The Progress of the Economic Recovery in the United States

The United States economy is growing.  However, the United States economy is not growing very fast and the growth does not appear to be very deep.  

January figures for Industrial Production were released today and about all one can say about the numbers is that the rate of growth is positive but modest.  And, the rate of growth seems to be declining. 

Year-over-year, industrial production grew at a 3.4 percent annual rate in January 2012. 

However, this is down from a 3.9 per cent, year-over-year, rate of growth in the fourth quarter of 2011 and down from a 6.2 percent, year-over-year, rate of growth in the fourth quarter of 2010.  In the fourth quarter of 2009 the economy actually declined by 5.5 percent, year-over-year. 

The numbers for industrial production are not inconsistent with the pattern of growth, year-over-year, of real Gross Domestic Product.  In the fourth quarter of 2011, the year-over-year rate of increase in real GDP was 1.6 per cent.  In the fourth quarter of 2010, the similar measure stood at 3.1 percent.  For the fourth quarter of 2009, like the figure for industrial production, the economy actually declined by 0.5 per cent.

Looking at the numbers in this way does not give one the upbeat feeling one can often get from just looking at the month-to-month change in the numbers.

Furthermore, information on the capacity utilization of industry (also released today) and the under-employment of working age people still indicates that there is a massive problem in our use of physical capital and of human capital. 

Capacity utilization in manufacturing stands at 78.5 percent in January.  That is, more than 20.0 percent of our industrial capacity is standing idle!  The important thing to me here is that the capacity utilization in the United States has been on a downward path since the 1960s.  Please check the chart below. 

Reading the chart from the left to the right shows a dramatic downward trend with each subsequent peak in capacity utilization being lower than the one previous to it. 

The question that remains to be answered is whether or not the trend will be continued with the “peak” in capacity utilization we are going to reach this time around.

The United States has a growing mis-match in the industrial capacity it has built and the industrial capacity that is useful.  This mis-match must be worked off…there is not an over night solution to this problem.

The same situation exists in the labor markets.  The under-utilization of working age people has grown since the 1960s.  In the 1960s about one in eleven or twelve people in the United States were under-employed.  The measure of under-employment now stands somewhere between one in four or one in five people that are of working age. 

The United States has a major problem.  Jobs and industrial capacity are not matched with the present makeup of our human and physical capital.  These under-employed persons and this under-utilized plant and equipment are not going to be matched up any time soon.  Thus, under-employment of labor and under-utilization of industrial capital are going to be around for a long time.  And, the rates of economic growth we are experiencing will not do much to help the situation.

The Outlook for Mergers and Acquisitions in 2012

The key issue in the area of mergers and acquisitions in 2012 is still uncertainty. There seems to be a lot of anticipation that the activity in this area could pick up during the year, but, like last year, there may be little to come of it. (http://www.ft.com/intl/cms/s/0/a29392 10-41d0-11e1-a1bf-00144feab49a.html#axzz1jqA4rKTp)

Many corporations still seem to have a “ton” of cash around.  Furthermore, the corporate bond market is flush; companies “sold $44.2 billion of both high- and low-rated corporate bonds this year, the highest on record for the time period….” Investors are “snapping up bonds…pushing the cost of borrowing for some issuers to record lows.” (http://professional.wsj.com/article/SB10001424052970203750404577171341742782200.html?mod=ITP_moneyandinvesting_3&mg=reno-secaucus-wsj)

“The yield on below-investment-grade, or ‘junk’ bonds fell to 7.93% Wednesday, the lowest since August 5 according to a Barclays Capital index.  An index for investment-grade bonds, which are of a higher credit quality, was at 3.62%.  In comparison, on Thursday the 10-year Treasury note yield rose to 1.972%.”

Funds are available. 

Corporate breakups are likely to continue or even accelerate in 2012.  Economic growth is not picking up speed.  Europe looks as if it is in another recession and this does not bode well for the rest of the west.  Companies are finding that the conglomerate structures they built up in recent are not very helpful in times like these, especially for those organizations that are suffering under the burden of too much debt. 

The western world is re-grouping from the excesses of the past ten to twenty years.  Those that still have the time to adjust are downsizing…laying off employees and discarding non-central businesses.  Those that don’t have this time are attempting to sell outright.

Those looking for deals have the ammunition to pull off these deals and they know that this is a “buyers” market with depressed valuations available.  They have the capability of being aggressive.   Whether or not they activate this aggressiveness is another question.

This is because a cloud remains over the M & A market, a cloud that kept many firms on the sidelines in 2011.  First off, a great deal of uncertainty exists with respect to the future of the economy.  Government stimulus policies, both monetary and fiscal, have not worked to any degree and it is debatable whether or not any additional actions will achieve much more.

In addition, Europe appears to be in recession right now and, given its sovereign debt crisis and the state of its banks, any recovery seems to be some way off.  It is uncertain how the situation in Europe might play out in the United States. (http://seekingalpha.com/article/317268-issue-number-1-for-2012-recession-in-europe)

Second, there is the upcoming election in the United States.  The uncertainty surrounding the policies of the American government with respect to business and finance over the past three years has been enormous…and largely uncalculable. At this time, we just don’t know how much the uncertainty in this area has retarded the recovery of American business and economic growth. 

Further uncertainties exist with respect to the impact of other actions of the federal government in areas like health care, the environment, and foreign affairs.  Some people are just learning about the expenses they are going to have to absorb with respect to Medicare, doctors fees, and health insurance.  As people learn more and more how their budgets are going to be affected, adjustments will be made to spending patterns and they won’t be up.

Third, in addition to the uncertainties created by new financial regulations and the complexity of these new regulations, there appears to be a growth in the government’s application of the anti-trust laws.  The recent treatment of the AT&T/T-Mobile merger is a case in point.  The government, ‘feeling its oats’ from this action, will probably step-up its aggressive behavior in this area, leading to even greater uncertainty relative to M&A activity.

Early in 2011, it looked as if there might be a big pickup in merger activity for the year.  Many of the same conditions we see today existed at that time.  And, what happened?

M&A activity did pick up in 2011 from previous years but we did not see the ‘big jump’ that many of us expected.  Instead of buying companies, many firms used their cash on hand or their ability to borrow at ridiculously low interest rates to buy back their stock.  This, of course, helped stock prices but it did not help the economy.

But, even a pick up in M&A activity will not do a lot to help the economy, especially in the short-run.  Buying companies outright or buying pieces of companies will initially result in efforts to achieve greater corporate efficiencies, higher levels of productivity, and will mean more reductions in employment.  This is a part of the “creative destruction” of a market economy.    

And, this should not be surprising.  The American economy has been subject to fifty years of credit inflation.  In such a time, among other things, businesses come to focus more on finance rather than production, they acquire other businesses that are not related to their core operations, and they hoard labor. 

The other side of the business structure created by credit inflation is the need to unwind and restructure what was built earlier.  That is what we face now. 

Let’s hope the boom in M&A business does take place.  Let’s hope that the corporate cash and corporate borrowing do not go just to corporations buying back their own stock.  Let’s hope that the unwinding and restructuring takes place because that is one prerequisite for business to get back to the capital investment activities that do drive economic growth. 

Monetaray Policy in 2011: Looking Back

Total reserves in the banking system rose by almost 50 percent in 2011 to average around $1.6 trillion.  The increase during the year was slightly more than $511 billion. (Remember in August 2008 when total reserves in the banking system averaged less than $45 billion?)

Excess reserves in the banking system rose by about $490 billion from December 2010 to December 2011 to a total of about $1.5 trillion. (Remember in August 2008 when excess reserves in the banking system averaged less than $2 billion?)

The Federal Reserve continued to pump reserves into the banking system in 2011 and about 95% of the reserves going into the banking system went into excess reserves. 

Bank loans fell during the year by approximately $50 billion.  There was a pickup in business loans (commercial and industrial loans) of about $122 billion, but real estate loans (primarily commercial real estate loans) fell by $150 billion and consumer loans dropped by $22 billion. 

Note that the pickup in business loans was predominately located in the largest 25 domestically chartered banks in the United States.  The increase here was approximately $95 billion. 

One can conclude from this that the reserves that the Fed pumped into the banking system did not, on balance, go to support an increase in lending.

Yet, the growth rate in both measures of the money stock rose during the year.  For the M1 measure of the money stock, the year-over-year rate of increase rose from 7.5 percent in December 2010 to 19.1 percent in December 2011. (This is using the 13-week average of the measure.)  The year-over-year rate of growth of the M2 measure of the money stock rose from 3.3 percent in December 2010 to 9.8 percent in December 2011. (Again using the 13-week average.)

The increase was highlighted by a whopping 45% rise in demand deposits!

But, this increase in demand deposits did not come from an increase in bank lending because the bank lending that might have resulted in an increase in demand deposits and hence the M1 money stock actually declined!

The reason for the huge increase in demand deposits seems to be that people are moving assets from short-term investment vehicles to demand deposit accounts. 

For the past two years or so I have been arguing that this movement into demand deposits is coming for two reasons.  The first reason is that interest rates on short term investments are so low that people do not believe that it is worthwhile to keep their money in interest bearing assets rather than demand deposits. (For example, Federal Reserve data record a drop of almost $90 billion in Institutional Money Funds over the past year.)

The second reason is that many people are still is difficult financial condition.  Hence, they are keeping what funds they have in transaction-type accounts so as to pay for necessary living expenses.  Additional information that supports this argument is that the currency component of the money stock rose by more than 9 percent this last year.  This is, historically, an extremely high number.  People in tough economic situations also hold more cash.

The evidence from the banking system is not very encouraging with regards to a pickup in economic activity.

How did the Federal Reserve inject more than $500 billion reserves into the banking system this last year?

First, the Federal Reserve increased its holdings of securities by roughly $442 billion.  Actual acquisitions of Treasury securities amounted to about $640 billion but these purchases were offset by a $43 billion decrease in the Fed’s holdings of Federal Agency issues and a $154 decline in the Fed’s holdings of mortgage backed securities. 

One should also note that there was a net decrease in funds associated with the bailout actions of 2007 and 2008 of approximately $140 billion. Also, primary borrowings from the Fed’s discount window declined by $36 billion.  One generally assumes that these “operating” factors are offset by the Fed’s purchase of securities.  Thus the “net” addition of funds from the increase in the Fed’s outright holdings of securities totaled about $266 billion. 

Second, the United States Treasury also played a role in the increase in bank reserves.  At the end of 2010, the Treasury held almost $200 billion in something called the U. S. Treasury Supplementary Financing Account. (I have mentioned the use of this account many times in 2010…here is one post: http://seekingalpha.com/article/256497-qe2-watch-version-4-0-fed-is-tone-deaf-and-spaghetti-tossing.) These funds were injected into the banking system this past year…the full $200 billion of them.  This can be added to the $376 billion mentioned in the previous paragraph to account for $466 billion of reserves going into the banking system. 

Third, the currency being demanded by the public mentioned above is supplied to the public by the Federal Reserve “on demand”.  That is, the Federal Reserve generally replaces the currency flowing out of the banking system into general circulation, dollar for dollar.  This past year, currency in circulation rose by about $93 billion.  Thus the $466 billion of the previous paragraph drops to $373 billion.

Fourth, the Federal Reserve has “pumped” dollars into the European banking system due to the sovereign debt crisis in Europe.  For example, Central bank liquidity swaps have increased by about $100 over the past year, most of the increase coming in the past six months.  This is not the only way the Fed influences what is going on internationally as the Fed holds other assets denominated in foreign currencies and also engages in reverse repurchase agreements with “foreign official and international accounts”.  If one roughly nets out the accounts associated with all of these type of transactions, we can say that the Fed roughly added another $104 billion to bank reserves which brings the total injection to $477 billion 

One final operating factor influences this total figure, payments into and out to the general account of the United States Treasury.  This fluctuates with tax payments and actual government expenditures.  The year-over-year drop in this account is about $28 billion and this brings the total increase in “reserve balances at Federal Reserve banks to $505 billion, which matches very closely with the $490 increase in excess reserves mentioned in the second paragraph of this post. (The difference is due to minor operating factors that we do not need to discuss.)

In summary, the Federal Reserve (and the U. S. Treasury) put a lot of reserves into the banking system this past year.  As usual, the Fed needs to take care of other operating factors that constantly impact the banking system, but in general, the injection of reserves came from the securities the Fed purchased as a part of the QE2, the dollars being advanced to European central banks to help relieve the pressures of the sovereign debt crisis, and the injection of funds into the banking system from the fiscal activities of the United States Treasury.

As of this time, the reserves going into the banking system have not been lent out…they are just sitting on the balance sheets of the commercial banks.  The extraordinary increase in the money stock measures are the result of the low interest rates that people can earn on their money balances and the need of people who are economically distressed to hole transaction accounts.

The efforts of the monetary authorities are not being felt, yet, by an increase in economic activity.

Business Loans Continue to Increase

The largest twenty-five domestically chartered commercial banks in the United States continue to increase lending to businesses (Commercial and Industrial Loans) over the latest four-week period according to the most recent Federal Reserve data.  Over the latest four-weeks ending November 2, large banks experienced a net increase in business loans by almost $11 billion.  Over the latest 13-week period, these loans have risen by almost $28 billion. 

From October 2010 to October 2011, the largest twenty-five banks have increased their portfolios of these business loans by a little more than $75 billion.

Still, one does not have a lot of confidence that these loans are going into areas that will contribute to the growth of the economy.  Larger companies are still accumulating “cash” to buy back stock or to make acquisitions.  Certainly the cost of borrowing is not a hindrance to these companies obtaining for these purposes these days. 

Commercial and Industrial loans have also increased in the rest of the banking system, but by a little more than one billion dollars over the last four weeks, and by just over $9 billion over the past 13 weeks.  It is not altogether clear what these loans are going for at the present time.  Given that this $9 billion increase is spread through about 6,400 banks, the rise in lending at each bank, on average, is not too great.

The interesting thing about the lending in the smaller 6,400 banks is that residential real estate loans have shown some increase over the past 13-week period.  Residential loans have risen by almost $25 billion over the past quarter, over $13 billion in the last four weeks alone.  The indication is that in some places in the United States, residential lending activity has been picking up.  We will have to watch this number closer in the upcoming weeks and months. 

The softest area in lending still remains the commercial real estate area and the weakness is predominantly in the small- to medium-sized banks.  These loans dropped by slightly less than $14 billion over the past 13-weeks, with more than half the decline at the smaller banks.  Over the past 4-weeks the declines in commercial real estate loans have all been outside the largest 25 banks in the country. 

All domestically chartered commercial banks in the United States reduced their holding of cash balance in the past 13-week period.  The largest 25 commercial banks lowered their balances by $185 billion. The other domestically chartered banks reduced their holdings by only $10 billion.  These decreases in cash balances came despite the fact that excess reserves in the banking system stayed relatively constant during this time period. 

In summary, the latest Federal Reserve statistics indicate that the banking system, as a whole, is becoming less conservative.  Business loans have been picking up for most of the last six months, especially at the largest 25 domestically chartered banks in the United States.  The question mark here, however, is the use that borrowers are putting these funds to.  It does not appear as if the loans are being used for productive purposes that would get the economy moving again. 

The commercial real estate area continues to stay week, especially at small- and medium-sized banks.  Here one still has questions about the quality of these loans on the balance sheets of the smaller banks and the implication of these difficulties for the future.   

One further note: Consumer borrowing at all commercial banks continues to remain weak.  Nothing seems to be happening in this area, which, again, has implications for future economic growth.  The consumer seems to be more interested in getting his/her debt under control than to really engage in more spending.  We will see what happens in this area as the holiday season approaches.

Closing note:  The largest 25 commercial banks in the United States, according to the Federal Reserve data, represented 57 percent of the assets in the banking system on November 2, 2011; foreign-related depository institutions represented 14 percent; and the other (roughly) 6,400 domestically chartered banks represented 29 percent.    

An Economic View from the Supply Side

As I have written before, the United States economy is recovering.  It may not be recovering as fast as some would like, but economic growth is positive.  Economic growth is not as rapid as some would like because there is still a massive debt overhang that must be eliminated, one way or another.

Furthermore, unemployment and under-employment are not dropping as fast as some would like.  The labor market is not improving with any speed because the economic policies of the last fifty years has resulted in a large amount of the United States manufacturing capacity being unused.  As physical capital is unused so is human capital.

Both of these situations took a long time to get to their present state and will take a long time to regain higher levels of economic growth, capacity utilization, and employment. 

The background for this situation can be examined from the following chart.

  This chart contains a graph of real Gross Domestic Product beginning in 1960 and ending in 2010.  I start with the year 1960 because that is the year before the United States government, both Democratic and Republican, introduced a “new” economic philosophy into its policy considerations, one that emphasized the inflation of credit throughout the economy. 

To me, the important thing about this chart is that real GDP is almost continuously rising.  Yes, there is a sizeable bump at the far right-hand side of the chart, and this is associated with the Great Recession, an apt title.  Otherwise, there are other little deviations from the upward trend, but these are relatively minor movements along the way.

This is where I take my stand with the economic growth proponents.  In the United States economy, growth is almost always positive.  The annual compound rate of growth for the period covered in the chart is 3.1 percent.  The annual compound growth rate of the United States economy, ending the calculation in 2007 (the Great Recession began in December 2007) the rate of growth rises to something around 3.25 percent.  But, growth is dependent upon the private sector, not directly on the government.    

I define credit inflation as a period in which the rate of growth of debt in the economy exceeds the rate of growth of the economy.  Over the past fifty years, the debt of the United States government has increased by more that a 7.0 percent annual compound rate of growth.  The debt of the private economy has risen in the range of 11.0 to 12.0 percent every year.  This meets my definition of credit inflation because these growth rates are far in excess of the rate of growth of the economy. During this period, the purchasing power of the dollar declined by about 85 percent.  In other words, a 1960s dollar could only buy 15 cents worth of goods and services today versus a dollar’s worth in 1960.

Side note on credit bubbles: when the annual compound rate of growth of the debt being created in a subsector of the economy exceeds the annual compound rate of growth of the economic growth of the subsector, a credit bubble can be said to exist.  The housing market bubble of the early 2000s fits this definition.

Credit inflation can have a detrimental impact on economic growth.  Credit inflation creates incentives that cause manufacturers to move away from the producing of goods and to move into the creation of finance.  Two examples of this are GE and GM: for example a couple of years ago GE was earning more than two-thirds of its profits from its finance wing.  In terms of the whole economy, there has been a huge swing over the past fifty years from the manufacturing sectors of the economy to the financial services sector of the economy.

Some of the consequences of this re-allocation of capital is that the employment of capital declined: capacity utilization is around 77 percent now relative to more than 90 percent in the 1960s.  Under-employment is over 20 percent now and was under 10 percent in the 1960s.  And, the income/wealth distribution is more skewed toward the wealthy than it was 50 years ago.

This has impacted economic growth.  For example, the annual compound rate of growth of real GDP has only been 2.5 percent over the past twenty years, down substantially from the rate of growth for the whole period.  Credit inflation, as an economic policy of the government, seems to have exactly the opposite impact on the economy that is desired by policy makers.

But the other important thing to notice in the chart is the “bumps in the road”.  In my opinion, all of these “bumps” resulted in some way from dislocations in the growth of credit instruments as a result of the monetary or fiscal policies of the United States government.  In most cases, the dislocations were relatively minor. However, as the debt load expanded and the private sector devoted more and more resources to financial services, the ability to carry the load grew greater and greater.

The debt burden cannot keep growing: it has to collapse sometime and along with it the economy.  In most cases the “bumps” were relatively minor.  I know it is never fun for anybody to be un-employed or under-employed, but in the aggregate sense, the “bumps” were not large. 

During the Great Recession and following, the “bumps” were much larger because the build-up of the debt dislocations were greater than ever.  However, since the debt burden must be worked off, it will take more time for the economy to achieve the longer run rates of growth that were achieved earlier in this fifty years of economy prosperity.  But, it will come. 

We must be aware of these dislocations and the things that must be done to re-structure the economy and get back to the economic growth performance we are looking for.  For example, we cannot ignore the state of the banking industry in this recovery. (See my post from last Friday: http://seekingalpha.com/article/295630-why-banks-aren-t-lending.)  Resolving the “bumps” just means that the previously created dislocations in finance and economics must be resolved.    

Post QE2 Federal Reserve Watch: Part 2

Excess reserves in the commercial banking system did not change much over the past quarter.  The two-week average for the banking week ending September 7, 2011 was $1, 569 billion.  At the start of August the total was $1,602 billion and at the start of June the total was $1,549 billion.  So roughly, excess reserves averaged around $1.6 billion over the past three months.

It’s kind of hard to appreciate the irony of saying excess reserves didn’t vary much over the past three months when in August 2008 the excess reserves in the whole banking system totaled only $2.0 billion. 

QE2 ended June 30.  So, we were not to expect the Federal Reserve to do too much to the banking system after this period of quantitative easing ended.  And, so far the Fed has done little or nothing.

This does not mean things were not happening in the commercial banking system. 

For example, the required reserves in the banking system rose by more than 20 percent from the banking week ending June 1 to the banking week ending September 7.  The rise was from about $76 billion to around $92 billion.  These are the reserves banks must legally keep on reserve to back up transaction and savings account balances.    

Most of the increase came in the last week of August and the first week in September when required reserves increased by more that $10 billion. 

The rise in required reserves came about due to a massive jump in the demand deposits held at commercial banks in August, which require the highest amount of reserves to be held by the banks! 

There also was a surge in savings deposits at commercial banks in August.  

The increases in demand deposits and savings deposits seemingly came about due to a large movement of funds from small savings accounts and institutional money funds. 

It was during this time that the Federal Reserve announced that it was going to keep short-term interest rates at very low levels for the next 24 months.  This announcement seems to have accelerated the movement out of short-term interest bearing assets to bank accounts…transaction accounts and savings accounts.  In a real sense the disintermediation continues. 

The point is that these movements on the part of wealth holders have influenced the money stock figures.  For example the year-over-year growth rate of the M1 money stock, the measure most affected by the shifts in money, the shifts toward demand deposits, has risen from about 12 percent at the end of May to just under 17 percent at the end of August. 

The M2 money stock measure has also risen but its growth rate remains under 50 percent of the growth rate of the M1 money stock.  Its rise has gone from about 5 percent to 8 percent over the same time frame. 

As I have pointed out for about two years now, the money stock measures appear to be growing because people are shifting out of short-term interest bearing assets because of the exceedingly low interest rates and are parking the funds in commercial banks in transaction balances and savings accounts. 

Some of this transfer is also occurring because people who are under-employed or having other financial difficulties want to keep their funds in accounts that can be accessed quickly to meet daily and weekly needs.      

The money stock growth is not occurring because the banking system in gearing up the lending machine and providing the loans needed for a more robust expansion of the economy.

I believe my interpretation of money stock growth is the correct one because this re-allocation of wealth balances from interest earning assets to transaction balances and other short-term bank assets has been taking place for two years or so and this movement has resulted in increasing growth rates for the money stock measures.  Yet, there has not been a real increase in bank lending during this time period and economic growth remains anemic with a stagnant labor market. 

Money stock growth is occurring but, one could say, for the wrong reasons.  The money stock measures are growing because people are protecting themselves and staying liquid while interest rates are so low.  This is not the behavior that drives the economy forward.  The money stock measures are not growing because of the monetary stimulus and this means that one cannot expect much economic growth from it.

The open market operations of the Federal Reserve have basically been operational over the past five weeks.  Federal Agency securities and Mortgage-backed securities continue to run off from the Fed’s portfolio and these run-offs have been replaced by US Treasury securities.  The off-set has been almost one-for-one, dollar-wise.

The interesting action on the Fed’s balance sheet has been a $34 billion increase in Reverse Repurchase Agreements with foreign official and international accounts.  Reverse repos take reserves out of the United States banking system.   In these cases, the Federal Reserve “sells” US Treasury securities under an agreement to buy them back at a later date. Over the past 14 weeks, reverse repos to foreign governments or their agencies rose by $43 billion.  One can only guess that these transactions have to do with the financial crisis that has been taking place in Europe.  More research needs to be done on this.

The net result of all this is that the Fed has done nothing overt since the end of second round of quantitative easing.  Economic activity continues to be stagnant and the under-employment situation does not improve.  Money stock measures continue to grow but for reasons not related to increases in bank lending and improving economic activity.  The question seems to be, where does the Federal Reserve go next?  Answers to this question are all over the board. 

The Economic Picture--No Steam Ahead!

The August unemployment rate was 9.1 percent.  Not much joy in Mudville.

About one in five Americans in the prime age for working range remain under-employed. 

We have the short-run problem related to economic growth and the fact that families, businesses, and governments need to get their balance sheets in order before they will really begin to spend again. (http://seekingalpha.com/article/290934-struggling-with-a-great-contraction) 

We have the long-run structural problems in the labor market related to the fact that the skills of many individuals of working age do not mesh with the jobs the economy is creating or is going to create.  For a dismal picture of this situation see the recent article in Bloomberg Businessweek (August 29—September 4, 2011) titled “The Slow Disappearance of the American Working Man.” 

And short-run growth seems to be going nowhere.  Just look at the year-over-year rate of change in industrial production.  Note that this series peaked in the second quarter of 2010.  The modest decline in this growth rate has now been going down-hill for more than 12 months.

Of course, the performance of industrial production is also captured in the year-over-year growth rate of real Gross Domestic Product.  Here the peak growth rate was achieved in the third quarter of 2010.  The growth rate has declined since.

If the economy fails to grow by 3.0 percent or more, jobs will not be added at a rate that will lower the unemployment rate.  And, growth at this rate will certainly not resolve the long run problem related to those that are holding part-time positions that would like to have full-time jobs and those people that have left the work force. 

Furthermore, this scenario is not one that is favorable to people making much headway in reducing the burden of their debts.  Thus, the “debt overhang” seems to be a part of the continuing saga of our economic malaise.  The environment for getting out of debt does not exist.

Given this picture, the questions that arise pertain to the concern that America may face a decade like Japan has faced or a decade like that in America in the 1930s.  Maybe this is the “payback” for the period of credit inflation we have experienced over the past fifty years.  Maybe the only way out of this situation, which is not a short-run solution, is to focus on the fundamentals, focus on the structural problems created over the past fifty years.

The Federal Reserve, so far, has acted so as to prevent another “shock” to the economy like the one they introduced in the 1937-38 period.  In this earlier period the Fed caused banks to become even more restrictive in their lending operations than they had been and this precipitated a second depression for the 1930s.  This time the Fed has flooded the banking system with liquidity and seems to be in no hurry to remove anything that appears excessive in terms of bank reserves even though bank lending remains modest, at best. (http://seekingalpha.com/article/290416-quantitative-easing-theory-need-not-apply)   

The short-run conflict that is going on right now is between the efforts of the Federal Reserve to stimulate bank lending and the financial system, and the efforts of families, businesses, and governments to reduce their debt loads.  At the present time, the latter interests seem to be winning.

The longer run question relates to whether or not the government stops focusing just on short-run solutions to the problems of the economy and begins to focus on the longer-term structural problems that exist.  The difficulty here is that it took a long time to get where we are now and it can be expected that it will take us a long time to get things back in order. 

The real dilemma is that we don’t create more problems for the future by implementing short-run solutions to our problems that will just exacerbate our longer-run problems.  In the long run we may all be dead, but we now seem to be dealing with the long-run problems left to us by earlier generations of policy makers that just focused on short-run solutions without any regard for the long run!

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, http://seekingalpha.com/article/287494-foreign-related-financial-institutions-continue-to-suck-up-u-s-excess-reserves.)   

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 http://seekingalpha.com/article/287494-foreign-related-financial-institutions-continue-to-suck-up-u-s-excess-reserves.)  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. 

Foreign-Related Financial Institutions Continue to "Suck Up" U. S. Excess Reserves

For your information, 0.4 percent of the banks in the United States, the largest 25 commercial banks, control 56 percent of the banking assets in the country. 

The smallest banks, banks less than $100 million in total assets, which make up 35 percent of the banks in the country, control 1.0 percent of the banking assets in the country.

The next size category, commercial banks with more than $100 million in assets but less than $1.0 billion in assets, make up 57 percent of the number of banks in the country.  These banks control another 9.0 percent of the banking assets in the country.

Consolidating these last two categories we find that 92 percent of the commercial banks in the country control only 10 percent of the banking assets of the country. 

Just thought you might want to know these facts.

Over the past year, the total assets in the banking system in the United States grew by a little more than $630 billion.

Over the past year, the cash assets in the banking system in the United States grew by a little more than $650 billion!

Thank you, quantitative easing!

Of the $650 billion increase in cash assets, over 75 percent of the increase went into the cash assets of foreign-related banking institutions in the United States.  And, over 85 percent of this increase went into the amount of liabilities due to the foreign offices of these foreign related banking institutions. 

Three cheers for the “call” trade!

And, what about stimulating loan demand in the United States to get the economy going?  The loans and leases at all commercial banks dropped by about $75 billion over the past year. 

Business loans (commercial and industrial loans or C&I loans) did rise by a little more than $55 billion during this time period but the increase largely took place at the largest 25 banks; business loans at the remaining 6,400 banks in the country stayed relatively flat. 

Over the latest 13-weeks business loans fell fairly dramatically at the smaller banks as the amount of assets in the smaller banks has actually declined. 

But, it is still the real estate area that continues to suffer.  Real estate loans on the books of commercial banks fell by about $175 billion over the past 12-month period.  Dollar-wise, the drop was roughly the same between the largest 25 banks and the rest of the banking system. 

The major part of the decline, however, came in the commercial real estate area, which declined by about $125 billion, again, with the largest banks and the smaller banks declining by about equal dollar amounts.

Over the last 13-week period, the decline in commercial real estate loans seemed to accelerate in the smaller banks relative to the larger banks.  This points to the fundamental problem the smaller banks are having with their lending in the commercial real estate area.  This in not supposed to get better in the near term.

The conclusions I draw from these data are: first, that the quantitative easing (QE2) of the Federal Reserve primarily went “off shore” and to this day remains “off shore.” 

Second, many of the smaller commercial banks in this country are in very serious financial condition and many of the problems are located in the commercial real estate area.  But, it seems as if there may be growing trouble located in their basic business loan portfolios.

Third, fundamental business lending seems to be picking up somewhat, but primarily at the largest 25 commercial banks in the country.  Commercial real estate lending at these banks, however, has not picked up and is unlikely to do so in the near future.

These statistics do not point to a banking system that is ready to underwrite a strong economic expansion.