Best of the Week
Most Popular
1. Gold Final Warning: Here Are the Stunning Implications of Plunging Gold Price - P_Radomski_CFA
2.Fed Balance Sheet QE4EVER - Stock Market Trend Forecast Analysis - Nadeem_Walayat
3.UK House Prices, Immigration, and Population Growth Mega Trend Forecast - Part1 - Nadeem_Walayat
4.Gold and Silver Precious Metals Pot Pourri - Rambus_Chartology
5.The Exponential Stocks Bull Market - Nadeem_Walayat
6.Yield Curve Inversion and the Stock Market 2019 - Nadeem_Walayat
7.America's 30 Blocks of Holes - James_Quinn
8.US Presidential Cycle and Stock Market Trend 2019 - Nadeem_Walayat
9.Dear Stocks Bull Market: Happy 10 Year Anniversary! - Troy_Bombardia
10.Britain's Demographic Time Bomb Has Gone Off! - Nadeem_Walayat
Last 7 days
Want To Earn A Safe 5% In Fixed Income? Buy Preferred Stocks - 24th April 19
Can Gold Price Rise Without a Rate Cut?  - 24th April 19
Silver’s Next Big Move - 24th April 19
How Can a College Student Invest Wisely? - 24th April 19
Prepare For Unknown Stock Market Price Action As New Highs Are Reached - 23rd April 19
Silver Plays a Small but Vital Role in Every Portfolio - 23rd April 19
Forecasting 2020s : Two Recessions, Higher Taxes, and Japan-Like Flat Markets - 23rd April 19
Gold and Silver Give Traders Another Buying Opportunity - 23rd April 19
Stock Market Pause Should Extend - 21st April 19
Why Gold Has Been the Second Best Asset Class for the Last 20 Years - 21st April 19
Could Taxing the Rich Solve Income Inequality? - 21st April 19
Stock Market Euphoria Stunts Gold - 20th April 19
Is Political Partisanship Killing America? - 20th April 19
Trump - They Were All Lying - 20th April 19
The Global Economy Looks Disturbingly Like Japan Before Its “Lost Decade” - 19th April 19
Growing Bird of Paradise Strelitzia Plants, Pruning and Flower Guide Over 4 Years - 19th April 19
S&P 500’s Downward Reversal or Just Profit-Taking Action? - 18th April 19
US Stock Markets Setting Up For Increased Volatility - 18th April 19
Intel Corporation (INTC) Bullish Structure Favors More Upside - 18th April 19
Low New Zealand Inflation Rate Increases Chance of a Rate Cut - 18th April 19
Online Grocery Shopping Will Go Mainstream as Soon as This Year - 17th April 19
America Dancing On The Crumbling Precipice - 17th April 19
Watch The Financial Sector For The Next Stock Market Topping Pattern - 17th April 19
How Central Bank Gold Buying is Undermining the US Dollar - 17th April 19
Income-Generating Business - 17th April 19
INSOMNIA 64 Birmingham NEC Car Parking Info - 17th April 19
Trump May Regret His Fed Takeover Attempt - 16th April 19
Downside Risk in Gold & Gold Stocks - 16th April 19
Stock Market Melt-Up or Roll Over?…A Look At Two Scenarios - 16th April 19
Is the Stock Market Making a Head and Shoulders Topping Pattern? - 16th April 19
Will Powell’s Dovish Turn Support Gold? - 15th April 19
If History Is Any Indication, Stocks Should Rally Until the Fall of 2020 - 15th April 19
Stocks Get Closer to Last Year’s Record High - 15th April 19
Oil Price May Be Setup For A Move Back to $50 - 15th April 19
Stock Market Ready For A Pause! - 15th April 19
Shopping for Bargain Souvenirs in Fethiye Tuesday Market - Turkey Holidays 2019 - 15th April 19
From US-Sino Talks to New Trade Wars, Weakening Global Economic Prospects - 14th April 19
Stock Market Indexes Race For The New All-Time High - 14th April 19
Why Gold Price Will “Just Explode… in the Blink of an Eye” - 14th April 19

Market Oracle FREE Newsletter

Top 10 AI Stocks Investing to Profit from the Machine Intelligence Mega-trend

Liquidity, Money Supply, and Insolvency

Stock-Markets / Financial Crisis 2019 Jan 13, 2019 - 04:43 PM GMT

By: Andy_Sutton

Stock-Markets

Liquidity is becoming of central importance once again. It is frequently mentioned in mainstream media articles, interviews, and ‘educational’ programs.  It was a central point of discussion during the financial market blowout in 2008.

The killing off of a little-known (until it was dead!) data series earlier this year by the not-so-USFed has gotten the beehive buzzing once again about a liquidity crisis – or the possible aversion of one in the short term. It has also gotten things buzzing about the longer term as well.


What Happened

Late in 2017, the St. Louis Fed stopped publishing interbank loan data. Period. Just prior to that, the amount of interbank loans on a weekly basis dropped to zero:

In typical fashion, however, the fine folks at the central bank have ‘cleaned up’ the series – and the chart, but not totally. See below:

Ironically, if you search for ‘Interbank Loans’ and you pull up the aggregate chart for all US banks, you will see that the data ends on 12/1/2017, but the data for ‘Small, Domestically Chartered’ Banks ends 1/3/2018, leaving the extremely small blip above.

Is this another M3 deal where a rather important data series was killed off to ‘save the taxpayers money’ (the excuse given for the cessation of M3) or did something fundamentally change in the way banks secure temporary liquidity? Here’s what we think: If you look at the chart, you can see that interbank loans were dropping pretty steadily. One can interpret that as a return to normalcy of sorts after the financial catastrophe in 2008. That interpretation probably isn’t that far off. There were a couple of periods where loans spiked – late 2012 and early 2017 in particular. These roughly coincide with the Eurozone debt crisis playing out and some of the goings on across the Atlantic. Then all the rumors about DeutscheBank started. We are of the opinion that the not-so-USFed launched a pre-emptive strike on another credit lockup by changing the way that its member banks (owners by definition) met their temporary liquidity needs.

It has often been said that the ‘fed’ is the lender of last resort. We believe the US central bank became the lender of all resort. That it decided that all interbank loans would go through it rather than banks going to each other. This is an important distinction because, while banks are certainly good at colluding, they are also very much interested in self-preservation. If there’s a rumor that some bank X was in trouble, they’d turn off the phones when bank X comes calling about a loan. Think of the cold shoulder Lehman’s Dick Fuld got in September 2008 when he spent an entire weekend calling everyone but Elvis with regards to securing a venture saving loan. He didn’t get one. Not even from the not-so-USFed. We are very sure there was much more to this than was or will ever be told.

If this is the case, why wipe out the data series and trigger a bunch of questions? Why not just continue the series and plop in the numbers the central bank lends out and leave it at that? Or just make it up like is done with so many other economic and financial statistics these days?

The Bigger Question

Regardless of why this was handled the way it has been – and we readily admit neither us nor anyone else will probably ever know why it was done this way – it begs a bigger question, which has started to emerge in the minds of many around the globe: Is it possible for the not-so-USFed to go broke? 

These questions are being asked for some very good reasons. A look at the USGovt debt is the first. $22T. The debt of the US population is another – the total amount varies depending on what sources you use, but according to usdebtclock.org, total consumer debt is almost $19.5T. Throw in the notional value of that quaking house of cards known as derivatives and that’s a whopping $602T, again, according to usdebtclock.org. We could keep going, but we think you get the point. This massive mountain is serviced by an M2 money supply that is reportedly just shy of $14.4T. It takes a bit of understanding to get to the fact that money supply is transactional only; it is not involved in the storage of wealth. A quick example. Tom buys 100 shares of company X from Joe. Tom transfers the payment through the Automated Clearinghouse (ACH). Joe then takes the payment and buys groceries. Tom now has 100 shares of stock and Joe has groceries, but the money is in the hands of the grocer. Ergo the money supply is lubricant for the economy, transactional in nature. We don’t need hyperinflation just because the national debt is $22T.  Or because a pile of financial derivatives with a ‘notional’ value of over $600T exists.

But what about that pile of derivatives? Certainly, it is unrealistic to conjure up a scenario where they all trigger at once. Many of the derivatives are stacked against each other. It’s a binary situation. This or that, not this AND that. Let’s say, just for kicks that 5% of that pile would trigger and money would have to be paid out. Now you’ve got a problem. The $14T worth of US M2 is spread throughout the economy as we described above. Some of it is cash and that lives in bank vaults, people’s safety deposit boxes and, contrary to the times, even in their wallets. Some of it is probably buried underground. Remember, the dollar is not just currency, it is also a unit of account. Things can be worth so many dollars. The net worth of everything in the US is far, far in excess of the money supply. Money is transactional. It zips around the economy. We economists even measure the velocity at which it zips around. It is very non-cleverly called ‘velocity of circulation’.

IF a $30T transaction would have to take place because 5% of the derivatives pile triggered, it simply couldn’t. Non-monetary assets would have to be thrown into the mix to settle it because there aren’t enough dollars for a transaction that big. Or, alternatively, additional dollars would have to be created for the purpose of making that transaction possible. This is the sort of thing that keeps central bankers awake in a runaway environment like the world locked into now.

Everyone assumes that the not-so-USFed can backstop any eventuality. It is a weighty assumption present in many economic models and scenarios where different outcomes are ‘gamed’ by modelers in an attempt to quantitatively assess risk.  The ‘fed’ stands out as the lender of last resort. This assumption is made because the dollar is the world’s reserve currency (stay with us here), everyone needs dollars and as such, it wouldn’t be that big of a deal if the ‘fed’ had to suddenly ramp up the money supply for a single enormous transaction or even a wave of smaller, but equally inexecutable transactions. Below we point out a slight oddity. The bulk of monetary inflation is created when new loans are taken out. Given the propensity of Americans and their government at all levels to borrow fresh money on a regular basis, monetary growth has settled to a tepid 5% give or take a few basis points. We’ll get to this point in our next column.

It is a very dangerous assumption. Built into it is the assumption that the world – not just people in the US – doesn’t mind being robbed of purchasing power as more money is created. It also carries the assumption that the rest of the world wants to exist in an unholy and clearly imbalanced financial relationship with a predatory monetary ‘authority’. Based on the number and frequency of deals being cut to sidestep the dollar, it is safe to conclude that at least some of the world’s population is no longer comfortable with the prior arrangement.

Lastly, there is perception. It is the only reason people will accept intrinsically worthless paper tickets (or equally worthless digital facsimiles thereof) in exchange for goods and services produced with scarce land, labor, and capital. Nobody really thinks about it. Watch a bank robbery in a movie sometime. What happens? You have a few people convinced that it is worth spending the rest of their life in jail for a bunch of paper? Why would anyone do that? Because they perceive it to have value. They know they can trade it for a bunch of stuff that really does have value. Back to our movie, some brave individual will often try to take on the robbers – usually unsuccessfully – in an attempt to stop the robbery. Why would anyone in their right mind be willing to die for a bunch of worthless paper? Same answer as before – they perceive the paper to be of value and thus the cause is a noble one.

In the end, it’s a completely tilted economic arrangement. The holders of the dollar assume all risk; the issuing ‘authority’ assumes none of the risk. The not-so-USFed is a glorified paper mill. It has paper and digital ‘assets’. Some have value, some are completely illiquid (Think of Maiden Lane, LLC 1,2, and 3). At the end of the day the question isn’t whether or not the ‘fed’ can go broke – it already IS broke. It continues to exist based on several factors: 1) the cost of unwinding dollar-denominated arrangements, 2) the difficulty in setting up a new system when there is full awareness that attempts to do so will likely result in sanctions, smear campaigns, and even military action, and 3) people tend to think in the short-term while making decisions that impact the long-term. The path of least resistance is to continue to tolerate the broken system even if all actors are aware that it is predatory, thereby ensnaring countless future actors and transactions in the same broken system.

As mentioned above, some countries are starting to buck this trend though. And that is the dangerous part. Every deal that cuts out the dollar makes the news. Never in the US of course, but elsewhere in the world. Alliances are being made based on a growing resentment of the forced USDollar hegemony that the world has experienced. Keep in mind, every country that has a fractional reserve fiat monetary system is in the same boat as the United States. The big difference is the dollar, despite all the recent scurrying for the exits, is still the reserve currency. That will change, however, and then people will finally realize that the real question that needed asking was not if the ‘fed’ could go broke, but could the ‘fed’ become irrelevant? As we enter 2019, the answer to that questions appears to be a resounding ‘YES’.

Graham Mehl is a pseudonym. He is not an ‘insider’. He is required to use a pseudonym by the policies of his firm when releasing written work for public consumption. Although not an insider, he is astonishingly bright, having received an MBA with highest honors from the Wharton Business School at the University of Pennsylvania. He has also worked as an analyst for hedge funds and one G7 level central bank.

Andy Sutton is a research and freelance Economist. He received international honors for his work in economics at the graduate level and currently teaches high school business. Among his current research work is identifying the line in the sand where economies crumble due to extraneous debt through the use of economic modelling. His focus is also educating young people about the science of Economics using an evidence-based approach.

By Andy Sutton

http://www.andysutton.com

Andy Sutton is the former Chief Market Strategist for Sutton & Associates. While no longer involved in the investment community, Andy continues to perform his own research and acts as a freelance writer, publishing occasional ‘My Two Cents’ articles. Andy also maintains a blog called ‘Extemporania’ at http://www.andysutton.com/blog.

Andy Sutton Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules