Fed Expansion Plus Commercial Bank Contraction

Although the year-over-year rate of growth in US True Money Supply (TMS) is still high by historical standards, the following chart shows that it has just dropped to its lowest level since late-2008.



However, it is more likely to rise than fall over the next few months. The reason is illustrated by the following chart of the annualised 3-month TMS growth rate. The annualised 3-month rate of US monetary inflation bottomed at just below 4% in March of this year and has since rebounded to 9.5%.

There are some interesting details behind this year's US TMS statistics. First, since January of this year there has been almost no net change in US commercial bank credit and yet the US money supply has risen by about $400B. This tells us that the rise in the money supply since January of this year was driven almost totally by the Fed. Second, since the end of April this year there has been a net contraction of almost $100B in US commercial bank credit while the US money supply has risen by about $250B. This tells us that the Fed has been responsible for more than 100% of US money-supply growth over the past four months.

The Fed has directly injected enough new money into the US economy over the past four months to cause the short-term rate of TMS growth to accelerate upward despite a credit contraction in the private banking sector, which confirms some things we already knew. Most notably, it confirms that a) the Fed's QE not only boosts bank reserves, but also boosts the quantity of money circulating within the economy (bank reserves are not included in TMS), and b) the Fed is capable of expanding the US money supply without any help from the commercial banks.

We think there are two main reasons why US commercial banks, as a group, are not expanding their balance sheets, the first being that the pool of willing and qualified borrowers has shrunk due to the lacklustre economy and existing high debt levels.

The second and probably the more important reason for the reticence of commercial banks to expand credit is that the banks are now far more risk averse due to having very weak balance sheets. The balance sheets that are made public generally look fine, but this could be mainly because banks are no longer required to mark their assets to market in the reports that are made public. We suspect that a proper marking to market of all bank assets would in many cases reveal a precarious financial position.

There's no way for us to know for sure, but balance-sheet weakness would go a long way towards explaining the recent behaviour of the commercial banking industry. It would explain why banks seem to be wary about monetising assets such as T-Notes in addition to being wary about making new loans.

The above is excerpted from a commentary originally posted at www.speculative-investor.com on 15th September 2013.

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