December 2012 Review Of Monetary Actions

Includes: DIA, SPY
by: John M. Mason

Year-over-year the excess reserves at commercial banks have declined from $1,461 billion in the banking week ended November 30, 2011, to $1,428 billion in the banking week ending November 28, 2012.

Year-over-year the total reserves in the banking system have fallen by almost 3.0 percent.

However, during that same time period, the reserves required by the banking system to back up deposits has risen by about 19.0 percent.

Households and businesses continue to move their funds from interest-bearing assets to transaction accounts and out of retail funds and institutional money market funds and other low interest yielding accounts. Demand deposits in depository institutions rose by almost 19.0 percent year-over-year and Other Checkable deposits increased by a little less than 5.0 percent.

Small time and savings deposits dropped by over 16.0 percent, year-over-year while money in retail money funds fell by about 5.5 percent and funds in institutional money funds dropped by 1.5 percent.

As we have seen over the past four years, households and businesses continue to transfer funds into transaction-type of accounts so as to carry out their daily business.

Note, that they are not increasing these balances by borrowing, the ways things happen in a healthy economy. They are increasing these balances by re-arranging their balance sheets. This is not a sign of a healthy economy, but of an economy scraping along, uncertain about its future.

Supporting this conclusion is the fact that the demand for currency is still running at historically high rates. The year-over-year increase in currency outside the banking system is almost 9.0 percent. And currency demand has been at high levels for more than four years, a sign that people are keeping money-on-hand for transaction purposes, to carry on their daily lives as well as possible.

Year-over-year, the Reserve Balances at Federal Reserve Banks have risen only about $55.0 billion even though excess reserves have declined slightly. However, only about $5.0 billion of this increase can be attributed to an increase in the Fed's holding of securities. The rest of the increase has come from "operating" factors, such as the decline in the General Account of the U.S. Treasury Department, which has fallen by $105 billion in the past year. When the Treasury writes checks from this account, reserve balances will increase at commercial banks while the General Account will decline as balances are drawn against it.

And, what about the third round of quantitative easing and the Fed's purchase of $40.0 billion in mortgage-backed securities every month?

Well, the Fed has been buying mortgage-backed securities. Because of the method used to purchase them (see my post of November 5, 2012), their acquisition of mortgage-backed securities does not show up immediately on the Fed's balance sheet. These transactions take 60- to 90-days to settle and do not hit the balance sheet for that amount of time. The Federal Reserve announced this policy on September 13, following the meeting of the Board of Governors of the Federal Reserve System that week.

Since the beginning of September, mortgage-backed securities held by the Federal Reserve have increased by $40.0 billion. But, total securities held by the Fed increased only $39.0 billion. Of this increase in mortgage-backed securities, a net gain of almost $32.0 billion was registered in the last four weeks. So, the purchase of mortgage-backed securities is taking place and is now showing up.

Still, these transactions are being dominated by "operating" factors. For example, the General Account of the U.S. Treasury declined by $84.0 billion in the last four weeks and this put far more reserves into the banking system than the securities transactions.

This is a seasonal swing. Note that this account only dropped by about $9.0 billion over the last thirteen weeks.

Another factor affecting bank reserves is currency flowing into the hands of the public. Here there is the longer run trend mentioned above and the seasonal impactcurrency in the hands of the public always rises between the middle of November and the next January. Currency in the hands of the public rose by $11.0 billion over the last four weeks and increased by over $29 billion over the past thirteen weeks. Year-over-year, currency in circulation increased by $91 billion.

So, on the Federal Reserve front we are seeing very little additional monetary stimulus hitting the financial system. There seems to be no pressure on short-term interest rates to rise, again suggesting that the economy is very weak and the demand for money is soft, and the financial turmoil in Europe has receded sufficiently so that very little pressure is being placed on the Fed to meet international liquidity demands.

Money stock growth, as stated above, is coming from portfolio changes, not from loan demand.

Bottom line, the United States economy is not robust by any means. And, looking at the monetary statistics and at the way the Federal Reserve is behaving, one can only draw the conclusion that economic growth is not picking up and the leadership at the Fed seems to be totally befuddled about what it can do, if anything.

The Federal Reserve may be having some impact on the mortgage market and the housing sector, but housing is starting out from such a low level of activity that even relatively high rates of improvement produce only small absolute increases in production. And, the biggest gainers from this Fed activity so far seem to be the largest banks in the country, like Wells Fargo (NYSE:WFC) nd JPMorgan Chase (NYSE:JPM).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.