VTI - Federal Reserve Watch: Look At All The Cash Assets Around

2023-06-23 14:43:01 ET

Summary

• Commercial banks in the United States hold 14.6 percent of their total assets in cash, around the highest level ever.
• An excessive amount of this cash comes from the effort of the Federal Reserve to "pump" money into the banking system to protect against a financial collapse.
• The resulting cash "bubble" is now still embedded in the financial system, making it all the harder for the Federal Reserve to combat the inflation now positioned within the economy.
• The Federal Reserve is fighting inflation, but, given all the cash around, the question becomes, is the Federal Reserve really doing enough?

The Federal Reserve continues to keep pressure on the banking system in order to combat the inflation that is alive in the world today.

We are now in the 15th month of the Fed's quantitative tightening exercise and the Fed's regular increases in its policy rate of interest.

The financial markets continue to look for the Fed to "pivot" from this "tight" monetary policy at any time. As I have argued in the past, investors just do not seem to have a lot of confidence in the Federal Reserve chairman, Jerome Powell.

At this point, after 15 months of quantitative tightening and raising interest rates, my question is really about just how tight the Federal Reserve really is.

If one looks at the data from the commercial banking system we see that commercial banks, as of June 7, 2023 carry $3,336.4 billion in cash assets.

This amount of cash assets represents 14.6 percent of the total assets of the commercial banking system. (Federal Reserve release H.8, Assets and Liabilities of the Commercial Banking system.)

If we take a look at bank balance sheets before all the Federal Reserve actions in 2020 and beyond we find this. On December 25, 2019, commercial banks had $1,780.2 billion in cash assets, which was just 10.0 percent of total assets.

History

Just a little bit of history here.

December 29, 2010

Cash Assets: $1,169.8 billion; Total Assets $12,045.5 billion; Ratio 9.7 percent.

December 27, 2000

Cash assets: $309.1 billion; Total Assets $6,273.7; Ratio 4.9 percent.

Since the beginning of the century, the commercial banking system is holding more cash as a percent of its total assets. The Federal Reserve policy efforts at these different times play a big role in how commercial banks manage their assets.

Federal Reserve Policy

Since March 16, 2022, the Federal Reserve has been tightening up on its monetary policy so as to battle inflation.

One of its major policy tools is something called Reserve Balances with Commercial Banks. These are "cash" deposits that the commercial banks keep on deposit at the Federal Reserve. They are very much like "excess reserves" in the banking system. They are very close in number and also in terms of movement with the cash assets that the commercial banks list on their balance sheets.

So, in general, Reserve Balances with Federal Reserve Banks go up and cash assets at commercial banks go up.

The following charts provide the information on Reserve Balances with Commercial Banks, found on Federal Reserve statistical release H.4.1.

On March 16, 2022, Reserve Balances with Federal Reserve banks totaled $3,893.4 billion...or approximately $3.9 trillion.

As can be seen, this series declined fairly rapidly in the first four or five months of the Fed's new policy of monetary tightening.

Then things slowed down. Reserve balances fluctuated between $3.1 trillion and $3.3 trillion until September of 2022.

Then from October 2022 until March 2023, the series fluctuated roughly between $3.0 trillion and $3.1 trillion.

Then, in March, several commercial banks experienced trouble. Silicon Valley Bank was the first.

The Federal Reserve responded by allowing more liquidity to enter the banking system One can see that Reserve Balances jumped up to more than $3.4 trillion in late March and now rests around $3.2 trillion.

So, overall, the Federal Reserve has overseen the reduction of "excess reserves" in the banking system, but the number, since March 16, 2022 to June 21, 2023 has only declined by $689.4 billion...not even $1.0 trillion.

So the Federal Reserve is tightening up on the banking system, but the commercial banking system has lost less than $700.0 billion...not even a trillion.

The commercial banking system still has, as of June 21, 2023, $3,209.0 billion in cash assets on its balance sheet.

That is an awful lot of money sitting around!

But take a look at where the banking system has come from.

The following chart looks at Reserve Balances with Federal Reserve Banks before March 16, 2022.

The data in this chart are starting from the time period "before" the advent of the Covid-19 pandemic.

One can see how the Federal Reserve allowed "excess reserves" in the banking system to grow to meet the liquidity needs of the banking system, the liquidity needs that grew out of the growing financial dilemma.

Note that the Covid-19 economic recession began in February 2020 and lasted through April 2020.

Before the recession hit, Reserve Balances with Federal Reserve Banks totaled less than $1.6 trillion.

By June 2020, Reserve Balances had doubled and were in excess of $3.2 billion.

Then the Federal Reserve began another policy of quantitative easing, and Reserve Balances rose constantly through into early 2022.

The maximum number that Reserve Balances hit was

Reserve Balances with Federal Reserve Banks hit a peak on December 15, 2021, when the series reached $4,273.6 billion. So, the maximum in "excess reserves" hit by the commercial banking system was almost $400.0 billion higher than the figure the Fed started out with on March 16, 2022.

The thing is, that analysts have been talking about how this time period really represents the time in which the Federal Reserve was producing an "asset bubble" in the financial system...an asset bubble that we have been working through in the effort to, in some way, bring down the inflation the U.S. was experiencing.

But, if the Fed created an "asset bubble," building on top of $1.6 trillion in existing cash assets in the commercial banking system, reaching $4.3 trillion in cash assets in December 2021 certainly does not suggest that the commercial banking system is having any real liquidity problem.

And, dropping from $4.3 trillion in "excess reserves" to $3.2 trillion, one could argue, does not really "strap" the banking system from being supplied with liquidity.

The banking system has 14.9 percent of its total assets in cash!

This is the result of the asset bubble created by the Fed. Total cash assets within the commercial banking system have rarely been this high!

And, that is after 15 months of quantitative tightening on the part of the Fed.

This is really the dilemma that Jay Powell and the Federal Reserve leadership face. It is what happens after "bubbles" are formed.

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