What Inflation?

Sure, stocks are rising and the dollar is tanking. But we don't have inflation. Yet.

Yes, the Fed's balance sheet has ballooned to the joke it is today, holding more than $2.1 trillion in assets. But what about the liabilities soaking up these assets?

Currency in circulation is only up 9.7% YoY, while the assets are up 80.5% in the same period.

So if all of this printed money is being used by the Fed to purchase toxic assets, where is it going?

Excess reserves, of course. Counting for $833 billion of the Fed's liabilities, the reserve balance with the fed has skyrocketed almost 9000% YoY. Excess reserves, balances not used to satisfy reserve requirements, total $733 billion, up over 38,000%!

Excess Reserves of Depository Institutions

The Fed pays interest on these reserves, and with an interest rate (return on capital) comes opportunity cost. Banks hoard the capital in their reserves, collecting a risk-free rate of return, instead of lending it out into the economy. But what happens as more loan losses occur and consumer spending grinds to a halt? The Fed will lower (or get rid of) this interest on reserves.

And that is when the excess liquidity synthesized by the Fed, the printed money, comes rushing in and inflates goods prices.

Right now, we have a case of a $2.7 trillion move in equity market capitalizations corresponding with an only $400 billion decline in money market funds. QE funneled through fractional reserve leverage into bank reserves is where the bank algos get the buying power to make up the difference (that, and AIG counterparty bailout funds). But this is purely liquidity. And with the forward-pulled demand thesis attempted three times before, the US govt at the debt wall, and no consumer credit in sight, the market is going to go right back down.

To get an inflationary bull market, the printed money/excess liquidity can't be exclusive to equities. Equities are where the QE's "inflation" has been seen of late, but it is little more than a Ponzi scheme, as the funds haven't entered the real economy (as the equity prices would suggest), and until excess reserves are unsequestered, there is no inflation, there is no nominal growth, and there is no bull market (however fallacious and inflationary to begin with).

The excess reserves will be released when the Fed/Tsy have no more bailouts/stimuli on their agenda and everything they wanted has been fully authorized and set into action. Until then, it will be a game of letting the market correct itself (ie Paulson allowing Lehman BK to crash stocks last year), spending months using that as political capital to issue unprecedented deficit spending/bailouts, fend off Congress/taxpayers as the panic mode wears off and they realize what they allowed via ultimatum/MAD, and crash the markets again when you run out of ammo to raise new political capital. And with Barney Frank stating HR 1207 will pass this October (something that cannot be allowed if the Fed/Tsy want to continue their shenanigans), the fall equity selloff I've been calling for seems all the more likely.

POMOs end September 2, until further notice and the Clearinghouse Association has already begun the MAD talk again...