|
This continues some investigations that we began last week.
October
27, 2013: What's Going On At the ECB?
This shows the assets of U.S. domestically-chartered banks, in
particular the ratio of "cash assets" to total assets. "Cash assets"
are either deposits at the Fed (bank reserves), or deposits/other
immediately callable loans to others.
Over time, this declined, as banks decided that they would rather
have a higher portion of higher-interest-bearing term assets (loans
and bonds). Recently, it has risen again as banks seek more
"liquidity." Banks don't want to lend to each other today, so that
means they have to keep more "cash assets" on hand. This ratio has
risen considerably, but is not too high historically, basically
returning to about where it was in 1970.
However, the composition of "cash assets" has changed. In the past,
it was only about 25% Fed deposits, and 75% loans to others with
immediate callability (in practice, probably overnight loans to
other banks). However, since banks don't want to loan to each other
anymore, fearing default, the have concentrated almost entirely on
Fed deposits.
In the past, foreign-chartered commercial banks had a relatively
small amount of "cash assets" in their U.S. subsidiaries. But, this
has changed. Also, what they have is likely 100% Fed deposits today,
as is the case for domestically-chartered banks. What this means is
that there has been a huge increase in demand for Fed deposits from
foreign-chartered commercial banks (mostly European).
Here's a closer look at the same thing, since 2005. We can assume
that "cash assets" after 2008 are 100% Fed deposits. We see some
interesting things here. Essentially all of QE2 (2010-2011) was
ultimately absorbed by foreign banks, with little expansion in Fed
deposit holdings by U.S. banks. Also, the more recent QE3+QE4 was
mostly absorbed by foreign banks thus far, although it seems to be
about 50:50 at present.
This does not necessarily mean that European banks "demanded" i.e.
wished to hold these larger Fed deposits. The Fed creates these
deposits via its QE programs; the banks don't get to decide that.
However, it does indicate relative desire to hold Fed
deposit balances. In other words, the foreign banks wished to hold
these deposits more than domestic banks (or disliked them
less), even if, possibly, both did not actually want any more
deposit holdings in an absolute sense.
Bank reserves (Fed deposits) have such high turnover that, even if a
certain bank is not the direct recipient of a Fed deposit via the QE
program (via the purchase of a bond by the Fed from a bank
customer), within a short period of time, it evens out so that each
bank holds what proportion of total Fed deposits it wishes.
Fed deposits are also directly fungible with banknotes and coins,
but banks mostly don't get to make that decision. Of course a bank
can ask for its deposits to be converted to banknotes and coins, but
banks don't have any particular need to do so unless its customers
are withdrawing banknotes and coins from the bank. Thus, it is
mostly the choice of nonbank entities (i.e. bank customers) that
determine the total composition of base money between
banknotes/coins and Fed deposits. So far, bank customers haven't had
the desire to hold more banknotes and coins. I think this is related
to stagnant wages; in other words, they aren't using more banknotes
because they "don't have the money to spend."
The U.S. subsidiaries of foreign banks used to be run much like
domestically-chartered banks, with cash assets around 5% of total
assets. However, since 2008, this has grown to a very high level
over 50%. This doesn't make much sense in terms of U.S. operations
alone, but probably represents Fed deposits being held as a portion
of all central bank deposits (ECB+Fed especially), in relation to
the bank's consolidated balance sheet. In other words, "cash assets"
(today exclusively central bank deposits) are being managed on the
consolidated level.
A closer look since 2005.
Here's a little longer-term look.
This shows the ratio of Fed deposits (bank reserves) as a percentage
of total assets at U.S. banks since 1947. The latest figures around
20% are different than the first chart because both
domestically-chartered and foreign-chartered banks are included
here.
What do I see here?
Overall, I think that banks, both foreign and domestic, have more
reserves than they wish to hold; in other words, that the Fed's QE
programs are oversupplying base money. This is evidenced by the very
high prices for loans and bonds at this time. Banks are "attempting
to spend" their "excess cash" on loans and bonds (in other words,
changing their balance sheet composition towards more loans/bonds
and less cash), in this process bidding prices to very high levels.
However, one reason that the Fed's QE programs have not yet had the
inflationary effect one might expect appears to be that a
substantial portion of it has been absorbed by what appears to be
new demand from foreign banks.
As we saw last week, this could be related to the contraction of
bank reserves in Europe by the ECB, basically the withdrawal of the
LTROs.
The important line here is the pink line, which shows bank
reserves (ECB deposits of banks). It has contracted almost back
to pre-crisis levels. This is driving overnight rates up a bit
in Europe, leading the ECB to talk about more LTROs or at least,
not contracting it any further. It would make sense that
European banks would also want to hold more "cash assets" and,
in effect, central bank deposits than was the case in the
pre-crisis period, as we saw was the case in the U.S. in our
first set of charts. However, the ECB has not allowed them to do
so readily.
We also see that the surge in foreign banks' holdings of Fed
deposits (the absorbtion of QE2) corresponds to a decline in
euro bank reserves (pink line) in late 2010.
Especially with various swap agreements and so forth, I suspect
that European banks are able to use Fed and ECB deposits
somewhat interchangeably. This has allowed them to substitute
the "excess" of Fed base money for the "shortage" of euro base
money, notably without moving exchange rates much.
I think that "gold prices" are also being heavily managed at
this time, as has been amply evidenced by others elsewhere.
However, one reason this has been as successful as it has been,
I hypothesize, is that the Fed hasn't been supplying as much
excess base money as it might appear, due to demand from
European banks.
What might this mean going forward?
We see that the contraction process in euro bank reserves (pink
line) has pretty much run its course. It won't go much lower.
This implies that European banks might not have much desire to
substitute Fed deposits for shrinking ECB deposits; in other
words, the additional demand for Fed deposits would cease. This
would mean that, if the Fed continues its QE3+QE4 program, it
might have more of an inflationary (i.e. a tendency toward a
decline in dollar value) than it has had thus far. This could be
prevented for some time perhaps by the various market management
techniques already in play. However, the forces they would have
to contend with would intensify, while their ability to do so
has already been weakened considerably by maintaining their
present operations for as long as they have.
In other words, the expected consequences of aggressive money
printing -- basically, lower currency value -- may manifest in a
more substantial way in 2014.
This might suggest why the Fed has been talking about tapering.
I suspect that, if these hypotheses have merit, the Fed and the
ECB are well aware of the situation, and are likely working
together in that regard. If the ECB's LTRO contraction stops,
the Fed would want to stop increasing base money supply.
With a little more thought, you might hypothesize that this was
done on purpose. The ECB and Fed are more-or-less owned and
managed by the same entities, so why not?
However, as we have seen, the Fed has been shying away from
actually tapering. I don't think they will do anything before
Yellen arrives in February 2014. And, I think that Yellen will
be even more dovish than Bernanke on average, not willing to do
anything that could cause short-term turmoil (i.e. higher
Treasury yields), and perhaps even pushing for a still more
aggressive policy (QE5), as has been hinted by her public
statements. The other FOMC members are perhaps not as gung-ho
about "easy money" as Yellen, but the 9-1 vote in favor of
continuing QE3+4 at the last FOMC meeting in October says to me
that they all use the same playbook. It's just a matter of
degree.
One potential source of greater base money demand coming up is
the nonbank sector. In a scenario where people wish to withdraw
their deposits at banks, in other words a bank run, they could
correspondingly wish to hold a greater portion of banknotes and
coins. In other words, their "cash assets" would consist more of
base money (banknotes) rather than demand deposits (at banks).
This is exactly analogous to what banks themselves did in 2008.
Those of you who were able to follow the arguments here should give
yourself a pat on the back. It takes a certain amount of mastery of
these matters to understand this line of thinking.
| |