No Demand Pressure On The Monetary System

Includes: AGG, IYF
by: John M. Mason

The Federal Reserve System cruises along buying up securities right and left and yet there continues to be little or no reaction in the banking system or the economy.

Over the past 52-week period ending on August 28, 2013, the Federal Reserve has added $810.5 billion in securities to its balance sheet.

As a point of reference, on August 1, 2007, just before the financial collapse started taking place, the whole balance sheet of the Federal Reserve totaled $855.7 billion. That is, the securities purchased during the last year almost equaled the entire balance sheet of the Fed at that earlier date!

Reserve balances at Federal Reserve banks rose by slightly more than $733.0 billion over the past year. And, excess balances held by the commercial banking system rose by just above $672.0 billion over this same time period.

The current, massive program of quantitative easing has apparently done little more than "pump up" the liquidity of the banking system.

Over the past four-week period, the Federal Reserve added $84.8 billion to its securities portfolio, hitting the $85 billion target monthly purchase rate right on the nose. Over the past 13-week period, the Fed added $261.3 billion to the portfolio, an average acquisition rate of roughly $87.0 billion per month.

Boy, are these guys good! They do what they say they will do!

The effective federal funds rate has finally drooped! Having stood erect over the past year in a range between 13 basis points and 17 basis points, in early May the rate went soft and dropped into the single digits. Even with no change in Federal Reserve stimulation over this time period, there seems to be little or no excitement going on in the short-term end of the money market. There just seems to be no demand pressure in the market at all.

Individuals and businesses still continue to move their funds into transaction balances. As I have been arguing for three years now, people continue to transfer funds into currency holding and demand deposits. There are, I have stated, two reasons for this. First of all, because of the bad economy, people need transactions balances to live off of and so they are keeping more of their funds in places that they can access easily to buy daily necessities.

Second, short-term interest rates are so low that it is not worthwhile for people to keep funds tied up in anything outside of the banks.

Currency in circulation is increasing by only 7.5 percent, year-over-year in recent weeks, still high by historical standards and down from a 9.3 percent rate of increase over the previous two years. In more normal times, people don't demand this much cash on a regular basis.

Demand deposit growth has slowed down…it is only increasing by about 15.0 percent, year-over-year. But, this growth rate has slowed down from 17.0 percent in the previous twelve months and 53.0 percent in the 52 weeks before that. All these rates of growth are at historically high levels.

Loan creation is not the explanation for these growth rates!

If the financial system were functioning more normally, the Fed would be increasing the monetary base, the commercial banks would be lending the funds being injected into the financial system by the Fed, and demand deposits would be increasing as borrowers spent the money they had borrowed. That is, the money stock would be increasing as the economy picked up steam.

In the current economy, the Fed is pumping reserves into the banking system, the commercial banks are setting on these funds, commercial bank loans are hardly increasing and when they do increase the funds seem to be staying within the financial arena and are not being spent on goods and services. Demand deposits are increasing because people are getting out of other short-term financial assets. And, the economy continues to chug along listlessly.

Places where people have generally placed funds as a "temporary abode of purchasing power" are increasing but substantially below the rates at which currency holdings and demand deposits are rising.

The general picture of the banking system basically remains the same as it has been for the last two years or so. The Federal Reserve pumps lots of reserves into the banking system. The banking system does little or nothing with the reserves because there really is no loan demand. Interest rates stay low. And, individuals and businesses use their banks to obtain currency or they use their banks as a transactions center for clearing checks written on their demand deposits. And, the economy meanders along.

How is tapering going to change this?

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.