What An American Bank Run Would Look Like

Technically the title of this post is wrong: the truth is that nobody could possibly know or predict what a bank run would looks like in details suffice to say that it would have terminal and devastating results on the global economy. One needs only remember what happened when the Reserve Fund broke the buck and the $3 billion money market industry was at risk of unwinding (for those who do not, Paul Kanjorski does a good summary here). What we do, however, wish to demonstrate is the tenuous balance between physical money - yes, just like precious metals, there is actual "physical money", better known as currency in circulation - and more abstract, confidence-based, "electronic money." Now when it comes to talking about systemic instability, pundits often enjoy bringing up the case of the $600+ trillion (recently discussed here in a different capacity) in synthetic derivatives, whose implosion would "wipe out the world." While that may indeed be the case (the memory of the CDS-precipitated AIG implosion is still all too fresh), since nobody really can comprehend the side effects of the collapse of global derivative system, which by some estimates is over $1 quadrillion when combining exchange and OTC based derivatives, it is largely based on pure conjecture. And, as we demonstrate below, one doesn't even need to do get that high up in the pyramid of credit money. The truth is that should there be an American bank run, what would happen is the conversion of all electronic dollars into physical dollars, as retail Americans rush to empty their checking and savings accounts, exit their money markets, while institutional America converts all "shadow" liabilities into hard dollar assets (Zero Hedge has a specific methodology of defining what liabilities make up the shadow banking system). The truth is that should there be a D-Day in the American banking system and there is a global scramble for physical paper (ignore gold) the conversion ratio for binary dollars into hard ones could be as high as 30 to 1. Which begs the question: should one apply a 90% discount when evaluating their electronic dollar exposure? That, and many other questions too...

Physical dollars

When looking at actual "hard" dollars, there is just one place: the Fed's weekly H.6 statementwhich shows what the total amount of currency in circulation at any given moment is. The H.6 is the statement that breaks down the two forms of monetary stock tracked by the Fed: M1 and M2. Currency is at the very top. As a reminder, currency, together with Fed bank reserves are the only two actual forms of money "printed" into circulation. Yes, there is much polemic over the nature of bank reserves, but they, together with currency in circulation are the only two actual liabilities on the Fed's balance sheet, backed by such assets as Treasurys, Mortgage Backed Securities and, questionably, gold (questionably, because as Ron Paul has been crusading, the existence of gold on the Fed's asset side is taken on faith, and is based on promises by the Fed that it in fact exists, but nobody is allowed to actually see it).

So how many actual physical dollars are there? Well according to the H.6, as of June 27, there was $967.3 billion in currency currently circulating within the US economy, while the H.4.1 tells us that as of July 6 there was $1.66 trillion in bank reserves with the Fed, which if need be can be promptly released as currency to the wider public on demand (granted the dynamics of this release are completely unclear).This adds up to just over $2.6 trillion in "physical currency" (which also happens to be the "record" asset side of the Fed's balance sheet).

So that's what the the 'supply' side of money looks like in a dollar bank run. What about the demand. In other words, who will have the non-contractual "right" to pursue these $2.6 trillion in cold, hard cash?

Let's start with the M1, which is where the first tranche of electronic dollars is situated.

M1, in addition to currency in circulation, also contains demand and checkable deposits. The most recent number for these two is $982.9 billion. So far so good: if only demand and checkable deposits were pulled, the currency in circulation would be sufficient, although there would be a small impairment of just about 1.5%.

Next up, we go to the M2, which in addition to the M1 components, also contains such abstract concept as Savings Deposits, Small-Denomination Time Deposits and Retail Money Funds. The dollar values associated with these assorted claims on cash are $5,662.8 billion, $827.9 billion, and $698.7 billion respectively, or a total of just under $7.2 trillion. Add to this the roughly $1 trillion in non-cash M1 and you get $8.2 trillion. And this is where things start getting interesting. Because should every retail saver who has documented paper claims in America's checking, savings, time-deposits and money market pull their money, they would find that there is just $2.6 trillion in cash available to actually satisfy said claims.

But wait, there's more.

While the M2 conveniently ignores it, another major component of monetary aggregates is institutional money funds, which adds another $1.833.2 trillion in claims to physical fiat. Added across and we get just over $10 trillion.

But wait, there's more.

Remember how on March 23, 2006 the Fed discontinued the M3 because it was "too expensive" to keep track of all this "money." Well, courtesy of various replication loophole Zero Hedge has been able to track a far more comprehensive indicator of the broadest money stock in the US economy: the shadow banking system, which for all intents and purposes is the same as above: namely claims on actual money however more by institutional accounts than retail.

The breakdown, based on the most recent Z.1 (through March 31, 2011) is as follows:

• GSE Liabilities: $6,577.8 billion
  
• Agency Mortgage Pools: $1,166.3 billion
• Asset-backed securities Issues: $2,280.6 billion
• Securities Loaned by Funding Corporations: $709.0 billion
• Liabilities in Fed Funds and Security Repo agreements: $1,263.3 billion
• Total Outstanding Open Market Paper: $1,131.2 billion

Whipping out the calculator, and we get... $13.1 trillion in shadow banking system claims. Adding across with the M1 and M2 stock noted above and one gets $23.1 trillion. As a quick reminder, the physical money, in a best case scenario, is $2.6 trillion when adding reserves, and in a worst case, $967 billion. In other words, the paper to physical dilution is anywhere between 8.8 times and 24 times.

But wait, there's more.

Observant readers will recall that in our 2009 piece which before anyone else had even considered it, explained how the Fed bailed out the world with FX liquidity swaps, one of the key take home messages was that there was a synthetic short on the USD to the tune of about $6.5 trillion courtesy of the USD carry trade and other considerations. In other words, this is how many dollars would have to be conjured up into existence to satisfy existing electronic claims (and why the Fed had to scramble to implement the FX swaps when it did). One thing that is certain is that in an American (and thus global) bank run, all of the dollar shorts would cover in milliseconds as the carry trade would collapse instantaneously.

The take home is that courtesy of this latest and greatest demand on cash, there is up to another $6.5 trillion in potential claims on underlying hard dollars (and likely much greater as this BIS study was conducted at a time before ZIRP, and before the USD was the new, step aside JPY, carry currency of the world).

Summing it all up

Putting together all of the above, there are anywhere between $967.3 billion and $2.6 trillion in physical claim satisfying pieces of paper which everyone would scramble to grab if the sky was falling, and against these there are just under $30 trillion in paper claims on said hard paper. This can be seen visually on the indicative chart below:

Do readers see now why it is irrelevant to add X trillions or even quadrillions in derivatives?Because when just taking the plain vanilla electronic claims on circulating dollars there would have to be between a 11x and 31x haircut when everyone rushes to procure the suddenly all too precious pieces of paper with the picture of a dead president on the face.

For all intents and purposes this has been more of a thought experiment than any indicative scientific evaluation as there are many other nuances when analyzing all of the above. However, for the sake of esthetic purity, the truth is that no matter how one slices and dices it, there will be an unimaginable scramble to get out of electronic dollars and into physical ones. The amusing thing is that there are many who are worried that physical silver claims may be diluted by outstanding paper. This is true, however, ironically, it is very true when dealing with the heart of the fiat system. And recall that we refused to look at the $1 quadrillion in credit money at the derivative level. We believe that for illustration purposes, knowing that at best 10% of electronic money is covered in a worst case scenario should be sufficiently enlightening. As for those who say that all the Fed would need to do is merely hit the print button and not stop, remember: this money would simply flow to bank reserves. How it gets from there to outright currency in circulation is something the Fed has been bashing its head over the past 3 years, so far, unsuccessfully. And any money paradropped into circulation directly, would not do anything to alleviate the dilution factor as it would add to both sides of the "claim" and "deliverable" ledger (not to mention that it would also leads to instantaneous hyperinflation).

So, in the loosely paraphrased immortal words of Troy Mclure, now that you know, roughly, what a bank run would look like, don't do it.

Why Canadians should care about a U.S. default

When even the U.S. Treasury refers to the possibility of a debt default by the American government as "an unprecedented event in American history that would precipitate another financial crisis," that tends to get the world's attention.

The doomsday scenario is certainly scary: A default causes global interest rates to soar as debt priced in the world's most liquid currency comes to be regarded as more risky, banks become more reluctant to lend — even to each other — and debt, the lifeblood of business investment, becomes less available.

As well, stock markets sell off and plunge the world into another recession.

And Canada, as an exporting country doing three quarters of its trade with the U.S., would share in that pain.

"The nuclear option," Peter Buchanan, senior economist at CIBC World Markets, told CBC News, "is certainly something one doesn't really want to think about."

But whether the sky will fall on Canada if lawmakers in its biggest trading partner don't manage to do a deal on raising their debt ceiling, cutting spending and lowering taxes is far from certain.

It depends.

A default is a problem if lenders lose confidence in the borrower's ability to pay back what it owes, refuse to lend it any more and the country runs out of money.

A key element of this debt showdown is no one knows how seriously financial markets will interpret a statutory default.

"We're really in some sense dealing with unknown waters," said Buchanan. "The U.S. has never defaulted on its debt before."

"There's no doubt that it would have serious repercussions," he said, but whether it would lead to another financial crisis is uncertain.

"Whether it would lead to a Lehman moment (a reference to the collapse of Wall Street investment bank Lehman Brothers in 2008) or not, I think it could, but we'd have to see. It's not something markets have had a great deal of experience with."

"There have been many, many experiences of sovereign defaults through history," said Martin Schwerdtfeger, a senior economist with TD Bank Financial Group, "but none of these have been so significant as a U.S. government default could be."

But Schwerdtfeger expects the effects of a default would be limited. "It's not that the markets have completely lost faith in the U.S. and its ability to repay debt," Schwerdtfeger said.

"We would expect that that situation would be corrected within a matter of days," he said, "because there is room for credit rating agencies not to assign a rating to all U.S. debt but just to one debt issue (if it's in default). And then that could be corrected once the U.S. made the (interest) payments."

Still, both economists agree a default would lead to higher short term interest rates. Because U.S. Treasuries are regarded worldwide as the safest debt anywhere, global bond markets would demand higher interest to reflect the increased risk of all debt, including Canadian bonds, but Schwerdtfeger believes the effects would be limited.

More than a default, which he believes in unlikely, Buchanan worries a deal to avert a default will include sharp spending cuts, a troubling possibility given that federal spending accounts for eight per cent of the American economy.

"That could weigh quite a bit on an already weak economy," he said, given the June employment numbers disappointed economists, showing job creation of just 18,000 compared with the 90,000 new jobs most had expected.

A debt limit agreement that included cutting $2 trillion in spending, Goldman Sachs economists have said, could shave 0.8 percentage points off economic growth next year.

"If the U.S. economy slows further or even lapses in recession that would have clear implications for Canada's economy given that about half our GDP is trade-related and three quarters of our trade is with the U.S.," Buchanan said.

15 Characteristics of a Wise Person

Proverbs 16:16 states, “How much better to get wisdom than gold, to choose understanding rather than silver!”

This is sage advice, but not really a prevailing attitude in today’s culture. Today, we often see people racking up huge bills on their credit cards because they can’t wait to get the latest and greatest products and services. We see people with huge homes and expensive cars, but empty, sad hearts. We see people on the brink of destruction due to bad decisions and bad habits. As the proverb says, wisdom, not wealth, gets you through this life successfully. If you are a wise person, you can wisely manage your finances as well.

If you want to become a wise person, you need to start acting like one. Here are some characteristics of a wise person to consider emulating:

Characteristics of a Wise Person

1. They Educate Themselves.
Educate yourself. Wise people learn the basics of personal finance, including information about budgeting, retirement accounts, mortgages, and life insurance. You can’t make solid decisions about money without a deep understanding of all of the elements involved in your finances.

2. They Are Disciplined.
Wise people exercise self-control. If you’ve invested in a stock as a long-term investment opportunity, don’t panic and sell the stock based on one day of volatility. If you have a set budget, use discipline to stick to your budget as you walk though the shopping mall. Tip: If you have trouble following a budget, try the envelope budgeting system.

3. They Admit Their Mistakes and Learn From Them.
People learn from their mistakes because they must live through the consequences. For example, if you’ve ever lent money to a friend or relative who wouldn’t pay you back, you are wise if you never lend money to these people again. No matter how hard the fall, always get back up and start again. Begin by admitting your mistakes, and then use those mistakes as learning opportunities.

4. They Are Patient.
Patience is a virtue, and valuable when it comes to personal finances. A wise person saves enough money to purchase a fun, new gadget instead of charging it to a credit card. Wise people take their time when making important decisions, like buying a new car, or a home. When you exercise patience, you give yourself a chance to properly gather information, and to weigh all of your options.

5. They Take Instruction Humbly.
A wise person admits that they don’t know everything. They accept the fact that other people are more qualified and more knowledgeable than they are, without dismay. By valuing others’ opinions and knowledge, a wise person opens up to the possibility of acquiring and retaining valuable information. Wise people are not entitled, and they welcome the input of others.

6. They Can Handle Rejection and Failure.
A wise person doesn’t worry about rejection when asking for a promotion during a job performance review. A wise person takes action on side business ideas to earn passive income, without worrying about failure. If you don’t risk failure, you may never obtain significant success.

7. They Know That They Can Only Control Themselves.
Wise people don’t worry about what other people think or what other people do. They know that they can only control themselves and that what other people think doesn’t matter. For example, if a wise person lives in a small, modest home because the house was affordable, he or she doesn’t worry about people in larger, costlier homes.

8. They Are Guided by Wisdom.
Wisdom is better than riches. Wealth is important, but does not take precedence over family, friends, and health. Money should be used as a means to achieving one’s goals, but should not be the end goal.

9. They Know Their Priorities.
Wise people put first things first and last things last. They put family time first, before hobbies or free time. They pay off debt, before they buy something new. Wise people have their lives sorted out, and they know where they should direct their attention.

10. They Are Trustworthy and Steadfast.
A wise person treats others as they want to be treated, because they know it will help them, not hurt them. The wise person is who we always go to when we need solid advice. Wise people are who we turn to and who we trust in times of need.

11. They Take Calculated Risks.
Without some risk, there is limited chance of success. Wise people take risks in support of their goals, without endangering themselves or harming others. Most great stories about entrepreneurial success started with someone taking a chance.

12. They Make the Most of Their Relationships.
Wise people understand and revere the power of networking. They don’t shy away from asking advice of successful friends and family members, and they share their successes with others. Wise people continue to learn and increase their base of knowledge, and they know this is significantly impacted by the relationships they cultivate.

13. They Don’t Live Beyond Their Means.
Wise people pay their bills on time and only buy things they can afford. They don’t feel pressured to spend money on items they don’t need.

14. They Don’t Pay Full Price.
Wise people clip coupons, sign up for discount clubs, and shop during sales. They don’t mind holding up the line at the grocery store while cashiers ring up coupons (i.e. extreme couponing). They willingly buy half-price sweaters in the summer, and discounted sandals in the winter. They comparison shop online to find the best prices for big purchases, and they never, ever pay full price.

15. They Don’t Squander Money.
Whether it’s a tip, winnings from a poker game, or a well-deserved bonus at work, wise people know they need to save or invest this money. Many people squander “found” money, but wise people know this money can help them achieve their long-term financial goals. Instead of wasting this money on something that won’t last or on items they don’t need, wise people put found money to work for them.

Final Word

If it’s true that you can become a wise person by emulating one, this article gives you the blueprint for success. Whether it’s gaining knowledge, putting family first, or taking risks, there’s a lot to be learned from wise people. Take a close look at your personal finances to determine whether you make wise financial decisions and how you can improve. It might just the right time for a change.

Do you have wise tips for managing your finances?

Three Energy Stocks Hammered By Market: AXAS, EOG, PETD, TPLM

The stock market has not been a safe place for investors the last few months, as worries over slowing economic growth in the United States and European sovereign defaults have led to a volatile sell off.

Energy stocks have been among the worst performers, as investor enthusiasm towards oil and liquids exploration and production companies reached a crescendo in spring, 2011, and then quickly reversed as investors moved to preserve profits. Here's a look at three that have seen a major drop from peak prices reached earlier in the year, and may be worth a look.

The Victims
Abraxas Petroleum Corporation(Nasdaq:AXAS) reached a high of $6 per share in March, and then again in April, 2011, before losing 50% of its value by the end of June. Abraxas is involved in various unconventional basins in the onshore United States, including the Bakken, the Eagle Ford Shale and the Niobrara. The company is putting virtually its entire 2011 capital budget into these and several other oil plays.

Abraxas Petroleum has bounced off the June, 2011 lows, and despite the haircut in the last two months, the stock is still up 49% over the last 12 months.

PDC Energy (Nasdaq:PETD) also saw a peak in March, 2011, hitting nearly $50 per share before losing 40% of its value and settling around $30 per share. PDC is working in many oily plays in the United States, including the Permian Basin in Texas and the Denver Julesburg basin in Colorado and Wyoming. The company is devoting much of its energy and resources towards the Denver Julesburg basin in 2011, and plans to drill 104 wells here during the year. Fourteen of these will be horizontal wells targeting the Niobrara formation, a play where the company has already reported several successful horizontal wells.

Several other companies have also drilled and completed horizontal wells to test this formation. EOG Resources (NYSE:EOG) was one of the early operators in the play, and recently reported three successful completions on its leasehold. The company plans to drill 40 wells into the Niobrara in 2011.

Triangle Petroleum (Nasdaq:TPLM) was also hammered by market, reaching a recent high above $9.50 per share before falling to $5.50 in late June, 2011. The company is working in the Williston Basin and has assembled 72,000 net acres prospective for the Bakken and Three Forks formations. Triangle is participating in more than 75 gross wells over the next year, and plans its first operated well in late 2011.

The market has been pounded over the last few months, as fickle investors continue to climb and then slip down the wall of worry that has characterized recent activity. Many energy stocks fell much farther than the overall market, and may represent an opportunity for those willing to do some research.

Gerald Celente - Coast To Coast AM July 11, 2011

Gerald Celente gave his views on Tim Geithner's recent comments on the current gloomy economic outlook. He also shared some solid investment ideas. "let's listen to what Timothy Geithner said yesterday our treasury secretary , he said that for a lot of people it is going to feel very hard harder than anything they experienced in their life times now for long time to come , well George go back a year ago last August when he said recovery is right down the road " Gerald Celente said "you could sum up the death of the American dream with four simple words that happened few years ago , too big to fail , they are too big to fail they are too big to tax and the burden is falling on we the little people , they can care less about us " here is what Gerald Celente is recommending for his clients " well we are saying the same thing , I used to talk about Canadian dollars but we have been out of those a long time and I keep buying Gold and Swiss Franks as you keep seeing these economies to fall apart and dictators toppled , you know the Swiss are the money cockroaches of the wordld so we are seeing that currency staying strong "

Jay Taylor: Turning Hard Times Into Good Times

click here for audio HOUR #1 HOUR #2

Italy: measuring sovereign debt in silver

They say that only the Greeks know what tragedy is. Wish that it were so. Italians, too, can speak of their own great tragedie. In fact, they are on the verge of an economic one right now. The country's financial future lies in the balance. But what should Italy do? They should look to the past, and stop repeating bad habits.

From 1859 to 1914, the Italian nation went heavily into debt. Perhaps eager to glorify the new Italian state on the world stage, politician promised the Italian populace anything and everything that a modern state could supply. Public schools, roads, infrastructure, the “Regio Esercito” (The Royal Italian Army) – all were handsomely paid for by issuing government bonds. No social desire was left unsatisfied. No public work was spared.

The result: In June 1914, on the eve of World War I, Italy’s debt was a staggering 15,766,000,000 lira. The debt was so great in fact that one-half of all Italian government revenue had to be used to service the interest on that debt.

Italy’s 20th century was beginning amid mountains of debt.

Those same mountains of debt are with Italy today. According to the latest news, Italy has a debt of just over 1.8 trillion euros. Italy’s debt-to-GDP ratio stands at 120%.

Can we compare 1914 Italy with Italy's current problems?

Professor James MacDonald’s book A Free Nation in Debt: The Financial Roots of Democracy gives us a clue: He says, in essence, that we should use sound money to make the comparison.

The term lira comes from the Latin word libra, meaning “pound.” It was a term of measurement and the substance it measured was real money – gold and silver. But by the early 20th century, however, the Italian lira was no where near equal to a pound. In fact, after centuries of debasement and devaluations, an Italian lira was only set at 4.5 grams of silver.

Therefore, in 1914, Italy was actually in debt by 70,947,000,000 silver ounces. In today’s value, that silver would be the equivalent of 1,830,432,600,000 euros. (In US dollars, it would be $2,600,917,020,000).

The conclusion is undeniably striking: in real terms, Italy's debt burden today is virtually the same as it was back in 1914.

The implications of this knowledge are two fold: First, it demonstrates the irrefutable fact that silver (like gold) has an immense storage-of-value ability. In fact, it is more than just an ability; it is its very nature to be uncompromisingly stable. Not even 100 years of Italian war and debt and political turmoil could shake silver of its monetary steadfastness. It is, as they say, argento massiccio.

Despite the best efforts of Italian monetary authorities to devalue away debt (when the country still used the lira) and despite depreciation in the euro over the last decade, according to silver, Italy is in exactly the same debt situation as it was close to a century ago.

For the sake of the Italian people, let's hope that the country's debt burden actually falls over the next 100 years when measured in sound money.

Jim Rogers Calls U.S. Debt Ceiling Talks “A Sham”

While his former colleague at the Quantum Fund, George Soros, was busy discussing the euro zone sovereign debt crisis, Jim Rogers chose to focus this week on the fiscal problems facing the United States.

In an interview on Fox Business News, the legendary investor provided his latest scathing criticism of American politicians and the federal government as a whole.

“They will probably raising the debt ceiling and announce some kind of wonderful deal, which they will promptly ignore,” Rogers contended. “The United States is not going close down. It might be good for the world if the United States closed down for a while, but I can’t see that happening. Something will happen, things will look better, but then in six months or a year, things will be worse again.”

“We are going to default one way or the other but they may not call it default. These debt reduction talks are a sham.”

While he did not discuss President Barack Obama specifically, he had some rather frank words for Treasury Secretary Tim Geithner. ”He never should have taken the job…Mr. Geithner doesn’t have a clue about what’s going on. Just about everything he has done has been wrong. We are in worse shape now than we were a couple of years ago except now we have staggering debt to show for the efforts.”

Rogers, generally quite entertaining in his media interviews, went on to say that “If congressmen had to go to the same grocery stores you do and send their kids to the same schools, and ride public transportation, the world would be a lot different. They go down to Washington and laws get passed that we have nothing to do with. But if everybody stayed home and voted from the high school gym, we would have a much different government and the world would probably be better.”

He also discussed some of his current investment positions, which happen to include the U.S. dollar. ”I own the U.S. Dollar. It has been terribly beaten down. Everybody is bearish on the U.S Dollar including me. It’s fundamentally a terribly flawed currency. But when everybody is bearish on something it is usually a time to own it.”

Why QE2 Failed: The Money All Went Overseas

by Ellen Brown --- Web of Debt

On June 30, QE2 ended with a whimper. The Fed’s second round of “quantitative easing” involved $600 billion created with a computer keystroke for the purchase of long-term government bonds. But the government never actually got the money, which went straight into the reserve accounts of banks, where it still sits today. Worse, it went into the reserve accounts of FOREIGN banks, on which the Federal Reserve is now paying 0.25% interest.

Before QE2 there was QE1, in which the Fed bought $1.25 trillion in mortgage-backed securities from the banks. This money too remains in bank reserve accounts collecting interest and dust. The Fed reports that the accumulated excess reserves of depository institutions now total nearly $1.6 trillion.

Interestingly, $1.6 trillion is also the size of the federal deficit – a deficit so large that some members of Congress are threatening to force a default on the national debt if it isn’t corrected soon.

So here we have the anomalous situation of a $1.6 trillion hole in the federal budget, and $1.6 trillion created by the Fed that is now sitting idle in bank reserve accounts. If the intent of “quantitative easing” was to stimulate the economy, it might have worked better if the money earmarked for the purchase of Treasuries had been delivered directly to the Treasury. That was actually how it was done before 1935, when the law was changed to require private bond dealers to be cut into the deal.

The one thing QE2 did for the taxpayers was to reduce the interest tab on the federal debt. The long-term bonds the Fed bought on the open market are now effectively interest-free to the government, since the Fed rebates its profits to the Treasury after deducting its costs.

But QE2 has not helped the anemic local credit market, on which smaller businesses rely; and it is these businesses that are largely responsible for creating new jobs. In a June 30 article in the Wall Street Journal titled “Smaller Businesses Seeking Loans Still Come Up Empty,” Emily Maltby reported that business owners rank access to capital as the most important issue facing them today; and only 17% of smaller businesses said they were able to land needed bank financing.

How QE2 Wound Up in Foreign Banks

Before the Banking Act of 1935, the government was able to borrow directly from its own central bank. Other countries followed that policy as well, including Canada, Australia, and New Zealand; and they prospered as a result. After 1935, however, if the U.S. central bank wanted to buy government securities, it had to purchase them from private banks on the “open market.” Former Fed Chairman Marinner Eccles wrote in support of an act to remove that requirement that it was intended to keep politicians from spending too much. But all the law succeeded in doing was to give the bond-dealer banks a cut as middlemen.

Worse, it caused the Fed to lose control of where the money went. Rather than buying more bonds from the Treasury, the banks that got the cash could just sit on it or use it for their own purposes; and that is apparently what is happening today.

In carrying out its QE2 purchases, the Fed had to follow standard operating procedure for “open market operations”: it took secret bids from the 20 “primary dealers” authorized to sell securities to the Fed and accepted the best offers. The problem was that 12 of these dealers – or over half — are U.S.-based branches of foreign banks (including BNP Paribas, Barclays, Credit Suisse, Deutsche Bank, HSBC, UBS and others); and they evidently won the bids.

The fact that foreign banks got the money was established in a June 12 post on Zero Hedge by Tyler Durden (a pseudonym), who compared two charts: the total cash holdings of foreign-related banks in the U.S., using weekly Federal Reserve data; and the total reserve balances held at Federal Reserve banks, from the Fed’s statement ending the week of June 1. The charts showed that after November 3, 2010, when QE2 operations began, total bank reserves increased by $610 billion. Foreign bank cash reserves increased in lock step, by $630 billion — or more than the entire QE2.

In a June 27 blog, John Mason, Professor of Finance at Penn State University and a former senior economist at the Federal Reserve, wrote:

In essence, it appears as if much of the monetary stimulus generated by the Federal Reserve System went into the Eurodollar market. This is all part of the “Carry Trade” as foreign branches of an American bank could borrow dollars from the “home” bank creating a Eurodollar deposit. . . .

Cash assets at the smaller [U.S.] banks remained relatively flat . . . . Thus, the reserves the Fed was pumping into the banking system were not going into the smaller banks. . . .[B]usiness loans continue to “tank” at the smaller banking institutions. . . .

The real lending by commercial banks is not taking place in the United States. The lending is taking place off-shore, underwritten by the Federal Reserve System and this is doing little or nothing to help the American economy grow.

Tyler Durden concluded:

. . . [T]he only beneficiary of the reserves generated were US-based branches of foreign banks (which in turn turned around and funnelled the cash back to their domestic branches), a shocking finding which explains . . . why US banks have been unwilling and, far more importantly, unable to lend out these reserves . . . .

. . . [T]he data above proves beyond a reasonable doubt why there has been no excess lending by US banks to US borrowers: none of the cash ever even made it to US banks! . . . This also resolves the mystery of the broken money multiplier and why the velocity of money has imploded.

Well, not exactly. The fact that the QE2 money all wound up in foreign banks is a shocking finding, but it doesn’t seem to be the reason banks aren’t lending. There were already $1 trillion in excess reserves sitting idle in U.S. reserve accounts, not counting the $600 billion from QE2.

According to Scott Fullwiler, Associate Professor of Economics at Wartburg College, the money multiplier model is not just broken but is obsolete. Banks do not lend based on what they have in reserve. They can borrow reserves as needed after making loans. Whether banks will lend depends rather on (a) whether they have creditworthy borrowers, (b) whether they have sufficient capital to satisfy the capital requirement, and (c) the cost of funds – meaning the cost to the bank of borrowing to meet the reserve requirement, either from depositors or from other banks or from the Federal Reserve.

Setting Things Right

Whatever is responsible for causing the local credit crunch, trillions of dollars thrown at Wall Street by Congress and the Fed haven’t fixed the problem. It may be time for local governments to take matters into their own hands. While we wait for federal lawmakers to get it right, local credit markets can be revitalized by establishing state-owned banks, on the model of the Bank of North Dakota (BND). The BND services the liquidity needs of local banks and keeps credit flowing in the state. For more information, see here and here.

Concerning the gaping federal deficit, Congressman Ron Paul has an excellent idea: have the Fed simply write off the federal securities purchased with funds created in its quantitative easing programs. No creditors would be harmed, since the money was generated out of thin air with a computer keystroke in the first place. The government would just be canceling a debt to itself and saving the interest.

As for “quantitative easing,” if the intent is to stimulate the economy, the money needs to go directly into the purchase of goods and services, stimulating “demand.” If it goes onto the balance sheets of banks, it may stop there or go into speculation rather than local lending — as is happening now. Money that goes directly to the government, on the other hand, will be spent on goods and services in the real economy, creating much-needed jobs, generating demand, and rebuilding the tax base. To make sure the money gets there, the 1935 law forbidding the Fed to buy Treasuries directly from the Treasury needs to be repealed.

Energy Stock Gearing Up For Major Move: APA

Apache Corp. (NYSE: APA) — This large U.S. independent exploration and production driller has been in a bull market since August 2009. But this year, APA stock has been consolidating its move from $90 before making another run at new highs. The stock has a history of consolidations just under its 20-day and 50-day moving averages where it is now.

The Moving Average Convergence/Divergence (MACD) indicator is now overbought and, with the euro showing weakness, APA could fall to its near-term support at close to $115, and then make a run to the top of the trading channel at $140.

S&P has a “five-star strong buy” on APA with a 12-month target of $160. Our near-term trading target of $140 should take a lot less time to achieve.