Volatility Engine

Summary: Quantitative Easing has produced less economic activity than expected. Instead, an ever growing bubble of cash is inflating our banks without making it, proportionately, into the economy via lending activity. The bubble will pop one day, and while the banks will survive, will there be an economy left for the rest of us? For more information on this post or on the Volatility Index produced by www.volatilityengine.com, please visit our website or contact seth.chelkea@volatilityengine.com. There should be little argument of the vital role lending plays in stimulating economic growth. Economic models abound that measure the impact of lending on economic activity and hence GDP. Also, one need to only casually peruse major media outlets to hear the droning wail of economists announcing our sputtering growth. As such, herein is yet another simplified view of the world. As noted in previous posts, one of the major outcomes expected from Quantitative Easing was to inflate the economy. Specifically, though, our banks were in need of liquidity as a result of the financial crisis. On the surface, the plan seemed simple. The Federal Reserve would purchase outstanding Treasuries from banks in the US and liquidity would be pumped into the system. Therefore the following chart: The period, on the chart, from approximately 2002 until the collapse of 2008, was marked by an up- trend of lending, matched by a reciprocal rise in GDP. Unemployment was manageable, the country was growing economically, and US Treasury securities were the backstop for many of the banks. Now we find ourselves in 2013 with a strong downward trend of moving below the level where banks have more cash assets than US Treasuries. For clarity sake, it should be noted that the cash positions referenced herein do not include deposits, which are counted as liabilities not assets. Perhaps if GDP was growing significantly, or if labor force participation was improve significantly, we could understand the value of this endeavor. Unfortunately, the next chart tells an all too grim tale: From 1997, and before, to the collapse in 2008 the ratio of cash assets held at banks compared to the loans issues, both residential and commercial was moderately declining if not truly flat. The downward motion from 2004 to 2008 mirrors the up-trend prior the crash on the previous chart. Cash assets were being employed in the service of issuing loans, thereby stimulating the economy. From the commencement of Quantitative Easing to the present, the ratio of cash-to-loans at banks in the US has exponentially grown. Banks have reaped the benefits of QE but have not, in turn, converted cash into loans and hence into economic activity. While Janet Yellen and her predecessor, Allen Greenspan, decry the existence of bubbles, one cannot argue with the shape and direction of the chart above. Also, we must wonder why we continue on the dangerous path of easing when the effect has been to simply inflate banks and not the broader economy.