The Fed: Uneasiness About QE3

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by: John M. Mason

"Just a few months after announcing a campaign to reduce unemployment, Federal Reserve officials are already debating how soon to stop it, reflecting persistent internal divisions about the effort's value." This from the New York Times. I am in the camp that says that Federal Reserve actions cannot reduce the unemployment rate. Latest figures on the unemployment rate: December came in at 7.8 percent and November was revised upwards to 7.8 percent.

How important is this? People who read my blog know that I am more concerned about the under-employment rate and not the unemployment rate. My measure of under-employment in the United States remains around 20.0 percent give or take a couple of percentage points. Discouraged workers and workers who have left the labor force are very important to me in explaining our labor situation. Also, the fact that participation rates in the labor market are now at a level around that achieved in the late 1960s is very important. In my mind, the Federal Reserve can do very little about these measures.

And, just what has the Fed done since early September when QE3 was announced? And, just what has the Fed done in the year 2012?

In terms of ease or tightness in the banking system and the money markets, the Fed has done very little since early September. Excess reserves in the banking system were around $1,451 billion in two weeks ending September 5. Excess reserves in the banking system in the two weeks ending December 26 averaged $1,453 billion.

The average federal funds rate was around 14 basis points in September; in December the federal funds rate averaged around 17 basis points.

Overall, I would argue that the banking system seems to be relatively comfortable with its reserve position. Excess reserves remain about the same as they were in early September when QE3 was announced and there seems to be little pressure on the money markets.

Since early September, the Federal Reserve has increased its securities portfolio by about $90.0 billion. Of this increase, $83 billion have come from acquisitions of mortgage-backed securities. The Fed's holdings of U.S. Treasury securities rose by about $17.0 billion while its portfolio of Federal Agency securities dropped by about $10.0 billion.

The thing is, since early September other operating factors have absorbed almost $115.0 billion in reserves resulting in an overall decline of about $20.0 billion in commercial banks' reserves held at the Fed. Currency draws continue to reduce reserves in the banking system: over $40 billion since September, and the General Account of the U.S. Treasure, the account from which the Treasury department pays the government's bills, increased by almost $60 billion.

So, even though the Federal Reserve increased its securities portfolio over the past four months, the reserve position of the commercial banking system remained roughly constant! Note that from January 4, 2012 to January 2, 2013, currency in circulation rose by $95.0 billion, an 8.8 percent increase.

The private sector continues its thirst for transaction-based assets. I have continually written over the past four years on the fact that the expansion of currency in circulation has remained at historically high levels. This, to me, is a continued sign of the weakness in the economy. When the economy is strong, when people are working, and when there is less uncertainty in outlook, people use less cash.

Furthermore, the private sector continues to move funds into demand deposit accounts from other short-term liquid assets. The year-over-year growth in demand deposits remain at very high levels keeping the M1 measure of the money supply growing rapidly, plus 13.5 percent December 2011 to December 2012. Small time accounts continue to drop year-over-year, falling $130.0 billion; retail money funds fell by $18.0 billion; and institutional money funds dropped by over $23.0 billion.

Thus, required reserves in the commercial banking system rose by almost 16.0 percent, year-over-year, while total reserves dropped by slightly more than 1.0 percent.

One can conclude from these figures that there is still much nervousness in the households and small- and medium-sized businesses. Individuals are keeping their money close in spendable forms to weather the uncertain economic times. The extremely low interest rates just contribute to this behavior. This kind of behavior is not consistent with strong economic growth.

One could say that the Fed's purchase of mortgage-backed securities in this past year went almost entirely to support the growth in currency in circulation. This, in my mind, does not stimulate the economy very much!

I am very uncomfortable with where Federal Reserve officials seem to be. I don't think they can do what many are saying they can do … reduce un- or under-employment. It doesn't seem to me that what they are doing is helping build confidence in the private sector or in commercial banks.

And, it seems to me that the low interest rate policy of the Fed is just contributing to the lack of discipline that exists within our government concerning the level of the federal deficit federal deficit. But, my major problem is that I don't see the Federal Reserve acting much differently during 2013.

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.