|
What are Banks doing with the Bailout Money? The evolution of the economic crisis is getting very interesting. Increasingly, banks are buying government bonds. To a degree, the banks are getting out of the business of being like highly leveraged hedge funds. Instead they are loading up on government bonds. On the other hand, governments, in particular the US Government, are taking over the role of highly leveraged banks and high risk hedge funds. The source of new liquidity to the economy is leaving the private sector and being taken over by government. This is an interesting turn for the United States, a nation that was established on the principle of limited government. Private Sector Deleveraging The brutal forced asset liquidations and hedge fund selling continues at all levels of the private sector, from the individual consumer to the largest investment banks. It is difficult to estimate, but noted adviser Marc Faber mentioned a figure of about $30 Trillion in equity asset losses globally this year alone plus other types of asset losses which may in total be as high as about $100 Trillion1 . The level of these private sector losses in asset values has been staggering. Against this trend of asset value losses is the massive monetary stimulation of global central banks. Below is a chart (courtesy of Chris Puplava of Financial Sense) of US Federal Reserve Assets2 . See also the two diagrams below (courtesy of Bud Conrad of Casey Research3 ). Although escalating to very high levels, the collective monetary stimulation of central banks is still an order of magnitude less than the extent of asset value losses.
The idea is to create enough inflation to counteract the deflation. To do this, money supply growth needs to be just enough to counteract the deleveraging and credit contraction, and to keep the economy moving forward. Too much money creation is likely to lead to a future inflationary spiral, an Argentina or Zimbabwe-type situation….like having your car’s wheels spinning while slipping backwards. Too little money creation and the economy plunges into Depression…. like having your car rolling backwards down a hill. But when your car gets just the right magnitude of fuel injection, you can continue moving forward. Is the magnitude of money creation appropriate? That is hard to answer, since there is no way to know exactly how much money to print. However, considering 10-to-1 leverage as a conservative estimate of the fractional-based reserve system, total government stimulus spending of $3 Trillion could equate to an effective asset stimulation of $30 Trillion or more. This level of stimulus may very well be what is appropriate. Until asset deflation reverses, governments will likely continue leveraging up by increasing liquidity, printing money, and soon monetizing debt (by buying longer-term bonds with “magic-money”; see below). In addition to spending on fiscal stimulus programs, governments may have little other choice to stem the current deflationary spiral. This leveraging of the balance sheets and capital injections into chosen “sectors” makes the U.S. Treasury and its Federal Reserve partner take over the role that was being played by the banks and the hedge funds….providing the liquidity for growth in the economy. It is as if governments are becoming gigantic hedge funds! It’s a Mad Mad Mad Mad World4 Money Multiplier Contracting As governments continue to provide this stimulus bailout spending, where is all the bank bailout money going? For insight, look first at the money multiplier, a measure of the amount of money the banking system generates with each dollar of reserves in the real economy. Here are three charts below courtesy of David Rosenberg of Merrill Lynch and Haver Analytics5 – with money velocity and the multiplier contracting precipitously, it appears that money is merely staying on bank balance sheets and not being used to fuel the real economy. Furthermore, various Fed surveys show that demand for consumer credit and residential mortgages from banks is near all-time lows. Banks might be hesitant to lend in this current environment in any case.
Banks Hoarding Cash So banks appear to be hoarding cash, including the cash they received from the government stimulus bailout programs intended to unfreeze the credit markets and get lending moving again. Look at the chart below showing cash assets of banks – it appears to be going through the roof. Cash on bank balance sheets has tripled in the past two months and is up more than 50% in just the last month. According to Merrill Lynch, bank lending to households and businesses have contracted at a 2% annual rate over the last month6 .
Banks Buying Treasuries So then what are the banks doing with all their cash? Look at the chart below showing banks have been buying up US Treasury Bonds like crazy in the same time period as mentioned above. In the last month, they have added $100 billion of US Treasury Bonds to their portfolios. If the extent of this bank buying of Bonds is similar to what happened in the 1990s, it is estimated that the buying potential could exceed $1 Trillion. This is an enormous figure.
Fed and Central Banks Monetization While the central banks may not be entirely happy with this behavior (using the bailout money to buy bonds instead of lending) by the banks, the central banks may soon be joining this effort of buying bonds. This process is known as monetization. Monetization occurs when the central bank buys government bonds with “magic-money”…money it has “created”. This is widely considered to be highly inflationary. The odds seem to favor high inflation in the future if central banks monetize. However, these are highly unusual times. There is some small chance of creating just enough money to counteract the deflationary forces. Most analysts expect high inflation to be the inevitable result of fighting deflationary forces - but nothing is inevitable. Perhaps the most admired adviser of our lifetimes, Sir John Templeton, said that those who are too certain of the answers don’t even understand the questions. Some analysts expect that a downward deflationary spiral is the likely outcome. This is entirely possible. However often things develop in ways no one foresees. The scenario that no analyst seems to foresee is one where the monetization and “liquefaction” is just enough to avoid a continuing downward spiral without being so much that it causes hyperinflation….a world which “muddles through” without worsening disaster. Why would central banks monetize?...create “magic-money” to buy bonds? A litany of reasons: Consider that oil-producing countries are now slowing their purchases of bonds due to lower oil prices and Asian countries are slowing their purchases of bonds due to a slowing global economy. With housing prices slumping, governments need to try to keep mortgage rates low which can be done through the buying of bonds. Somebody has to buy the rising supply of government bonds to finance the stimulus bailout programs and the upcoming massive wave of unfunded liabilities (recommended to see: I.O.U.S.A.). This monetization, which is highly inflationary, counteracts the credit contraction, which is highly deflationary. The challenge is to not overdo it and not underdo it. The government and central bank policies of lowering interest rates, providing liquidity, increasing lending facilities, and monetization of bonds is called quantitative easing (QE). A few recent commentaries by economic commentators provide some insight into this QE:
US Federal Reserve Chairman Ben Bernanke recently stated that the Fed can buy “longer-term Treasury or agency securities on the open market in substantial quantities…This approach might influence the yields on these securities, thus helping to spur aggregate demand.” Implications What are the effects of all this leveraged “hedge fund-like” government stimulus spending and QE monetization of debt? The US Treasury Bond market will directly benefit from central bank buying. With governments printing money out of thin air and creating massive levels of liquidity, precious metals are likely to benefit greatly as well. In this sense, gold may be viewed as an “anti-monetization currency”. Even without inflation, gold could be the beneficiary of the developing epic battle between credit contraction and monetary expansion. Taking a quick look at the behavior of gold and bonds relative to the equity markets and to each other leads to the following charts, courtesy of www.stockcharts.com. These charts may indicate that the trends implied by the above analyses are beginning to form. First look at how bonds have outperformed equities this year and in particular over the last few months – in this chart, TLT representing long term treasury bonds is divided by SPX representing the S&P 500:
Next look at how gold has outperformed equities this year and in particular notice the last few months – in this chart, GLD representing gold is divided by SPX representing the S&P 500.
And finally look at how bonds have been outperforming even gold over the last few months – in this chart GLD representing gold is divided by TLT representing long term treasury bonds.
In this current environment, given the above analysis and charts, it is not incompatible to be bullish on both gold and bonds. Resources:
1
http://www.cnbc.com/id/15840232/?video=935450306&play=1 Cliff Küle's Notes seeks to economize your reading and study time. Cliff Küle reads volumes and tries to choose the most interesting and insightful to present to you. Cliff Küle summarizes texts so that your most precious commodity...TIME...is being used as productively as possible. That is what Cliff Küle seeks to accomplish. A newsletter service will be introduced on the 1st of January of the new year. www.cliffkule.com contact information |
