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The Era of Easy Money Is Over and Liquidity Is Tightening: What Do You Want to Do?

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The smart money is raising liquidity and the dumb money is providing it.

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Friday after the market closes is always an exciting time for me because that's when the Fed's H.8 data on commercial banking assets and liabilities is released. The data has a one week lag, but it represents a fairly up-to-date picture of lending activity. Friday's release was for the week ending August 14 and showed that total banking credit declined by $6.4 billion on the week with loans and leases declining by $10.6 billion. This decline in credit creation during the dog days of summer should not be, in and of itself, too troubling, but it is consistent with an emerging trend of decelerating credit growth.

Total bank credit is comprised of two main categories: loans and leases, and securities. A bank can make a loan or buy a bond. In January, total bank credit was $9.979 trillion of which total loans and leases represented $7.25 trillion and securities represented $2.73 trillion. The week ending August 14, total bank credit was a mere $9.984 trillion with loans and leases up to $7.295 trillion and securities at $2.688 trillion. So basically, in the last six months, you have total bank credit down $4.8 billion with loans and leases up only $46.7 billion and securities down $41.8 billion.

Commercial Bank Credit Vs. Loans and Leases



Credit growth, which is consistent with nominal GDP growth, has only grown by $167.6 billion over the past 12 months at a 2.35% pace year-over-year and is thus far negative on the quarter after Q2 posted the slowest pace of NGDP growth since emerging from recession. To give you an idea of how weak this credit growth is, in the same period a year ago, loans and leases grew by $323.4 billion at 4.75% YoY growth rate. The demand for money is decelerating.

Over this time period the Fed has pumped $500 billion into the financial system, so you would expect some of this to show up in bank credit. It hasn't. This suggests it's all in the bond market, which means that a lot of it has been vaporized by the recent meltdown. It's amazing how fast the market can eliminate excess liquidity. This is why tapering is tightening, and this excess liquidity removal is also why real yields are rising and the dollar is strengthening.

The Monday after Ben Bernanke top-ticked the stock market at his May 22 Congressional testimony, I wrote in Bernanke's Worst Nightmare: Rising Real Interest Rates:

Participants in the equity market obviously do not realize that the QE negative interest rate wind at their back is no longer present. Just as El-Erian implies, they have fallen prey to the illusion of QE stimulus via rising equity prices. In reality, the price of gold -- and more importantly, real interest rates -- are actually reflective of tightening monetary conditions. Perhaps Wednesday's capitulation flush reversal was indicative that the equity market is finally getting the message.

I was partly right and partly wrong. Some equity market participants did get the message, but others did not.
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