The Ferret vs The US Economy: Our Monthly Economic Report

To keep our clients’ businesses healthy, happy, and one step ahead of their competition, we’re always looking for indicators to show us where the US economy is headed. Depending on what the future holds, we might recommend increasing sales initiatives, adjusting cash on hand, increasing or decreasing debt, or other strategies to weather tough times or take advantage of good ones. We don’t have a crystal ball but there is a set of important indicators we watch that gets pretty close.

The charts below illustrate the use, flow, and stimulus to the economy as represented by gross domestic product, or GDP. The tables and charts below show, at different times, the stimulating effect of money supply expansion or contraction by the Federal Reserve and loan expansion or contraction by overall banking system.

In short, we are seeing a muted effect on the US economy due to unnecessary loan restraint by the banking system. Banks held on to an extraordinary percentage of the 2009 stimulus provided by the Federal Reserve as free excess reserve – as much as $2.5 trillion at any given time. Instead of stimulating the economy, the stated goal, these reserves remain with banks as dormant deposits. Releasing this money supply could have a huge positive effect on the economy.

Let’s walk through the numbers. As a note, all of the data used to create the charts below come from the US Department of Commerce and the Federal Reserve.

In 2000, just after the Dot-com bubble, our GDP here in the US was close to $10 trillion. Our M2 money supply – cash, checking deposits, and other highly liquid assets – was about half of that, close to $5 trillion. This put the US at a 2x multiple of GDP to money, meaning that every $1 in our money supply would add $2 to our GDP.

In the same year, our total aggregate debt was $18 trillion (think credit cards, line of credit loans, mortgages, etc.), putting our GDP to debt ratio at 0.55. Put another way, every $2 of debt in this country in the year 2000 would create $1 of GDP.

If you look at the first quarter of 2016, you see a troubling direction for these numbers. GDP is almost double but the M2 money supply is 2.5x larger. That means that our money supply is growing faster than our GDP, dropping our GDP to money supply ratio by almost 30%. Now, each dollar of money supply is only worth $1.50 in GDP (and dropping). In other words, the money that we have to work with is 30% less efficient than it was in 2000.

In the same time period, the aggregate debt has gone up at the same rate as the money supply, outpacing GDP growth. Now, it takes almost $3 in debt to create the same dollar in GDP. Our debt, like our cash, is significantly less efficient. If our cash and debt performance were the same as it was 16 years ago, our GDP would be almost 40% higher, or over $25 trillion.

That’s not great. Despite all of the businesses started and capital invested and innovation generated, our GDP is deleveraging and underperforming. So what gives?

This second chart compares GDP growth to the federal funds rate. The first thing we want to concentrate on is the 3^rd column, or the real GDP annual change (indicated year compared to the previous year). This is actual change modified by inflation to give us the real performance of GDP. Consistency and growth existed until 2008 and 2009 when the most recent financial crisis occurred – the Great Recession. Growth returned, albeit at a slower pace than before.

Now, look at the real federal funds rate. This rate basically sets all other interest rates in the economy and shows whether the Federal Reserve is stimulating the economy or attempting to slow the economy. Currently the Fed is being simulative through low nominal interest rates and negative real interest rates, which are generally highly simulative.

So, overall, the Fed is attempting to stimulate the economy by keeping interest rates low. This should give families, small businesses, and corporations access to debt which can be spent on goods and services, stimulating growth and GDP. But real GDP growth is slower now than any time since 2009. And now the real interest rate is going back up +200% while the economy is still underperforming. This is not a great sign of things to come. The economy is depressed and the Fed is, for all intents and purposes, acting to depress it further.

In 2008, the Fed put forward a massive economic stimulus program to pump trillions of dollars into large financial institutions to keep them from collapsing. The thought behind this was to avoid a recession by securing existing shaky loans and ensuring that responsible lending would continue.

What actually happened? Well, some of that stimulus money went where it needed to go but a huge portion started pooling in excess cash reserves. Compare the 2^nd column with the 3^rd one above. The Federal Reserve is about 3 times the reserves it had in 2000, showing extra caution after the 2008 crisis. But the banking industry? It’s currently holding 1,785 times what it was in the year 2000!

In theory, banks could create at least $6 of loans for every $1 of excess reserves held. In aggregate, this would be the equivalent of almost $14 trillion in additional loans into the economy if the reserves were used.

What’s worse is that lending has actually slowed down. Pre-2008, on average, $2.45 of GDP was created by each additional $1.00 of bank loans. From 2008 on, that ratio is down to $2.17 (average) of GDP per $1 loaned. So not only are they holding on to money that should be loaned out, they’re loaning out at a slower rate than before despite astronomical reserves.

This reserve money is doing nothing productive by sitting around. This could be lent out at the currently very stimulating interest rates for all of the activities that contribute to economic growth.

Stimulus money was given to the banks in 2009 without enforced guidelines for how it needed to be used. Instead of pushing that money back out into the hands of consumers and business owners, the banks, overly fearful of another collapse, held on to trillions of dollars they didn’t need. Now, that money is “theirs” and it sits unused.

So how does this turn around? The fastest route to the growth our GDP needs and should have had to begin with is to force the banks to move this stimulus money out of their coffers in into the money supply.