Is the Federal Reserve About To Overflow the Bathtub?

Published by WallStreetWeather.net

What consistently stands out when reading the Minutes of FOMC meetings is the amount of time the Fed devotes to discussing the stock market. The Fed appears to be unilaterally focused on promoting the wealth effect through the equity markets after liquidity needs have been satisfied.

Yet for all the discussion in the Minutes from the August 9 meeting about financial markets, what was blatantly missing was the August 4 announcement that Bank of New York Mellon (BK) would start charging customers with an average monthly deposit balance of $50 million+ a minimum 0.13% annual fee. This fee increases if the yield on the 1 month Treasury bill closes below 0% on the last day of the month.

What this is showing us is the financial bathtub is overflowing with liquidity. In essence, the plumbing of the U.S. financial system does not have the capacity to absorb any more liquidity. Chairman Bernanke is focusing on macro economics to the detriment of the mechanical structure of the banking system. He is testing the limits of how much pressure the plumbing can withstand before the pipes burst. If the Chairman miscalculates the stress level, he could have an awful mess on his hands.  And the problem is that Chairman Bernanke and Vice Chairman Janet Yellen are completely out of their element when it comes to understanding the flow of water since both were born without any planets in the intuitive water element.

Saturn represents limits and boundaries, which are concepts the Fed and especially Chairman Bernanke whose chart is myopically focused on growth and excess liquidity, have yet to master.(2)
Venus represents money and banking. With expansive Jupiter in Taurus and Saturn in Libra, the two signs ruled by Venus, excess liquidity has resulted in cash hoarding as businesses and consumers fearing economic contraction would rather deposit their cash in the safety of FDIC-insured bank accounts than risk losing principal.

For the first time, Bank of NY Mellon is blatantly forcing their customers to accept a negative nominal interest rate. This is because the bank is forced to pay 0.10% FDIC insurance on “hot money” that it cannot recover in loans.(1) Additional liquidity pumped into the system by the Fed would force progression of this trend to consumers. This is already happening indirectly through increased service fees on accounts that banks do not deem to be profitable.

Nominal interest rates are the rates you either receive on your savings or pay on a loan. Real interest rates are nominal interest rates adjusted for inflation. For example, if you receive 0.25% interest on your certificate of deposit or savings account and the CPI is 2%, the nominal interest rate is that 0.25% and the real interest rate is actually -1.75%. You are losing by paying the bank 1.75% to hold your money. This can easily be hidden from view for consumers but businesses are clearly aware that they are borrowing money for free. Once nominal interest rates actually turn negative, the alchemy can no longer be masked. Currently the 3 month Treasury bill has been fluctuating between a slightly positive and slightly negative nominal interest rate. Investors are actually paying the government to hold their money!

Oftentimes in economics there is a conflict between macro policy and micro policy. While it’s beneficial for individuals to save and strengthen their balance sheets, during times of economic stress this is actually detrimental to the overall economy. While further increasing liquidity might benefit the overall economy, at the individual financial institution level it creates extreme stress.(3) The Fed Chairman is reaching a point where the ability to balance the macro and the micro (Saturn in Libra) could easily become out of kilter.

Adding more liquidity when the issue is lack of demand is not going to change anything. The issue is not inflation or deflation, the issue is one of capacity. If the financial system has reached its limit to hold anymore liquidity, it doesn’t matter where we stand on inflation/deflation or employment for that matter. A bathtub can only hold so much water before it overflows.

(1)”Hot money” describes bank customers who keep moving their money to banks offering the highest yield for the shortest term possible. JPMorgan Chase CEO Jamie Dimon frequently uses this term in earnings conference calls to say that the bank does not want hot money.

(2) Chairman Bernanke could start learning these lessons when he experiences his Saturn return in November 2012.

(3) Since this is a collateral crisis, it doesn’t matter if mortgage interest rates were at 0% if the borrower doesn’t qualify.

Ben Bernanke: December 13, 1953 time unknown Augusta, GA
Janet Yellen: August 13, 1946 time unknown Brooklyn, NY

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