QE3 Up To This Point In Time

by: John M. Mason

We have now completed seven weeks of the latest period of quantitative easing on the part of the Federal Reserve System, called Quantitative Easing Three or QE3.

At the end of the latest banking week, October 31, 2012, nothing remarkable has taken place. (A banking week for the Federal Reserve begins on Thursday and ends on the next Wednesday.)

The statement released by the Fed on September 13, 2012 after its September meeting of the open market committee (FOMC) included the following:

"To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month."

This policy, which garnered a lot of attention, was to be continued on into the future without an end date given.

Since this period of quantitative easing began, the Fed's holding of securities has actually decreased by about $2.5 billion. Over this time period, the Fed's holdings of mortgage-backed securities did increase, by $8.3 billion, but unless the portfolio of mortgage-backed securities held by the Fed experienced a substantial amount of maturities, purchases of mortgage-backed securities came in nowhere near the amount stated in the FOMC statement.

Furthermore, commercial bank reserve balances held by the Federal actually declined during this period by almost $70 billion.

This was mirrored by the decline in commercial bank excess reserves, which fell by about $28 billion from the two-week average ending September 5, 2012 to the two-week average ending October 31, 2012.

That is, since the period of QE3 began, excess reserves in the banking system have fallen!

This is not what was expected when the September 13 FOMC statement was released.

But, there has been little or no pressure being seen in the money markets. The Fed has established a target range for the Federal Funds rate, but the "effective" Federal Funds rate has remained well within the Fed's target range and, if anything, there seems to have been some weakness in the Fed Funds rate over the past several months.

The average "effective" Federal Funds rate for the past seven weeks has been 0.15 percent. Over the past 13-week period, the "effective" Federal Funds rate has average a little over 0.14 percent.

Seemingly, no pressure here in spite of the decline in the excess reserves in the banking system or the decline in reserve balances held at Federal Reserve banks.

Loan demand at commercial banks appears to have picked up somewhat over the past four to six months, yet, there is no demand pressure spilling over into the money markets that would cause the Federal Reserve to purchase open-market securities to offset the pressure from loan demand filtering through the commercial banking system.

Loan demand, however, is apparently not strong enough to create cause any kind of expansion of bank liabilities -- either demand deposits or time and savings deposits.

As I have been reporting for the past three years, there has been a remarkable shift in the asset holdings of the private sector caused by high levels of unemployment and very low levels of interest rates.

People have continued to move funds from institutional money funds, retail money funds, and small time and savings accounts into demand deposits. Over the past year, assets in institutional money funds have declined by about 1.0 percent, and assets in retail money funds have declined by over 6.5 percent, while small time and savings accounts have declined by almost 12.0 percent.

Demand deposits at commercial banks have risen by almost 20.0 percent.

This pattern has been occurring for more than three years.

The other thing is that currency outstanding has risen by over 9.0 percent. This is a historically high figure, and has been going on since the Great Recession began.

Not only can people not earn much interest on their asset holdings and have shifted funds into transactions accounts to have the money available, but individuals out-of-word or experiencing financial difficulties want to hold their funds in either currency or demand deposits because they need them to live off of.

As funds in commercial banks have shifted from time and savings accounts to demand deposits, the needs of the banking system for required reserves have increased. Year over year, required reserves in commercial banks have grown by almost by almost $14 billion.

Still, total reserves in the banking system have fallen by more than $113 billion, reflecting the lack of pressure on the banks to meet loan demand.

Overall, the monetary base -- the foundation of all the money and credit created in the financial system -- declined modestly over the past year. The increase in the currency in circulation over the past year roughly offset the decline that took place in the total reserves of the banking system.

The conclusion that I draw from this information is that nothing remarkable has taken place since the Fed announced that it was beginning a new round of quantitative easing. Loan demand, and hence, pressure on the banking system, has been minimal. There appears to be no pressure whatsoever on money market interest rates.

As a consequence, the Fed has done little or nothing up to this point in terms of engaging in a major purchasing plan to add to its securities holdings.

The private sector continues to take funds out of short-term interest-bearing accounts and place them in transactions-type of assets, currency holdings and demand deposits.

This is not a sign of money easing, but an indication that there are still major problems in the economic system that are being worked out. But, this "working out" will not add to any more economic growth in the short run.

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.