Deposits Over Loans: Excess Reserves

What happened in 2008 was a once in a lifetime event and this is illustrated in the following chart comparison. There was a historic correlation between deposits and loans, but that correlation has broken down since the 2008 financial crisis.

 

Since 2008, deposits have increased at the banks, but lending by banks has not gone up substantially. All of this money is parked at the Federal Reserve at ultra low interest rates. It is not flowing into the economy and as long as lending doesn’t grow, the Fed can’t raise interest rates. More so, the Fed can’t stop QE until lending goes up substantially.

The difference between the deposits and the loans are the so called “excess reserves”. Historically, a high amount of excess reserves will be quite inflationary, the question is when will we see all of this inflation come? When lending finally starts (red curve goes up), inflationary pressures will come. The Federal Reserve will have to sell its bonds and mortgages, reduce its balance sheet to counter this inflation. Or it can raise interest rates. The question is, will they see this coming or not? Will they act appropriately soon enough or be too late to counter inflation? I’m not counting on it, that’s why I protect myself against inflation.

As mentioned before, the amount of excess reserves is the difference between deposits and loans and it is shown in the chart below:

As you can see, we had $2.4 trillion in excess reserves in January 2014, which almost matches the amount of money printing or QE from the Federal Reserve. When this trend reverses, it could mean that lending growth has started, that banks are finally using their excess reserves to buy things and that’s the moment when we will see the inflation coming. So monitor this chart!

For more info read this article.

(If you’re wondering why there is a bleep in 2010, that’s the “Financial Accounting Statements No. 166”. This new set of rules deals with the way U.S. banks must handle off-balance-sheet vehicles (OBSVs). They needed to bring these off-balance-sheet items back on their books.)

Correlation: Margin Lending Vs. Stock Valuation

I came across an interesting correlation: Margin Lending Vs. S&P.

Margin loans are programs that allow investors to borrow money to buy equities. So if you think through it: the higher the margin balance in the market, the higher the S&P will go, because people will have more borrowed money to put in the stock market. Today, the total margin balance is at $350 billion for NYSE member firms.

The evidence is presented on Chart 1. You can see that there is no lag between the two charts, so it’s a rather useless correlation to time the market.

Chart 1: Margin Balance Vs. S&P

Although fairly useless, sometimes there are discrepancies that can be spotted. For example, the rising Australian stock market could be overvalued at this moment when you look at their declining margin lending rate (Chart 2). So it can be interesting to watch this correlation.

Chart 2: Margin Balance Vs. ASX200