Brian B. Sullivan, CFA, President and Chief Investment Officer, Regions Investment Management
April 23, 2014
A column to help investors gain perspective on today's market noise
Plenty of Gas But No Ignition; Wait---Is That a Spark?
For years now the Federal Reserve has been pumping fuel into the economy, in the form of money. They have done this through buying bonds in the open market, and other methods. At first, they were trying to boost liquidity in the banking system to forestall banking failures. Then they continued in an effort to stimulate growth. This effort was more complicated and difficult. The Fed thought that by buying bonds the price of bonds would rise while the expected return for other buyers would decline. By making bonds less attractive they hoped to push investors into riskier assets, such as stocks, real estate, or private business. Step three was for businesses to take the new capital given them by investors and spend it on growing their businesses. Step four was for businesses to resume their borrowing to further grow their businesses. Unfortunately, steps three and four have not occurred. Bond prices rose and yields on bonds fell, stock, real estate and private business valuations rose but little was taken by management to grow the business and even less was borrowed to further grow the business.
We measure the amount of money in the economy in several ways. The most basic is the Monetary Base which includes money in circulation, money in bank vaults, and money on deposit with the Federal Reserve. When the Fed buys bonds, this measure rises.
Another measure is M2. M2 is money in circulation, checking accounts, savings accounts and CDs under $100,000. It is money that is under the control of consumers and businesses other than banks or the Federal Reserve. Ordinarily it is about 8 times the size of the Monetary Base. So when the Fed spent $1 to buy bonds, they expected to get a total of 8 extra dollars in the economy.
As shown in a nearby graph, although the Fed was adding money to the Monetary Base it was not leaving the banking system and not getting into the hands of consumers or businesses. Instead as the monetary base doubled, in 2010, the ratio was cut in half and when the base tripled, in 2013, the ratio dropped to a third. No real stimulus was reaching the patient.
Another way to see the ineffectiveness of Federal Reserve stimulus is the growth of bank loans to the public. In the second chart it is evident that there has been almost no growth in lending during this recovery. The level of loans bottomed in 2011, and since has grown at a slow pace. Although the economy is bigger and the population has increased, lending is only fractionally ahead of its peak in 2008. Prior to the recession lending grew at an 11% per year pace. Since bottoming in 2011, growth has been at only 4% per year. A lack of lending was at first blamed on banks and their reluctance to lend. Once bank capital reserves grew and loan charge-offs diminished, banks changed from reluctant to eager lenders. Now the blame if any lies with borrowers.
But a change in borrowing may be at hand. New commercial loans for the first quarter are well ahead of any period in the in this recovery. Growth in new loans is leading analysts to estimate that total bank loans grew at an 8% pace in the first quarter. 8% is not the 11% we were used to, but is a lot better than the 4% we have had in the last three years.
If loans are growing, capital spending is increasing meaning jobs for construction workers and jobs for equipment manufacturers. We might be at the beginning of a sea change in which the money which has been created by the Fed is spent and circulated in the economy. An increase in growth and jobs will follow. That would be welcome news.
©Regions Bank, Member FDIC. The foregoing represents the opinions of the author, Brian Sullivan, and not necessarily those of Regions Bank or Regions Investment Management, Inc. (RIM). RIM provides commentary to clients of Regions Bank, an affiliated company wholly owned by Regions Financial Corporation. The information contained in this report is based on sources believed to be reliable but is not guaranteed as to accuracy and does not purport to be a complete analysis of the security, company or industry involved. Neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This report is designed to provide commentary on market strategy and the opinions expressed reflect the judgment of the author as of the date of publication and are subject to change without notice. RIM assumes no responsibility or liability for any loss that may directly or indirectly result from the use of such information by you or any other person. Investments discussed in this report are not FDIC-insured, not deposits of Regions Bank or its affiliates, not guaranteed by Regions Bank or its affiliates, not insured by any government agency, may go down in value, and not a condition of any banking activity. Investment advisory services are offered through RIM, a Registered Investment Adviser. RIM is wholly owned by RFC Financial Services Holding LLC, which in turn, is a wholly owned subsidiary of Regions Financial Corporation.