|February 23, 2013
Lee Adler, The Wall Street Examiner.
This is how Bloomberg reported one of the biggest stories of the year, "JPMorgan Leads U.S. Banks Lending Least Deposits in 5 Years"—and got it backwards:
The biggest U.S. banks including JPMorgan Chase & Co. and Citigroup Inc. are lending the smallest portion of their deposits in five years as cash floods in from savers and a slow economy damps demand from borrowers.
The average loan-to-deposit ratio for the top eight commercial banks fell to 84 percent in the fourth quarter from 87 percent a year earlier and 101 percent in 2007, according to data compiled by Credit Suisse Group AG. Lending as a proportion of deposits dropped at five of the banks and was unchanged at two, the data show.
Consumers and companies are reluctant to take on risk until they see more signs that business is improving, even as the Federal Reserve maintains near-record low interest rates designed to fuel growth. Putting more of the unused money to work could boost profit and help turn around the U.S. economy, whose 0.1 percent annualized drop in the fourth quarter was its worst showing since 2009.
These deposits aren’t about people taking cash out of mattresses and depositing it in the banks. This story should not be about the banks not lending, because that’s not true. They are. They have been growing loans at a measured pace between 3.5% and 5% a year since 2011. That is absolutely consistent with the growth of the economy, and dare I say, the potential growth of the economy. The story is not that loan growth is not keeping up with deposit growth. It’s that deposits are growing too fast for the economy. That’s dangerous, and the Fed is directly responsible.
Bloomberg actually reported the real story it but buried it in a single line midway through the report.
At the same time, total deposits also reached a five-year peak of $5.04 trillion, according to the data, leaving hundreds of billions of dollars of potential fuel unused.
Needless to say they left out a lot and misinformed readers that savers were flooding bank accounts. That seemed to imply that the source of deposit growth is either the nation’s mattresses or maybe thin air, when the truth is that there’s only one major source for the rapid growth: the Fed. That’s the big story. The Fed is blowing a deposit bubble. If history is any guide, that will inevitably result in more–and more dangerous– capital misallocation, in other words, more and bigger bubbles. That’s always where too much, excessively easy, money leads.
The Fed has been buying $115-$120 billion of MBS and Treasuries from the Primary Dealers each month and will continue to do that until it ends or modifies this program. It buys those securities by crediting the dealers’ accounts at the Fed. That is the absolute genesis of central bank fiat money. Abracadabra- $2 billion to the account of Goldman Sachs! The dealers almost immediately move those funds into their deposit accounts at their affiliated bank under the same corporate umbrella or they transact business and trade with counterparties, whereupon the money gets deposited in the counterparty banks. That’s how the Fed creates deposits.
The Fed is growing deposits far faster than banks can deploy them. It is growing them far faster than the economy can use them. It is growing them far faster than anybody wants or needs. And so, as Bloomberg correctly points out, but buried where no one will see it, there are “hundreds of billions of dollars of potential fuel unused.” Therein lies the potential for big problems.
Loans have been growing at 3.5-5% per year since 2011. That’s consistent with what the economy demands and needs. Since US population is only growing at less than 1% per year, why should the economy grow any faster than 2-3%? Why would the Fed want to push deposit growth up at the rate of 9-10%, which is what the growth rate has been since the Fed began settling its QE3 purchases. That forces and encourages banks and those with access to easy credit like the Primary Dealers, other broker-dealers, and especially their hedge fund clients, to “invest” (speculate) in things that aren’t needed or are counterproductive. That includes buying commodities, or bonds yielding next to nothing, or higher yielding junk with substantially greater credit risk. That spawns bubbles, and bubbles eventually beget crashes.
Source: Federal Reserve H.8 and H.4.1 Data Download Programs
As this chart shows, since the Fed began QE in 2009 the growth of the bank deposit to loan ratio has correlated directly with the growth of the Fed’s System Open Market Account. There’s no mystery here. This is a direct result of the mechanics of the Fed’s policy. The problem since 2009 has been that there’s not enough loan demand in this economy to absorb all those deposits. Loan growth was negative until 2011, when it finally turned the corner, but at nowhere near the growth rate of deposits. So the banks need to scrounge around for other investments. Meanwhile since early 2009 around the time the Fed began QE, the deposit to loan ratio has risen from a low of 0.94 to a peak of 1.29 in early January, backing off only to 1.27 currently.
There is absolutely no mystery where the deposits came from that drove the ratio to these levels. They came from the Fed. Since 2009 the Fed has added $2 trillion to its assets. Since 2009, bank deposits have grown by $2 trillion. It doesn’t get any simpler.
A brief exception to the direct correlation was in the third quarter last year when the Fed’s balance sheet was flat but deposits surged. That came from foreign inflows, but that flow stabilized in the October- January period. The Fed began settlement of its QE3 MBS purchases in November. The surge in the deposit/loan ratio from November to January was a direct result of the Fed pumping those deposits into commercial banks, just as it was in the previous 3 years. The correlation has been 1:1. It doesn’t get any more direct.
I have tried for years to watch monetary and market data closely and observe where there are correlations and what they typically mean. I try to discern trends and discern when they are changing. I try to remember a little history.
One of the old ideas that I have verified to my satisfaction along the way is something I first heard from the old men trading in the galleries of the brokerage houses back in the 1960s when I began “watching” the market. That is, “Don’t fight the Fed.” The Fed wants inflation. It wants higher stock prices. It wants long term yields to stay low. It is trying to achieve all that by buying Treasuries and MBS from Primary Dealers, funneling immense amounts of cash into their accounts month in and month out.
Why would I fight that? The Fed can and does get its way for extended periods, until something forces it to stop and then reverse policy. The Fed rarely adjusts policy because it is successful. It adjusts when forced to by an unanticipated problem.That problem is virtually always in some form or other, inflation.
Financial asset bubbles are one manifestation of inflation. They are more insidious because so many people are profiting from them, investors get giddy and overconfident, and the Fed goes to sleep. Consumer prices are another story. They’re another manifestation of inflation. The exact pain. Bubbles and CPI inflation can occur together, but are often independent of one another, as is the case now. Over the past couple of years, the biggest asset bubble has been in bonds, and I believe also in stocks, although that one is at an earlier stage.
From listening to Bernanke, I gather that the theory is that this money pumping will drive stock prices higher and thereby trickle into economic growth, from the “wealth effect.” He also thinks that the Fed’s actions will stimulate housing by keeping mortgage rates low. To some extent those policies have worked, or didn’t work but appeared to. Mortgage rates, while historically low, have actually risen since the Fed began its QE3 MBS purchases, both from when the purchases started in September, and when they began to settle in November. Bernanke has also historically been in denial that Fed money printing results in massive malinvestment and may drive commodity prices higher, which is what happened in the last round of QE. Ultimately I believe that’s what forced him to pause between QE2 and QE 3/4.
He is also in denial (or simply disingenuous) about the costs of financial repression, or as I call it, ZIRP Bernankecide. Retirees have been driven to the poorhouse and can no longer spend. Conservatively managed pension funds can’t generate adequate returns. Pensioner incomes will be cut. Insurers are being squeezed, driving up insurance costs. The Fed acts likes ZIRP is a win win. But the fact is that it imposes real, painful, and I would say immoral, economic costs, that are at least equal to, if not greater than the benefits that accrue to the Fed’s commercial bank clients. Over the long run, the transfer of the wealth of middle class retirees by suppressing their rate of return on savings in order to liquefy and make the banks profitable cannot be considered a good thing. It’s bad for the economy, and it’s terrible for public morals and mores. Under the circumstances and in view of the fact that financial fraud is never punished, cheating becomes an excusable, even acceptable mode of behavior not just at the top, but at all levels of society. It’s called Getmineistan, and that’s where we’re headed, and maybe where we already are.
The Fed pretends that low interest rates are a free lunch, that somehow the whole economy benefits on balance. That’s insanity. I have personally seen the lives of seniors destroyed because they can’t earn a decent return on their savings. Fed policy does not increase economic income, it merely displaces it to less productive uses. Is that how we want to encourage growth, by penalizing prudent savings and punishing the elderly who have saved all their lives and avoided risk? What kind of message does that send people? The wrong one.
Meanwhile the bull market will go on for as long as the Fed can ignore the hidden costs that its policies impose both on the economy, and to the fabric of society. Eventually those costs will become too great to ignore.
While I don’t know what will happen, if history repeats and commodity prices start to bubble up again before consumer prices and wages rise, the Fed will be in a Catch 22. So far, the Fed has had success in jawboning speculators into not buying commodities and driving commodity prices higher. It did it again today in its minutes propaganda. I’m sure the Fed was patting itself on the back this evening for getting the market to sell off as it did, and especially for the break in commodity prices, particularly oil, gold, and silver.
Eventually, the Fed crying wolf about ending QE sooner rather than later will no longer impress traders, who will return to buying oil, and agricultural and industrial commodities. Rising input costs would then pinch business profits. Consumers facing rising food and energy costs would cut back spending, hurting business sales. Rising food prices could also again trigger political instability around the world in places where food is the largest share of people’s spending. In fact, that’s already happening. Rising costs and pinched consumer spending would cause companies to need to cut back employment. That could lead to a vicious downward spiral.
What would the Fed then do? Could it afford to stop QE? QE is what is driving stock prices higher and will probably continue to drive stock prices higher until it ends. By stopping it, the Fed would deprive the dealers and their hedge fund clients of the fuel they need to continue pushing their bids up. Stock prices would fall. There would be a firestorm of problems in the markets and economy leading to a massive decline in stock prices and economic activity.
On the other hand, could the Fed continue or even increase QE in the hopes of giving a boost to consumer prices, increasing corporate pricing power so that they could continue hiring and even increase wages? That would probably stoke even greater commodity speculation, tightening the squeeze on companies and consumers. It would run the risk of a massive inflationary spiral with rising bond yields. How would the US government then pay the interest on its debt? Would foreign creditors still have the ability and will to continue supporting the Treasury Ponzi? Or would the Fed be left as the sole buyer? What would the implications of that be?
I don’t have the answers. Those would be a couple of worst case scenarios. Of course maybe the Fed can manage through all of this so skillfully that the economy will grow out of these problems before any of the bad outcomes happens. History says otherwise, but it often takes a generation before we bear the fruits of the Fed’s blunders. Maybe the process will devolve quickly, or maybe it would take years and years to play out. Humans have a tough time with perspective on things like this in terms of the great sweep of history. If we watch the minute hand of a clock, we can’t see it move. But night time comes. Economically, I think it’s dusk. Night is coming.
I have not a clue what is most likely to happen. History says that we come to the brink again, have a market crash correcting some of the excesses, wash, rinse and repeat. I just suspect that the excesses that corrupt Fed and government policy have created will be far more difficult to correct and recover from in this cycle than in the past.
I see the bigger issue as a moral question, not a policy question. If we do not take corrective action against those in power perpetrating massive financial frauds and making policy to benefit the powerful at the expense of the powerless, if we do not turn away from the idea that easy money is the cure all, that those at the pinnacle of economic power know what’s best for us, if the only answer is repeatedly to go through the wringer and transfer the savings of the middle class to the banking and corporate executive class, then we simply slowly descend toward the dissolution of civil society.