When people talk about “cash in the bank“, or “money on the sidelines“, the conventional wisdom reverts to an image of inert capital, used by banks to fund loans (as has been the case under fractional reserve banking since time immemorial) sitting in a bank vault or numbered account either physically or electronically, and collecting interest, well, collecting interest in the Old Normal (not the New ZIRPy one, where instead of discussing why it is not collecting interest the progressive intelligentsia would rather debate such trolling idiocies as trillion dollar coins, quadrillion euro Swiss cheeses, and quintillion yen tuna). There is one problem, however, with this conventional wisdom: it is dead wrong.
As we explained in “Dear Steve Liesman: Here Is How The US Financial System Really Works“, in a day and age when i) the Fed has to step in and fill the void of deposit creation left by traditional bank lending, which has been dead for the past 4 years, via reserves, and ii) commercial banks like JP Morgan can step in and use this deposit excess (i.e., direct fungibility of excess reserves) for investment purposes, a surge in deposits means one simple thing: the banks have more dry powder to invest as they see fit.
Don’t believe us? Believe the Federal Reserve of the United States instead:
[B]anks are required to maintain reserves equal to only a fraction of their deposits. Reserves in excess of this amount may be used to increase earning assets – loans and investments.
Deposit expansion can proceed from investments as well as loans. Suppose that the demand for loans at some Stage 1 banks is slack. These banks would then probably purchase securities. If the sellers of the securities were customers, the banks would make payment by crediting the customers’ transaction accounts; deposit liabilities would rise just as if loans had been made. More likely, these banks would purchase the securities through dealers, paying for them with checks on themselves or on their reserve accounts.
We realize that this is diametrically opposite to what the general public has been indoctrinated by the Fed and its explanation of how excess reserves are used by banks, not to mention by an insolvent federal deposit insurance corporation, because imagine the panic that would ensue if people were to realize that the money they dutifully earn and save, and then deposit in a bank in a checking or savings account where it is assumed to be safe, is actually used as funding for ultra risky trades by firms like JPM’s London-based Chief Investment Office (as JPM itself showed precisely happened), for example allowing a bank like JP Morgan to buy the stock or bonds of a bank like Goldman Sachs?
And after all, when one strips away all the different schools of meaningless philosophic thought, and the quasi-religious monetary dogma, in this modern age all money (and reserves), whether low-powered, high-powered, M1, M2, is really just electronic 1s and 0s in some mainframe, resulting from credit creation, either by commercial banks, or by the Fed, either under traditional or shadow bank conduits, which can be repoed, re-repoed, hypothecated, re-hypothecated at a whim, and a moment’s notice.
Yes folks: this is money, it is not a philosophy textbook, and money will do whatever it is told, not what some archaic monetary school of thought allows it to do.
So when one puts all of this together, what does it mean from a fund flow perspective?
Simple: the Fed purchases assets on an unsterilized bases, as it started doing with QE3 but especially following the expiration of Twist when it is now adding $85 billion to its balance sheet on a monthly basis, the result is excess reserves, which appear on bank books as excess deposits over loans. Then commercial banks take a hint from the JPM CIO (which in turn was simply caught doing what banks have always down with excess reserves throughout history, and especially since 2008) and use the funds to buy risk assets.
Period. End of story.
Certainly the story that claims “money is on the sidelines” when talking about bank deposits: absolutely incorrect – money sitting in deposits is used by the banks to ramp the market, courtesy of the unwind of Glass-Steagall.
Which is why tracking deposit flow data is so critical, as it provides hints of major inflection points, such as when there is a massive build up of deposits via reserves (either real, from saving clients, or synthetic, via the reserve pathway) which can then be used as investments in the market.
And of all major inflection points, perhaps none is more critical than the just released data from today’s H.6 statement, which showed that in the trailing 4 week period ended December 31, a record $220 billion was put into savings accounts (obviously a blatant misnomer in a time when there is no interest available on any savings). This is the biggest 4-week total amount injected into US savings accounts ever, greater than in the aftermath of Lehman, greater than during the first debt ceiling crisis, greater than any other time in US history.
So the next time someone asks you how it was possible with retail investors fleeing the market in droves (see relentless, 24 week straight outflows from domestic equity mutual funds) and putting their money in other assets, or money markets, or, alas, in the “safety” of bank accounts, that the market experienced its biggest move higher ever to start the new 2013 year, now you know.
Oh and thank Bernanke for creating $85 billion in ‘deposits’ each month which will be used by banks to, what else, buy stocks.