Summary
- The financial system has lots and lots of money just sitting around in bank vaults throughout the country.
- This massive excess of "cash" is allowing the financial system to operate as if the Federal Reserve is not engaged in quantitative tightening, working to break the back of inflation.
- The Fed continues to be serious about fighting inflation, but the money put into the banking system at an earlier time is just so plentiful that investors feel unconstrained.
- This is the dilemma the Fed faces right now, and this will have to be the hurdle that the Fed must get over before it becomes the master of the money once again.
Last week, I wrote about how "Raising Money on Wall Street has become Cheaper and Easier."
There is lots and lots of money still around, even though the Federal Reserve has been tightening up the money stock for almost a year now.
It seems to me that we really don't understand the amount of liquidity that is now in the hands of people in the financial markets.
For one thing, as I have stated many times over, the Federal Reserve has on its books somewhere around $3.0 trillion in commercial bank excess reserves. (This is from the Federal Reserve statistical release H.4.1.)
You look at the balance sheets of the commercial banking industry (looking at the Fed's H.8 statistical release) and you see that the commercial banking industry has more than $3.0 trillion it lists in "cash assets."
In other words, the financial system is awash in money.
You can see this in other pieces of information that keep coming out.
For example, the Wall Street Journal has recently published the article titled, "Investors Are Exiting U.S. Stock Funds During 2023 Rally":
"Investors have pulled a net $31 billion from U.S. equity mutual funds and exchange-traded funds in the past six weeks...through Wednesday."
And, the stock market has been rising during this period of time.
"That marks the longest streak of weekly net outflows since last summer and the most money pulled in aggregate from domestic equity funds to start a year since 2016."
"Over the same period, investors have funneled roughly $12 billion into international equity funds, about $24 billion into taxable bond funds, and nearly $3 billion into municipal bond funds."
"Flows toward funds outside of domestic equities indicate a level of apprehension from investors who aren't buying the 2023 rebound in U.S. stocks."
"The sense of opportunity certainly lies elsewhere."
But, my point is, this is the investor attitude even though the Federal Reserve is removing money from the financial system.
And, there is apparently enough liquidity circulating around that investors can pull money out of this market and put it into another market, while other investors are moving major amounts of money around in different directions.
But, no market collapse.
Money is circulating, not leaving.
The Shape Of Investing
Furthermore, other investment patterns are changing.
"Passive investing, or, simply following the market, has gained traction since the launch of the first ETF three decades ago. But last year, stock picking made a comeback as the megacap technology stocks that are heavily weighted in the major U.S. indexes struggled in an elevated interest-rate environment."
As I have written many times before, the expansion of passive investing came about as the Federal Reserve came, more and more, to dominate the rise in stock prices.
Quantitative easing played a big role in the rise of stock prices in the past decade.
But, now, as I have been writing about in recent weeks, with the Federal Reserve engaging in quantitative tightening, stocks prices, more and more are going their own individual ways.
Consequently, the idea of value investing is coming back into vogue.
"Last year, stock picking made a comeback as the megacap technology stocks that are heavily weighted in the major U.S. indexes struggled in an elevated interest-rate environment."
What's Happening?
And, so the flow of money is moving one way or another.
Investors are more and more interested in individual stocks.
All, this massive flow occurring as the Federal Reserve attempts to take money from the financial system.
The difficulty?
The Federal Reserve put so much money into the system in earlier years that it is finding it very difficult to take much money out of the system at this stage of the economic cycle.
This is why we are seeing what we are seeing right now.
The U.S. economy has never been in such a state before.
Commercial banks are sitting on more than $3.0 trillion in cash assets.
This is why you can have stock rallies when the Fed is removing reserves from the banking system.
This is why you can have $31 billion in funds pulled from U.S. equity mutual funds and exchange-traded funds in the past six weeks and hardly feel the breeze go by.
And, so on.
In a very real sense, the movement of funds in the financial markets is beyond what the Fed is trying to do because of all the "excess" funds that are embedded within the system.
This is what the Federal Reserve must ultimately overcome if it is to stage a real battle against inflation.
Funds are exiting the stock funds, but the stock market is rallying.
Why are many investors confused?
Well, in the past it didn't work this way.
In the past, the financial system was not so overloaded with funds. Hence, tightening up the money markets worked and resulted in financial markets responding to the lessening of cash funding.
And, in many cases, the financial markets experienced disturbances that were rather dangerous for the financial system as a whole.
We may get to this point, but it is not going to happen in the very near future.
This is a new experience.
The Near Term
Keep an eye on the flow of funds throughout the financial markets.
Right now, there is no apparent shortfall to the cash that is available.
Consequently, we can get these monetary flows from this market to the next. We can get stock market rallies which seem to counter what the Fed is doing. We can continue to have discussions about whether or not the Federal Reserve is going to "pivot" out of its quantitative tightening.
With $3.0 trillion in cash in the vaults of commercial banks, it seems as if there is still some time left before the financial system gets really "tight."
For further details see:
Lots Of Money Around