In my ongoing Twitter chat with Bloomberg’s Kathleen Hays last night and this morning, I mentioned that with QE3 cash settlements having begun on November 14, that should be bullish for the economy and the markets going forward.
There were no QE3 settlements before November 14. The Fed’s first MBS purchases were in September. These purchases were and are forward contracts with settlement periods of up to 60 days or more. The first purchases in September began settling on November 14 with more on November 19 and 20. The next settlement period will be December 12-20, with at least $70 billion set to settle.
As you know, cash talks, and BS walks, even Fed BS. The cash flow is what matters. When that money hits the street, the poop starts to move, and a whole lot of cash will be hitting the Street next week and in the months to come; even more so if the Fed ups the ante and announces a program of outright Treasury purchases at the next FOMC circus on December 12. That’s what the Vampire Squid and other Primary Dealers have forecast. They are talking about $45 billion a month in outright Treasury purchases on top of the $40 billion in MBS outright purchases. The Treasury purchases will have added impact because, unlike the delayed impact MBS purchases, they are a direct injection into the vein, with the effect delayed only as long as it takes the dealers to redeploy its profits, and the Treasury to spend its take.
I tweeted to Ms. Hays that “Cash flow drives everything. With QE3 cash settlements now under way, econ #s should begin to accelerate in Dec and Jan,” and she asked me “What is mechanism?” That’s where I managed to condense what I explained in Part 1 of this article into a few brief phrases in my next tweet.
1-Fed credits Primary Dlr Accts 2-They buy Treasuries (+stocks, MBS et. al.) 3. Treasury spends- cash enters banking system.
As expanded upon in Part 1.
First the Fed credits Primary Dealer accounts for the MBS purchases. Then the dealers buy Treasuries along with more MBS, stocks, and whatever else they fancy, but most importantly Treasuries. The Treasury receives that money and then turns around and spends it, converting the initial financial credits created by the Fed’s MBS purchases, into economic credits and economic activity.
I did not say that if it were not for the new money from the Fed, these credits would need to be deducted from some other activity. But since the Fed expanded the entire systemic balance sheet with those new MBS purchases, it was additive in terms of economic credits, not to mention asset inflation. It’s why both stock prices, commodity prices, and economic data all move when the Fed injects new cash into the system, and they stagnate when the Fed stands pat.”
After my tweet we had this exchange:
Kathleen Hays: In theory, yes. But one big story has been banks loathe to lend. Sitting on reserves, liquidity. Why skeptics say QE impact weak.
Lee Adler: I stick with Accounting 101. Worked so far. As SOMA breaks out, stocks and economy will also.
In other words, when the cash starts to flow, the dealers will redeploy some of it in the markets, including stocks and commodities as well as Treasuries. Here’s a representation of how that has worked in the past with stocks and using the just released data on factory orders.
I then agreed about the impact of QE. The law of diminishing returns applies. But we really don’t know if QE3 is working, or if the impact is that diminished or not because the cash is just beginning to hit the street. It’s far too early to say it’s impact is materially diminished.
In addition, the conventional wisdom that the banks are just sitting on reserves and not lending is just flat out wrong.
First, since March 2011, bank loan portfolios have swelled by $500 billion via increased lending. It is true that much of that was at the expense of the non-bank shadow banking system, but the banks are where the economic debits and credits originate, and on that score, the banks are growing their lending. It can be argued, and I would agree, that the shrinkage of the shadow banking system is a drag, but it has not been enough of a drag to stop the economy from steadily putting up modestly bigger numbers. And the argument that banks aren’t lending just doesn’t pass muster.
Finally, the idea that banks “are sitting on reserves, ” which is seemingly universally accepted, just is not true. Banks are lending and acquiring other financial assets, including MBS. Since June 2011, when the Fed ended QE2 until last month when the Fed began settling its QE3 purchases, the Fed held its asset base flat at around $2.6 trillion. At the same time, the trend of bank reserves was also essentially flat in the vicinity of $1.6 to $1.5 trillion. But from June 2011 until November 2012, commercial banks in the US added $800 billion to their assets. Banks are clearly not just “sitting on reserves.”
Not only will the truth set ye free, it will make you a better informed investor. What you do with this knowledge is entirely up to you.
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