Guess What?

The deficit as a % of the GDP is imploding. How come we have not seen that anywhere in the headlines. Heck, they could even use the word “IMPLODING” as a real attention-getter.

Don’t blame it on anything – just thank the tax-payers. Personal income taxes have hit records at all levels. Corporate taxes the same. You want to know why we have a “tepid” recovery? Not because of the Fed…not because of QE anything.

It is because we are driving money away from where it should be.

It should be getting used for growth, investment and production gains. Instead, a massive amount of it during this recovery has gone into ineffective tax hikes to pay for social programs. That is plenty for another morning note though.

For now—it’s simple

There is ONLY 100 Cents in a Dollar

You shave a bunch off the top to pay for other things and you get less to invest in the future. Simple math.

The “difficulty” we have seen business work around for the last 8 years is government. Much more of it than before. The good news is that we have grown in spite of it all. Hinting that underneath all the frightening chatter about our future, the system is doing just fine – and it is getting stronger not weaker.

Plenty of Money

Why is it that central banks are everyone’s go-to solution for solving the problem of weak economic growth? They shouldn’t be.

It is a far simpler problem to address. Producing comes before consumption does. Production and investing in the future drives growth.

A few charts will help better depict the state of money. We have plenty of it. So many fears are driven by a complete misunderstanding of the cards on the table.

One important measure of money is the amount of money relative to the size of the economy. As Scott tells us, “Think of this as the amount of one’s annual income that is kept in ready cash form (checking accounts, savings accounts, money market funds, cash).”

Demand in the U.S. has been rising since the late 1990s, and it has now reached an all-time high.

The most well-known measure of money supply is M2. The charts above show that M2 has been growing at an annualized rate of just over 6% for decades.

Oddly, a major portion of this growth has been in bank savings deposits. Why odd? Because for many years, these accounts have paid little, if any, interest.

I would suggest we recognize this as a sign of deep-seeded fears still leftover from 2008-2009. Meaning the demand for the safety of these accounts is very strong.

They offer little benefit beyond being a safe repository of money that is easily accessible.

Taken a step further, were it not for deep-seeded fear and a dire view of the future, why on Earth would anyone buy a negative interest bond?

In the chart above showing those same bank savings deposits, notice the massive increase since 2008.

I would agree with others when they point out that it may not be a coincidence that the $4+ trillion increase in bank savings accounts since the beginning of QE1 is of the same order of magnitude as the Fed’s QE purchases.

In effect, banks took in $4 trillion of savings deposits and used that cash to purchase notes and bonds which were in turn sold to the Fed in exchange for bank reserves. Banks invested their deposit inflows with the Fed.

Speaking of banks and money…

Today, banks hold about $2.3 trillion of excess reserves. Bankers will tell you however, that these are not levels chosen by banks not desirous of lending money.

Instead, these huge levels of reserves as a result of regulatory requirements that have been implemented since 2008. They come from a myriad of new measures, including reserves required to collateralize deposits, the risk-weighted capital requirements imposed by the Basel Accords, plus the soon-to-come Fed-imposed requirement that banks hold highly liquid assets (mainly bank reserves) equal to 100% of the amount that Fed stress tests indicate they would need to survive another liquidity crisis.

In other words, banks have accumulated a mountain of excess reserves not because they don’t want to lend against those reserves but because they had to accumulate them in order to survive under the regulations.

So, be careful what you wish for from your political powers.

In Summary

Banks may therefore not be as flush with excess reserves as the numbers suggest. They have responded to changing regulatory burdens by becoming more conservative and hoarding cash.

Consumers have done the same in response to the loss of confidence that still persists in the wake of the 2008 financial crisis.

In short, there are lots of reasons why the demand for money is strong.

So what is holding the economy back?

I am shocked none of the current candidates are covering this at all in the campaign rhetoric but it is pretty basic – and provides a slew of solutions to work into the system:

Turn the focus instead to fiscal policy as I opened this note referencing.

Central banks have done pretty much all they can.

What’s standing in the way of progress?

Burdensome regulations, high marginal tax rates, intrusive government, subsidies for uneconomical green projects and most of all, that set of emotions which holds such great control over the perception of our future:

Massive fear and uncertainty.

Surprise Is To The Upside – Not Downside

The funny thing about all of these trepidation’s is that markets have always feared downsides – right? Except history tells us the same thing – over and over and over. Things improve over time.