Wednesday, January 31, 2018

QE...The Gift That Just Kept Giving...Is Now Taking

I know the Federal Reserve doesn't effectively create money or directly monetize.  I know this because then Fed chief, Ben Bernanke, told us so (HERE).  But still, something has me wondering about that exchange, now almost a decade ago; the simplest of math.


The plan to utilize quantitative easing and avoid direct monetization went like this: The Fed would digitally conjure "money" to buy the US Treasury bonds and Mortgage Backed Securities (remove assets from the market) from the big banks.  However, the Fed would force those banks to deposit the newly conjured "money" at the Federal Reserve.  This would render the new dollars inert and avoid the trillions of newly created dollars from going in search of the remaining assets (particularly levered from somewhere between 5x's to 10x's...turning a trillion into five to 10 trillion...or more).

The chart below shows the Federal Reserve balance sheet (red line) and the quantity of those newly created dollars that the recipients of those dollars, the banks, deposited at the Federal Reserve (blue line).  But the green line is the quantity of newly created dollars that have "leaked" out...also known as "monetization".
The interplay of QE and excess reserves resulted in the peak QE impact taking effect long after QE was tapered and had ceased (chart below).  The trillions in assets remaining with the Fed, but the new cash no longer under lock and key at the Fed.

The impact of $800+ billion of pure monetization from late 2014 through year end 2016 was spectacular.  The split of the new money ending up in the hands of the largest banks (multiplied by "conservative" leverage somewhere between 5 to 10x's, easily amounting to trillions in new cash looking for assets) and back in the hands of pension funds, insurers, etc. is a valid question.  Unquestionable, is that it created a "bull market" beyond belief and this should not have been surprising.

The chart below shows the Wilshire 5000 in red representing all US equities actively traded, national disposable personal income in blue (all forms of income after taxation), and the net monetization in yellow.  The "bubbles" of '01 and '08 pale in comparison to the present explosion.  However, the increase in income represented by DPI does not justify the increase.  However, when the unlevered quantity of monetization is added, the picture is more interesting.
The same chart below, but focused from '07 until '18.  The jogs in the monetization subsequently followed by the Wilshire are probably noteworthy...but the most recent decline in available monetization hasn't materialized in the Wilshire...at least not yet.
However, that change since 2017 should begin to effect the market in 2018.  The change in flow from the declining Federal Reserve balance sheet coupled with fast rising interest payments on Excess Reserves (billions for the banks for not taking any risk, not making any loans to keep the cash locked away) should help to hold the Excess Reserves from declining any faster than the Fed's balance sheet reduction.
This cessation of "leakage" of new money coupled with extreme lows in savings, extreme valuations in asset values vis-à-vis disposable incomes (detailed HERE), decelerating deficits as a % of GDP with rising interest rates (detailed HERE), and rapidly decelerating population growth domestically and globally (detailed HERE and HERE) does not likely add up to a positive picture.  More likely is the next and greatest down leg in these centrally directed boom bust cycles.