The Great Depression of 2016

 I confess.  I’m not expecting a depression this year. The above title is a “hook”, and I borrowed it from a book written by Dr. Ravi Batra in 1985 (The Great Depression of 1990 – Why it’s got to happen – How to protect yourself) in order to make a point. I hear the same sentiments in the financial media today that prevailed from the late 70’s to the late 80’s, captured in such immortal works as Crisis Investing – Opportunities and Profits in the Coming Great Depression (1978), The Coming Real Estate Crash (1979), and What’s Next? How to Prepare Yourself for the Crash of ’89 and PROFIT in the 1990’s (1987).

Today it’s The Real Crash of 2016 (2008 Wasn’t the Crash, It Was Only the Tremor Before the Earthquake). Almost all of today’s predictions of an imminent collapse are based on the premise that the economic growth that we’ve had since 2009 – as slow and halting as it’s been – is all the result of the Federal Reserve opening the money floodgates. Once inflation heats up, and they are forced to turn this torrent off, the economy will crash, the U.S. will go bankrupt and gold will soar to $10,000/oz.   And that’s before the government suspends all benefits and seizes personal assets. The chart below seems to show that the Fed – through the various QE programs – has indeed inflated the money supply to an unprecedented degree.Excess Bank Reserves

But this chart shows the growth of bank reserves, not the money supply.  The best measure of the money supply – M2 – does not show this parabolic growth at all.M2 Money Supply

Since 2009, M2 has grown at the same roughly 6% annual rate that it did for the previous 15 years. Why this tremendous disconnect between the growth of M2 and the enormous amount of reserves banks now hold? Why haven’t these reserves worked their way into the economy in the form of loans to businesses and consumers, causing higher growth and extraordinary inflation?

According to Mike Bazdarich of Western Asset Management, this growth in reserves is the result of a series of regulatory requirements that have been implemented since 2008, (e.g., reserves required to collateralize deposits, the risk-weighted capital requirements imposed by the Basel Accords, plus the soon-to-come Fed-imposed requirement that banks hold highly liquid assets (mainly bank reserves) equal to 100% of the amount that Fed stress tests indicate they would need to survive another liquidity crisis). Banks’ demand for reserves has skyrocketed because it’s possible that half or more of the current excess reserves held by banks today is effectively dictated by various requirements and requirements to come, some of which are still difficult to estimate.

In other words, banks have accumulated a mountain of excess reserves not because they don’t want to lend against those reserves but because they had to accumulate them in order to survive. Banks may therefore not be as flush with excess reserves as the numbers suggest. They have responded to changing regulatory burdens by becoming more conservative and hoarding cash. (For a more detailed explanation see Calafia Beach Pundit at http://scottgrannis.blogspot.com/2016_02_01_archive.html

Most of our economic problems today are a result of tax, regulatory, social and educational issues.  They do not stem from a Fed-engineered money deluge.  To see what that looks like, see Scott Grannis at http://scottgrannis.blogspot.com/2016_03_01_archive.html

Don Harrison

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