a government could be focused on maintaining high levels of employment, low levels of unemployment. 

Of course, the credit inflation of the 1960s destroyed the underlying assumptions of this international monetary agreement and this was institutionalized on August 15, 1971 as President Richard Nixon took the United States off the gold standard and floated the value of the dollar.

The subsequent period of credit inflation and the consequent explosion of financial innovation has taken us into another realm.  And, it is this new environment we are dealing with now.

Money can now flow almost anywhere at extremely rapid speeds.  Money can flow almost instantenously into different sectors of the financial market.  Thus a change in investor sentiment or the introduction of new information or a change in the stance of monetary policy can create “bubbles” in different sectors of the economy. 

We saw a growing occurrence of bubbles over the past 20 years.  We saw the dot,com bubble in the 1990s followed by its collapse in the early 2000s.  We saw the housing bubble in the early 2000s, followed by the collapse in the housing market in the latter part of the decade.  We seemed to have had stock market bubbles in both decades. 

Recently we seem to have had a bubble in international commodity markets due to the quantitative easing of the Federal Reserve system along with bubbles in certain emerging nation stock markets.  One can also make the argument that the recent behavior of the Treasury bond market represents a bubble.  How else can you explain the fact that the yield on Treasury Inflation Protected Securities (TIPS) has been negative.  Participants in the financial markets were not interested in TIPS for their yield but as a price play connected with the “rush to quality” in international financial markets.  (See Jeremy Siegal and Jeremy Schwartz, “The Bond Bubble and the Case for Stocks,”

Former Fed Chairman Alan Greenspan continues to claim that a bubble cannot be perceived before-the-fact, that is, before the bubble has burst.  Hence, the Federal Reserve could not fight off bubbles in financial (or commodity) markets because they could not be identified.  This seems to be the reigning philosophy of the current leadership at the Fed.   It is the old model of monetary policy.

Yet, the liquidity of international financial markets is a reality and the existence of bubbles is a fact of life.  I believe that these facts are being accepted by the people running our governments and central banks.   Yet, their thinking still has a ways to go and their model of how central banking should be conducted has not been completely formed. 

For one, these “leaders” seem to think that every problem they are facing is a liquidity problem.  I have addressed this earlier. (See Thus, their solutions are systematically based on the maintenance of liquidity in international capital markets.

The fact that the market for an asset may be illiquid because it is related to cash flow problems, say as in real estate investment, and that no amount of liquidity will bring the value of the asset back to previous levels seems to escape these “leaders.”  That is, an asset is liquid, until it is no longer liquid.

Second, the model being used by these “leaders”, a model that places high economic growth to achieve low levels of unemployment, leads these “leaders” to adopt policies, like QE2, that are totally inappropriate for the current economic situation.  Providing liquidity in these cases may create further bubbles, as presented above, but may have little or no effect on economic growth or employment.

Fed Chairman Ben Bernanke is a very creative person.  He has been improvising monetary policy for the last three years.  The old model does not seem to fit any more.  Yet, a new model has not been created.  But, any new monetary policy must be based on the reality of today, a reality dominated by instantaneous flows of money to almost any where in the world.   

Keynes knew that you could not focus a nation’s economic policy on its own employment situation when capital flowed freely throughout the world.  That is why he created his macroeconomic model.  His followers, especially the fundamentalists Keynesians, don’t seem to understand this reality.   It is time to move on.  It is time to accept the reality of the “New” liquidity.

Tuesday, August 23, 2011

The Number of Banks in US Banking System Continues to Decline

There were 40 fewer banks at the end of the second quarter than there were at the end of the first quarter according to data just released by the FDIC.  On June 30, 2011, there were 117 fewer banks in the banking system than at December 31, 2010.

The commercial banking system continues to shrink.

The good news?

The number of institutions on the FDIC's "Problem List" fell for the first time in 15 quarters. The number of "problem" institutions declined from 888 to 865. This is the first time since the third quarter of 2006 that the number of "problem" banks fell.

The FDIC closed only 20 banks in the third quarter of 2011.  The average number of FDIC closings per week for the year 2. 

So, the pace at which the banking system is declining appears to be slowing. 

The smaller banks continue to bear the burden of the decline.  Since the end of 2010, about 3 percent of the banks with assets of less than $100 million have fallen out of the banking system.  The total number of these banks that dropped out of the banking system was 64.

Note that these smaller banks makes up only about 1 percent of the total assets in the banking system.

The number of banks with assets between $100 million and $1 billion declined by 61 banks, but this represented only about 2 percent of the number of banks in this category.

Note that this category of bank makes up only about 8 percent of the total assets of the banking system.

The largest banks, those with assets of more than $1, actually increased by 8 in the first half of 2011.  Note that these banks make up 91 percent of the total assets in the banking system.

Remember, from the Federal Reserve statistics, the largest 25 commercial banks in the United States make up about 60 percent of the total banking assets in the country. 

The vast majority of the banks on the FDIC’s list of problem banks fall in the less than $100 million in asset class.  The middle class of banks ranked by asset size make up the next largest portion of the problem list. 

So, it seems as if we need to say good-bye to the smallest banks and farewell to many of those in the middle category of banks.  Even if these smaller institutions are not closed, they will be acquired by the larger banks and so the average size of bank in the United States will continue to rise.

My forecast for the past two years is that the number of banks in the banking system will drop to under 4,000 over the next four-to-five years.  Not only will this decline occur due to the weeding out of the problem banks, but the smaller banks will just not be able to compete in the new world of banking that is so dependent upon the new information technology spreading throughout the financial world. 

And, the larger banks?

Again, I see that the largest twenty-five domestically chartered banks in the United States will control close to 70 percent of the total assets in the banking system over the next four-to-five years.  Foreign-related financial institutions will move up to the 10- to 15-percent range. 

So, the 3,950 or so smaller banks will have only 15- to 20-percent of the total assets in the banking system.  This will mean that we will still have a lot of smaller banks around…or, my estimate that there will still be around 4,000 banks in the banking system is optimistic.

The banking system in the United States is changing.  We are not a country based on agriculture that needs a lot of local banks.  That went out with the 1930s.  We are not a country anymore that is based on manufacturing that needs a lot of sizeable regional banks.  That went out with the 1980s.  We are a country that is in the midst of the information age and the predominant financial institution in such an age will be large and will have a sizeable international presence.   

So, the decline in the number of banks in existence is not surprising.  The fact that the decline will continue is also not surprising.  And, a continuing decline will take place even if the economy picks up strength. 

Monday, August 22, 2011

The Fed: Still In A "Hole"!

There are articles all over the place discussing the possibilities for what Fed Chairman Ben Bernanke is going to say at his late August speech at the Federal Reserve Conference in Jackson Hole, Wyoming.  Last year, of course, Bernanke announced QE2.  And, for the next ten months we lived QE2. 

The question is…what is Bernanke going to spring on us this year?

Listen to this…”what is Bernanke going to spring on us this year?”

Ben Bernanke is considered to be one of the most creative economists in the world.  He has basically improvised his way through the last three years or so in a way few others could.

But, this is the central bank we are talking about.  Historically, central banks have been the promoter of stability.  Central Banks have been predictable.  Central banks have attempted to reduce uncertainty.

And, maybe this is a clue to the situation we face in the world today.  Maybe things are not what they once were.  Maybe central banking must change…must create a new “business” model”.

Central banking after World War II was different than it was before the 1930s.  Benjamin Strong, President of the Federal Reserve Bank of New York, Montagu Norman of the Bank of England, Emile Moreau of the Banque de France and Hjalmar Schacht of the Reichsbank were what central banking was all about during the 1920s and early 1930s.

But, the world was on the gold standard back then, international capital flows were restricted, and the world was moving from economies based on agriculture to economies based on industrial manufacturing.  “Country” banking, Fed Districts, and the Fed’s discount window dominated central banking in the country.  

The world after World War I was different from the world after World War II and the central bank had to develop a new model. 

Post-World War II, the responsibilities of the central bank changed and grew.  The objectives of central banks also changed.  Whereas the primary responsibility of central banks before this time had been to be the “lender of last resort” to the banking industry, it now took on new responsibilities.  First, under the influence of Keynesian thinking, central banks became responsible for achieving high levels of employment.  Then, after the work of Milton Friedman and the Monetarists, the Fed added price stability as another goal of monetary policy.  Thus, the Fed entered the manufacturing era with three goals, being a lender of last resort, achieving low unemployment, and keeping inflation under control.

Then things changed during this time period.  The global economy became a reality and capital became mobile throughout the world, the gold standard collapsed, and fixed exchange rates gave way to floating exchange rates.  The manufacturing economy gave way to the information age.  Large domestically orientated banks became global behemoths and financial innovation (allowed by the advances in information technology) came to dominate the financial scene. 

Toward the end of the twentieth century, the environment shifted.  Money easily flowed where it wanted to.  We had the high tech bubble of the 1990s and the explosion of securitization.  We saw countries brought to their knees by the international capital markets.  France was certainly the most noticed instance of this but the United States also felt the “end of the stick” and this led Treasury Secretary Robert Rubin to convince President Bill Clinton to get the budget under control.  The fiscal policy of the Clinton administration “bailed out” Alan Greenspan for the time as Fed Chair constantly waited for the substantial increase in productivity to come from the advances in information technology. 
The 2000-2001 recession came followed by Greenspan’s fear of a further deep recession which resulted in a lengthy period in which the target Federal Funds rate was kept at 1.00 percent for an “extended period of time.”  The housing bubble resulted accompanied by a bubble in the stock market.  It seems that in the new financial environment, funds could flow effortlessly around the world and create bubbles where ever the opportunity arose.

Chairman Bernanke came along and Bernanke, an “inflation hawk”, raised interest rates and kept a lid on the banking system until the “crash” came.  The Fed kept the “punch bowl” away from the economy for too long. 

This story is leading up to this point.  Bernanke’s effort at “inflation targeting”, which over stayed its welcome, was the last effort to conduct monetary policy under the “old”, post-World War II monetary regime.  Everything since that time has been improvisation and innovation.

This puts us right where we are today.  There is no current model of central bank operations that can explain what the Fed…and the European Central Bank…and the Bank of England…and so forth…are doing…or will do. 

We are in a new age…the information age.  It became apparent over the past ten years that money…credit…finance…was just a subset of information.  Money, credit, and finance, are really nothing more than 0s and 1s that can be “sliced and diced” anyway one can want.  And, a buyer can be found for these “sliced and diced” pieces of information. 

The large banks and other large financial institutions understand this.  So do many of the manufacturing giants of the past 60 years or so.  General Electric was at one time earning three-quarters of its profits from…its finance wing.  And, what about GMAC and General Motors?  And, the list goes on. 

We have gotten to the point where a huge proportion of the economy is represented by the finance industry…both in terms of income and in terms of employment. 

The manufacturing age is fading.  Yes, we still need manufacturing, but we also still need agriculture.  The world moves on.  Where is employment going to be in the coming years and what kind of training are these workers going to require.  The problem in the United States seems to be a misfit between where the jobs are and how the workforce is trained. But, we are talking about banking and about the Federal Reserve and about monetary policy. 

To me it is evident that things have changed in the financial industry.  Over sixty percent of the commercial banking industry in terms of assets are in the hands of twenty five banks, and most of the activities of these banks are nowhere near what the activities of commercial banks were fifty years ago.  And, most of this difference can be related to the advances in information technology.

And, my prediction for the next five years…you will hardly know what banking is in five years.

Where does that leave Mr. Bernanke and the Fed?  My guess here is that the Fed is going to have to go through changes in its “business model” just as most other institutions are doing.  The conduct of monetary policy in the future will be different than it is now, just as the conduct of monetary policy in the last half of the twentieth century was different from that in the first half. 

I don’t know how monetary policy is going to be conducted in the next decade or so, but my guess is that it will be different.  The Fed is in a “hole” and must find its way out of the “hole” and not dig the “hole” its in any deeper.     

Friday, August 19, 2011

The Debt Crisis: It Ain't Over Until It's Over!

The people in charge, both in the United States and Europe, still believe that the problem we are facing is a liquidity problem.  They, therefore, continue to come up with plans that “kick the can down the road a little further” but fail to come up with any solutions that will allow us to move on into the future.

For three years now, I have been arguing that the problem is not a liquidity problem but a solvency problem. 

There is too much debt outstanding in the world!  People, businesses, and governments cannot carry this debt much further, their debt load is unsustainable. 

This is a solvency problem.

Liquidity problems are short-lived problems.  They have to do with the ability of an asset holder to sell assets into the market place at prices that are near to the value of the assets on the balance sheet of the asset holder. 

Liquidity problems arise because the two sides of a market have different information sets.  The sellers of assets have a different set of information than do the buyers.  Because of this, the buyers generally take a little vacation until they have more information about the asset prices and regain sufficient confidence in the amount of information they have to begin trading again.  At this time the liquidity problem goes away.

Central banks (and other government agencies) may intervene in the market providing a floor to asset prices until such time as the buyers start buying again.  This is the “classic” function of the central banks to provide liquidity to the banking system.

Solvency problems are different.  When solvency problems occur, the holders of assets know that the value of their assets are below that recorded on their balance sheets.  They are reluctant to sell the assets or recognize the value of the assets because any write down of the value of the assets would have to be taken against net worth and this might threaten the solvency of the economic unit that holds the underwater asset.

A solvency problem is a “sell” side problem whereas a liquidity problem is a “buy” side problem.

Economic growth or price inflation may help asset prices regain their balance sheet value.  However, in the absence of either of these forces, market prices may remain below the book value of the asset and this threatens the existence of the household, business, or government.

There is too much debt outstanding in the world!  Whoops, I said that before?

Much of the debt is underwater.  Economic growth or inflation are not coming along fast enough or strong enough to “buy out” this underwater situation.  Hence, the threat of insolvency exists for many people, businesses, or governments. 

Sooner or later asset values are going to have to be written down!

Continuing to postpone the day when they are going to be recognized just creates more and more uncertainty.

The fact that the people running the governments in America and Europe can’t come to grips with this just creates even more uncertainty.   

This uncertainty is the biggest factor in the marketplace right now.  With so much uncertainty in the world, market participants jump this way and that way in response to almost any new bit of information being released. 

And, my guess is that this volatility will continue until people recognize the nature of the problem they are facing.  Until the people running things accept the fact that the crisis they are facing is a solvency crisis and do something about it, this uncertainty and volatility will just increase. 

As Yogi Berra said, “It ain’t over ‘til it’s over.”

Until people realize it is a solvency problem and propose solutions to “get it over with”, the situation will continue. 

Now we know what it is like to live in a world without leaders!    

Thursday, August 18, 2011

Fed Interested in "Cash" at Foreign-Related Financial Instituions

Seems like the Fed is interested in something I have been writing on for at least four months: the cash assets that “foreign-related (financial) institutions have been accumulating during the period referred to as QE2. (See

Reporting this morning in the Wall Street Journal, David Enrich and Carrick Mollenkamp claim that the“Fed Eyes European Banks,” ( “Federal and state regulators, signaling their growing worry that Europe’s debt crisis could spill into the U. S. banking system, are intensifying their scrutiny f the U. S. arms of Europe’s biggest banks…”

“Officials at the New York Fed ‘are very concerned’ about European banks facing funding difficulties in the U. S…the worry is that the euro-zone debt crisis could eventually hinder the ability of European banks to fund loans and meet other financial obligations in the U. S.  While signs of stress are bubbling up, the problems aren’t yet approaching the severity of past crisis.”

Up to now, borrowing dollars hasn’t been a problem.  “Thanks partly to the Federal Reserve’s so-called quantitative easing program, huge amounts of dollars have been sloshing around the financial system, and much of it has landed at international banks, according to weekly Fed reports on bank balance sheets” 

This is just what I have been reporting since early this year. 

“Regulators are trying to guard against the possibility European banks that encounter trouble could siphon funds out of their U. S. arms.”

“Part of what is unsettling regulators and bankers is the speed at which funding can reverse direction.  This spring, foreign banks were able to build up ample cash cushions, thanks largely to quantitative easing…”

In July, 2010, non-U. S. banks had $418.7 billion on reserve and collecting interest at the Fed, according to Fed data.  By July 13 of this year, the total more than doubled, to about $900 billion.  Some major European banks were among the main drivers of this trend, according to their U. S. regulatory filings.”

Again, you could have read it here first.

“In recent weeks, though, the cash piles at foreign banks’ U. S. arms have diminished…foreign banks’ overall U. S. cash reserves fell to $758 billion as of Aug. 3, the latest data available.”

One note on this, the figures on cash assets at these foreign-related financial institutions can swing fairly dramatically from week-to-week and August, in banking non-seasonally adjusted statistical series, can be very interesting. 

Also, the buildup in cash assets at these foreign-related institutions began early enough this year that they could have been used for the “carry trade.”  Interest rates were so low in the United States that borrowing here and investing at the higher interest rates that could be found throughout the world was being done by most of the large financial institutions in the world. 

On June 28 of this year I wrote, “In essence, it appears as if much of the monetary stimulus generated by the Federal Reserve System went into the Eurodollar market. This is all part of the “Carry Trade” as foreign branches of an American bank could borrow dollars from the “home” bank creating a Eurodollar deposit. This Eurodollar deposit could be lent to foreign banks or investors and this would not change the immediate dollar holdings of the American bank. This lending and borrowing in Eurodollar deposits could then multiply throughout the world. And, the American bank might be the ‘foreign-related” institution mentioned above and included in the statistical reports.

Note that the original dollar deposit created by the Fed is still recorded as a deposit at one Federal Reserve bank no matter how much shifting around the borrowing and lending in the Eurodollar market occurs.

Thus, it appears as if the Federal Reserve pumped one-half a trillion dollars off-shore since the end of 2010!”  (See 

So, there may be more than one reason for the build up of cash assets at the foreign-related institutions.  This is why we need to keep our eyes open and look at a wide-range of data. 

It’s interesting to me that the Fed did not seem worried at all about this cash buildup earlier this year even though the foreign-related institutions seemed to be siphoning off a lot of the funds the Fed was supplying to the banking system that was supposed to go into bank lending to get the economy moving again. 

Monday, August 15, 2011

Growth Accelerates in Money Stock Measures

Let’s start with another interesting fact from the commercial banking industry: 92 percent of the banks in the country hold 10 percent of the total banking assets in the country as of March 31, 2011 (FDIC banking statistics) but this total ($1,181.0 billion in total assets) is only 60% of the cash assets in the whole banking system on August 3, 2011 (Federal Reserve H.8 release) and only72 percent of the Reserves at Federal Reserve Banks on August 3, 2011 (Federal Reserve H.4.1 release) and only 74 percent of the Excess Reserves in the banking system for the two-week average ending August 10, 2011 (Federal Reserve H.3 release).

In other words, the total assets residing in 92 percent of the commercial banks in the United States is substantially less than the amount of excess reserves pumped into the banking system by the Federal Reserve since August 2008. (For more comparisons see my post of August 15, 2011,   

Now let’s look at the recent behavior of the money stock measures.  Both measures of the money stock (M1 and M2) experienced accelerating rates of growth over the past year, with the acceleration increasing over the past several months. 

The M1 money stock measure was growing at a year-over-year rate of 16.1 percent in July, up from 10.0 percent in January 2011 and 5.4 percent in the summer of 2010.  The M2 money stock measure is growing year-over-year in July 2011 at 8.3 percent, up from 4.3 percent in January and around 2.5 percent in the summer of 2010.

Is this a sign that the Fed’s quantitative easing (QE2) is working or is it a result of something else going on in the economy? 

Generally when the money stock measures are growing, commercial bank lending is fueling the growth.  Banks loans are put into demand deposits to spend and this spending spurs on the economy.

It is hard to find much loan growth in the commercial banking sector at this time. (See my post  Thus, it is hard to conclude that the increase in the growth rates of the two money stock measures results from the Fed’s injection of reserves into the banking system.

The path that I have been following over the past two years is that the extremely weak condition of the economy and the extremely low interest rates are causing a “dis-intermediation” of sorts as people move their funds from interest bearing assets into transaction-related accounts to either be able to pay for necessities because cash flows are low due to unemployment or other situations of financial distress, or, because interest rates are so low on savings or money market accounts that it is doesn’t pay for wealth-holders to keep money in these latter types of accounts.

What we see is that demand deposit accounts at commercial banks have exploded.  In July, the year-over-year rate of growth of this component of the money stock has increased dramatically to over 37.0 percent, up from just 21.0 percent in March of this year.  Other checkable deposits at depository institutions have also increased by not at such a rapid pace. 

Along with this we still see substantial drops in “savings” categories.  Small-denomination time deposits have fallen at a 20.0 percent rate, year-over-year.  Retail money funds have dropped by over 6.0 percent, year-over-year, and institutional money funds are still declining at more than a 4.0 percent, year-over-year rate. 

Funds are still moving from (formerly) interest earning accounts to transaction-type accounts. 

One further indication that some of this is due to “economic stress” is that the amount of currency in circulation is increasing.  In July, currency in circulation was more than 9.0 percent higher than it was a year ago.  This is up from around 7.0 percent earlier this year.

My basic point here is that although the growth rate of both money stock measures are increasing, that this information does not indicate that Federal Reserve monetary policy is working or that economic growth will benefit from this expansion.

The money stock measures are experiencing increasing rates of growth due to the fact that the economy is extremely weak and that interest rates are extremely low.  People…and businesses…are just re-allocating their funds so that their money is easier to get for spending purposes (distress) or that other assets are earning so little it doesn’t pay to keep funds in those accounts…or both.

In my view, there is no cause for hope for an economic recovery in the current monetary statistics.