A Bloomberg article headline on Saturday, July 24 caught our attention: “Stock Bulls Look Toward $17 Trillion Burning a Hole in Pockets.” It was the weekend, and this piece must have slipped through the editorial cracks. Phrases like “cash on the sidelines” and “dry powder” are common enough these days—but not from the likes of Bloomberg.
To summarize, the reporter notes that cash on deposit at commercial banks has risen “33% since 2019 to $17 trillion,” up from $13T in January 2020. In short, there is $4T in additional cash today waiting to be deployed in financial markets. Further, money market funds (MMFs) are near an all-time peak of $4.5T. There’s plenty of buying power, the writer implies, to propel equities much higher.
On the Nature of Financial Assets
The reporter neglects to mention that for every buyer there must be a seller. This is true whether transacting in investment assets, like stocks, or in consumable goods, like a box of Wheaties. As we have mentioned in several of our recent communiqués, once issued, shares of stock outstanding must be owned by somebody all the time. These securities often remain in existence for decades. If Bob buys 10 shares of XYZ from Sam for $10 each, a simple transfer of wealth occurs. Sam gives up his claim on the future cash flows from XYZ in exchange for $100 in cash. For $100 in cash, Bob acquires a claim on those future cash flows for as long he owns the shares. Value has been exchanged, but none has been created.
What is true for investment securities and consumer goods is also true of dollars. Once created, they also must be held by someone. When XYZ trades in the market, the buyer parts with cash, which the seller then receives at settlement. The dollars used in the transaction change bank or brokerage account balances in like amount. The essential point is that, when trading previously issued shares, dollars cannot remain in financial markets like water stays in a sponge. They change hands just like equity shares.
Therefore, there is no cash on the sidelines of the market. Bank-deposit accounts and MMFs are part of the game. There are no sidelines.
Money Market Funds
A cursory consultation of history demonstrates that MMFs are not on the sidelines. First, there were $3T in money market funds from 2010 through 2018. If those funds were fuel for a bull market, we would, perhaps, expect the total to decline as indexes rose. Similarly, after MMFs surged to a new peak in 2020, totals have remained relatively unchanged despite a 90%+ rise in the S&P 500.
Second, MMFs reached a peak in 2008 and that preceded a major selloff in the making. If that was cash on the sidelines, it certainly didn’t come to the rescue. That total continued to grow until the nadir of the financial crisis when stocks turned the corner, perhaps undermining our argument. But that 2009 high coincided with the beginning of quantitative easing (QE), as does the current 2020 all-time high. Causation between MMF levels and the future growth of the index cannot be easily established.
What, then, does account for these MMF increases? It well may be an increase in the assets that MMFs hold. In times of economic stress, firms tend to hoard cash, most of which is used to buy the very short-term securities that MMFs hold, like Treasury bills. The composition of Treasury issuance (bills, notes, and bonds) can affect MMFs totals. In the second quarter of 2020, as the U.S. government engaged in enormous deficit spending, the Treasury securities issued increased the outstanding total of bills by $2.6T.[1] The net totals of notes and bonds were relatively unchanged. To the extent that MMFs hold only and all issued T-bills (an unrealistic hypothetical intended merely to make the point), had the Treasury issued 10-year bonds instead of bills, MMFs could not have increased their holding of short-term Treasuries. Therefore, given the skew in Treasury issuance toward T-bills, it should be unsurprising that MMF totals have increased.
Bank Accounts
The additional $4T increase in money on deposit with commercial banks since the COVID crash is, likewise, not cash on the sidelines. As noted above, those dollars must be held by someone, and the shift from buyer to seller leaves the aggregate number of dollars unchanged. Given there has been an increase in deposits, though, it is only natural to wonder where it came from.
It seems more than coincidental that the Fed increased its balance sheet almost precisely $4T when it re-engaged QE on a massive scale. As is visible in Figure 3, the increase to commercial bank deposits (blue) nearly matches the increase to the Fed’s balance sheet of assets purchased (red).
In the past, the supply of dollars grew slowly through bank lending (and government deficits). During the last 12 years of QE, however, the Fed replaced government liabilities that have a yield, like Treasury bonds, with liabilities that have no yield, like bank reserves. When the Fed buys a Treasury bond from a pension fund, through the intermediation of a bank, the Fed ultimately trades dollars for that bond. The illustration below from the Bank of England makes clear how this results in increased bank deposits.[2]
Those dollars will reside in the bank account of the pension fund. They could then be traded for some other security, which would result in a deposit of those dollars into the bank account of that security’s previous owner. Basically, if the Fed is trading dollars for bonds, we should expect deposits to rise. There are fewer Treasury bonds in existence and more cash. New bond issuance by the U.S. Treasury does not necessarily sop up these new deposits, as the banks have ample reserves with which to buy Treasuries and can warehouse the new issues on their own books, leaving deposits intact. Unfortunately, that doesn’t mean equities must rise. Rising equity prices are not primarily a function of the quantity of dollars. In the long term, those prices should be determined by cash flows. In the short term, though, it’s the ebb and flow between speculation and risk aversion that dominates the pricing trend. The current exuberance in the housing market is a real-time, tangible-asset example.
That Which Is Unseen
While a healthy economy requires a continually expanding money supply to facilitate the increasing number of transactions, dollars being created so willingly by the government has a dark side. If dollar balances have increased because the Fed has traded them for bonds, then dollars are not increasing due to bank lending. That is, dollars are expanding not because of a healthy economy but despite lackluster domestic demand.
Figure 5 shows that household debt has grown slowly (blue line) since the 2009 recession. The growth in that line has shifted secularly lower and the level is essentially flat since 2017 (red line). Since bank-loan origination increases the money supply, this graph demonstrates that either (1) consumers have not demanded markedly more credit or (2) banks have not found them creditworthy enough to extend them loans in a fashion similar to before the crisis.[3] Given that bankers generally lack lending restraint except in moments of crisis, the causation likely stems from consumer demand. Even at low interest rates, consumers cannot grow their own debt totals at an increasing rate unless wages keep up, and wages manifestly have not.
We see a similar dynamic in the corporate sector (Figure 6). While business loans have risen in recent years (replete with weak covenants and protections for lenders), the growth in bank lending is well below where it was prior to the 1990s.
Overall, the slower growth in corporate and household debt is confirmation that both firms and households may be pushing the limits on their capacity to service debt. While debt totals are near all-time highs, it’s more the actual behavior of households that drives this conclusion. They are expanding their liabilities at a much slower rate than a decade ago. Further, data show large portions of their COVID relief funds were put toward reducing their debt balances. That may give them some wiggle room to expand again in the short term, but, ultimately, the trend seems to indicate the total is near a ceiling.
The growth of household debt and GDP are highly correlated (Figure 7). Therefore, as the former has fallen, the latter has become anemic. Growth in debt cannot meaningfully accelerate, however, as absolute debt levels remain high. If interest rates rise, all the worse! Virtually any remaining growth would evaporate.
This situation creates a dangerous feedback loop that the Fed may have trouble arresting. If the Fed were to halt QE and allow rates to rise, debt service would quickly become a burden on most sectors of the economy. Thus, Fed policy is not one for economic revival as advertised. It is the baseline for economic survival. Given the constraints of zero interest rates, it is a policy with increasingly minimal returns, as the investments made possible by such low rates include the following: the financing of weak corporations, “leveraged real estate transactions, “carry trades” that employ enormous amounts of leverage to profit from small yield differences, and speculation on margin.”[4] These do not contribute meaningfully to economic growth.
To keep those rates low, the Fed must trade dollars for bonds. It is hotly debated whether QE itself creates new money supply or whether the actual mechanics of Treasuries issuance create it. Regardless, the current level of commercial bank deposits shows quite clearly that they have risen. But the private-sector actions did not create this money, as is typically the case through bank-credit expansion. The government did. Banks did not find sufficiently creditworthy borrowers, and/or consumers simply did not demand more loans. Thus, bloated deposit accounts may be more a sign of lethargy than vitality. Consumers aren’t required to spend their money and, given the proportion of relief funds that haven’t been transacted, it appears they’re in no hurry.
Markets and Stagnation
As described earlier, once money is created it must be held by someone. Therefore, while the new funds burgeoning in commercial bank accounts can be used to buy stocks, the withdrawals from bank accounts will be replaced with deposits from the sellers. Like hot potatoes passed around, they will remain in circulation. When the music stops, some folks will be holding stocks, and some will be holding dollars. That doesn’t affect the quantity of either. Though they will remain the same, when risk aversion displaces speculation, the market prices of stocks won’t be so fortunate. What does affect the quantity of dollars is fiscal and monetary policy. The masters of the financial universe have flooded commercial accounts in the middle of a debt-fueled secular decline in growth. That is not cash on the sidelines. Those funds are in the game. As long as debt totals remain high, however, the prospects for growth remain weak. We’re not optimistic about what that means for equity markets, and we’re prepared for a selloff. There are plenty of scenarios that could prolong the current cycle, but the cash in deposit accounts does not seem to be one of them.
[1] https://www.sifma.org/resources/research/us-treasury-securities-statistics/us-treasury-securities-statistics-sifma/
[2] https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf
[3] Banking regulations also may affect the status quo, but they don’t change the impact of muted lending on economic growth.