The Impossible Math Of The Federal Reserve

Authored by Steven Vannelli via Knowledge Leaders Capital blog,

Earlier this week, the Federal Reserve officially signaled the beginning of its balance sheet run-off. At this point, that’s old news. But, yesterday, the Fed released the Z.1 Flow of Funds, which adds to the intrigue of the balance sheet run-off. Why?

Instead of getting wrapped up in fancy terms like quantitative easing and large-scale asset purchases, I find it easier to think about extraordinary monetary policy from a savings standpoint. Distilled to its roots, the Fed has been manufacturing “savings” from thin air for the better part of a decade. When the financial crisis hit in 2008, American savings were depleted, so the Fed had to step in to produce savings (to finance huge government deficits). Now the Fed is attempting to remove that “savings”… at a time when:

  1. The private sector is experiencing falling savings.
  2. The government is likely on the precipice of expanding its dis-saving in the form of greater deficits.

Some data and charts will help explain the concept. In the Flow of Funds, released quarterly by the Fed, the relevant section to this discussion (out the 198 page report) is F.4 – Savings and Investment by Sector. Below is a clip from that table, highlighting aggregate net savings by sector.

A couple quick notes about the above data:

  1. Net savings of domestic business is basically undistributed earnings.
  2. Net household savings is a residual of income minus consumption.
  3. Net government saving (or dis-saving as is the case) is the aggregate deficits of federal, state and local governments.

These net savings are the aggregation of what is left after businesses replace worn out capital and pay dividends, what households have after paying their bills and what the government has after paying its bills. It is the country’s seed corn. If there is no net savings, there can be no net investment.

The financial crisis of 2008 decimated the stock of savings, and it actually dipped negative for the first time ever. Current aggregate net savings in the US are $355 billion. That’s it!

Decomposing net savings into its sectoral components, we’ll start with the household sector. After the financial crisis, American households ramped up their savings, but since peaking at the end of 2012, household savings are plummeting.

Next, we can turn to the corporate sector. After the financial crisis corporate profits surged, and undistributed corporate profits peaked in the third quarter of 2010 at just over $800 billion. But since then, corporate net savings have been fading.

Last, we have the government. After the tech wreck of 2000, government dis-saving picked up pace, but after the financial crisis the rate of dis-saving exploded.

So, when we combine the net savings of all the sectors and compare it to GDP, we get the following chart highlighting the long-term structural decline in American net savings.

If the Fed starts shedding assets at $10 billion/month, ramping to $50 billion/month by 2019, can the private sector absorb these securities at the same the government budget deficit is set to widen by perhaps $100-$150 billion in the next couple years?

Not to state the obvious, but all else equal, if the fed started shedding assets at $30 billion a month (or $360 billion a year), they would exhaust the entire stock of private savings. This doesn’t allow for larger government deficits. Given the current savings level, it is mathematically impossible for the Fed to shed assets at $50 billion/month. By 2019, as we are farther out from peak net savings rates set in 2015, it is likely the stock of private savings is smaller still, and hence the ability for the Fed to shed assets at a rate of $50 billion/month is utterly impossible. Net savings have fallen in the last 2 years from a peak of just over $700 billion to the current $355 billion. Will savings halve again in the next two years? If so, there is no mathematical way in the world the Fed can shed assets at the rate it outlined yesterday.

While we are on the topic of aggregate net national savings, I thought it would be instructive to remind readers of our analysis on the relationship between net national savings and asset prices.

First, the cycle of net savings as a percent of GDP is a great way to measure movements in the US Dollar. As can be seen in the chart below, with about a two-year lead, the US Dollar follows the movement of net national savings. The drop YTD in the US Dollar, and our hypothesis that we have entered a US Dollar bear market, square with this analysis. Suffice it say, I think the opinion that Fed rate increases is US Dollar bullish is just plain wrong.

For US Treasury bonds, history suggests that a decline in the savings rate is associated with lower interest rates. Bond bear markets like 1987, 1994 or 2010 occur when the savings rate is rising. The foundation for a bond bear market does not appear in place.

For gold, history suggests that a falling savings rate is associated with higher gold prices. Here again, with about a two-year lag, gold prices are highly correlated with national savings. The foundation for a bull market in gold appears to be in place.

Lastly, I’ll look at stocks. In the charts below I use our KLSU indexes which are market-cap weighted indexes that capture to the top 85% of a region’s market cap. Unfortunately, our history is a little shorter here as our indexes only go back to 2000. But, I think the trend is still pretty clear. Below I plot the performance of KLSU North America relative to KLSU Developed Markets. This not an encouraging looking chart for US equities.

For other developed regions, the turn in the US savings cycle is positively associated with their outperformance. For visual clarity, I inverted the net savings line (right axis). The two-year old deterioration in US net savings makes Europe’s outperformance YTD more logical.

For emerging markets, the turn down in US net savings is also broadly positive. Here again, the net savings series is inverted for visual clarity.


philipat Stuck on Zero Fri, 09/22/2017 - 19:45 Permalink

The author has overlooked a teeny weeny thing called the ESF. It is impossible to know the size of this for sure but best estimates run into the Trillions, perhaps 10-15 Trillion. So there will be a "mystery" buyer (Think "Belgium") for the Treasuries the Fed wishes to sell which will have no inpact on "savings" or "the savings rate" because the ESF is accountable essentially to nobody and its "assets" are entirely off all books.Maybe the ESF will also become the final resting place of the other half of the Fed's Balance Sheet, the toxic shite otherwise known as MBS, bought at full face value from the TBTFs using the peoples' money as part of the process of bailing them out. Too big to fail or jail don't ya know...

In reply to by Stuck on Zero

yogibear Fri, 09/22/2017 - 12:14 Permalink

Who needs savings when you can just print dollars and give them to China and other countries for goods?Party on!!! Federal Reserve will just buy any  US Treasuries China dumps.Print, print, print.Zimbabwe economics American style.

SDShack yogibear Fri, 09/22/2017 - 13:03 Permalink

Yeah, so many glaring holes in the math of this article. Like nothing said about the excess savings held by the rest of the world (much of it backed by real assets, not fiat), because we all know that no foreigners ever invest or purchase USSA assets! Good grief how stupid are these people!

In reply to by yogibear

wwxx Fri, 09/22/2017 - 12:43 Permalink

Can you really have THE SHREADDING, at whatever pace, without another world wide shock wave [as in 2008], to blame it upon?  I think not. wwxx

Quinvarius Fri, 09/22/2017 - 12:56 Permalink

They are just going to transfer these assets to off balance sheet accounts or pay bankers to buy them.  They might even just forgive banker loans completely.  The Fed has never in history shrunk it's balance sheet.  It only grows.  This event will end up being inflationary, one way or the other.  Also, keep in mind, they are complete and total liars.

Rebelrebel7 Fri, 09/22/2017 - 13:06 Permalink

The intellectually and morally impaired surveillance industry has been surveilling innocent people and selling information on them for profit to other intellectually and morally impaired genetic mutants! They and the people that they sell it to are thieves and half-witted, fraudulent, perverted monsters, and terrorists, who are biologically incapable of integrity, morality, respect for the rights of others, an original idea, or single linear thought, and are  totally devoid of critical reasoning! Having those characteristics, qualifies them for being sociopaths!.Rebelrebel7

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Turn on ( your device ), Drop In , and Zero In!Song by modern day hero that has proven that the survellance establishment is selling information on us, Einnfalt: is your life America!Watch "Maurice Ravel Bolero London Symphony Orchestra Valery Gergiev" on YouTube "Imagine Dragons - Radioactive" on YouTube "PIL - Public Image" on YouTube interest is The 8th wonder of the world- those who understand it earn it, and those who do not pay it.- Albert EinsteinIf America has a capitalistic economy, we must really suck at creating capital with a $21 trillion national debt and $500 billion trade deficit in 2016! Where is the capital?!Life under The Federal Reserve Act of 1913:Watch "HELTER SKELTER THE BEATLES NO COVER VIDEO ORIGINAL" on YouTube up and drink the coffee! Smelling it doesn't work!This is not capitalism! This is Mussolini style debt financed militaristic bankism!Lying about history and reality does not change history or reality, it only changes the person who is lying , and for the worst! Hillary Clinton is a walking example of this!Congress must be charged and held accountable for power crimes! All laws which they have passed in violation of the Bill of Rights and laws exempting themselves from accountability!The central banking third-way, triangulation strategy of the neocons and neoliberals,  is to unite the country ( and the world ) around perpetual war, the anhialation of the Bill of Rights and the constitution, globalist free-trade policies in a race to the bottom, pitting US workers against those earning $2 a day, through a  central banking debt financed money supply which enslaves virtually everyone in the world with only a few notable exceptions, North Korea and Venezuela who have rejected privately owned Central banks!  The false flag against communism and socialism is nothing more than that, with communist China and socialist EU countries to varying degrees as proof! We must do the opposite! We outnumber them on a scale of 1,000 / 1!Unite the sane and independent center! Commit to not choosing sides in the neoconservative / neoliberal civil war !Don't take it to the streets! Take it to the internet! Legislation has never been changed as a result of people protesting with signs!Let the pen and the truth be your deadliest weapons against the corrupt, war-mongering, psychopathic establishment!Watch "Pink Floyd - Another Brick In The Wall (HQ)" on YouTube't be a useful idiot that elevates the establishment's two party system!Both parties have destroyed the Bill of Rights and both parties are war mongering treasonous tyrrants!This strategy could destroy the two parties which have  destroyed America!Americans should unite around issues that we can all agree upon. These issues are all ignored by the establishment elites of the neocons and neoliberals.1.We must repeal the Federal Reserve Act of 1913 and abolish the Federal Reserve. Congress must resume its responsibility and coin money and regulate its value as granted to Congress in Article 1 Section 8 Clause 5 of the constitution.The fundamental flaw in main stream economics is that it begins by accepting  the validity of the Federal Reserve Act of 1913, the IMF, BIS,  and World Bank which are all part of the privately owned banking cartel charging interest to sovereign nations which is nothing more than a bank tax on citizens for which they have no right to claim, therefore making it a circular argument based on a logical fallacy!If we continue down the yellow brick road of the Federal Reserve Act of 1913 and privately owned international central banking cartel:1.)We will destroy the economy  when we  reduce the national debt,  because the money supply is based on debt.2.) There will  be an endless boom bust cycle because when the banks issue loans, they create money in the equivalent of the principal of the loan, but do not create the money required to pay the interest on the loan, leaving a shortfall in the money supply of the interest payments required.3.) We will go deeper into debt or destroy the economy because the only central bank solutions are  to issue more debt or destroy the economy.If Congress were to resume its responsibility as stipulated in Article 1 Section 8 Clause 5 of the constitution and coin money and regulate its value debt free, and if other nations would do the same:1,) The budget would automatically balance.2.) There would be no need for income taxes, estate taxes, capital gains taxes, and corporate taxes.3.) There would be no need to reduce spending.The rise of cryptocurrencies has litigated and won the case before the world, precisely how easy it is to get rid of the central banks! I prefer cash, which would not use the gold standard because history has proven that every time that it has been implemented,  most of it ends up in the hands of a few wealthy families, and it and they destroy the nation!During the middle ages in England, King Henry 1st implemented the tally system and the bankers and goldsmiths did not control the economy, the average man provided everything necessary for his family by working 16 weeks a year! The rest of the time was spent learning, traveling,  on the arts, and volunteering for the church! For more on this topic please read The Web of Debt and the Shocking Truth About Our Money System And How We Can Break Free by Ellen Hodgson Brown J.D.2.The military should be used for defending our borders. We should close the 698 permanent foreign military bases and 400 temporary military bases. Our international meddling is jeopardizing national and international security, human life, and economic prosperity. We should retract from all war on foreign soil.Watch "Rage Against The Machine - Bulls on Parade" on YouTube The prison industrial complex and the war on drugs must end. It is a horrific human rights abuse and is completely unacceptable.4. All laws which violate the Bill of Rights must be immediately repealed. The NDAA, The Patriot Act, HR6393, The American Freedom Act are all grotesque unconstitutional violations of the 4th amendment.  5. Freedom of speech and of the press , and  the right to assemble, must be protected. The government has removed the common thread that wove the fabric of our nation, our liberty, in a futile attempt to take the heat off of them, where it rightfully belongs, and to incite civil war, leaving corruption as usual in charge!* * * * * * * * * * * * * * * * * * *What's up Doc?!Medical spending accounts for 18% of GDP, 12 % of GDP spending is totally wasted in a medical establishment free for all that is killing tens of thousands of Americans each year!Everyone knows that the medical community is first and foremost and also for most, a snake venom racket that profiteers off of the misfortunes of others!2/3 of prescription drug spending is spent on psychiatric drugs ! Not only have they been proven not to work,  they make the underlying psychiatric ailment worse, and also cause extremely dangerous and costly health problems! 20% of patients use 80 % of the medical benefits! These drugs have been proven to  lead to obesity, diabetes,  heart disease, chronic pain,  and many other severe and frequently life threatening health risks such as the potentially fatal neuroleptic malignant syndrome. Atypical antipsychotics have also been proven to increase obsessive compulsive behavior including compulsive gambling and substance abuse. There is currently a class action lawsuit against Abilify for this! "Suicidal Tendencies - "Institutionalized" Frontier Records" on YouTube is zero incentive for anyone in America to discuss this because they are all making trillions off of it!Under stress, the brain activates the fight or flight response. Since we live in a fascist society which has the worst human rights abuse record on the planet, the majority of people opt for mental flight. They stay where they are, but mentally check out through the use of drugs and alcohol!All treatment centers rely on 12 step programs that have a 6% success rate, effectively showing a 0% success rate since 5% simply quit on their own without treatment, this is a  statistically insignificant increase in recovery success in contrast to no treatment. These programs have high suicide rates and add to the increased depression and alienation of those who question the "wisdom " of Bill Wilson!Since treatment centers make $12,000 to $50,000 for treatment, they are highly content with the revolving door policy of alcoholics and addicts relapsing and returning!The problem with 12 step recovery programs is that they are fascist in nature, increasing the fight or flight response and subsequently,  relapse.The 12 steps in and of themselves are excellent, but the Big Book which members place above the bible is completely insane and new comers whose lives have been turned into shambles are told that everything is exactly as God intended it. If that is the case, I guess that if they drink or use drugs, that is God's intention,  so why even bother going to AA? The newcomers  are also mentally assaulted if they reject the flawed ideology. They say the serenity prayer, but only believe that they are supposed to accept all of the injustices of the world and have been brainwashed into believing that they cannot change people, places, or things. If you have ever cleaned a house, or have done any gardening,  you know that is a lie! If you have ever had a discussion with someone, and either your own mind, or theirs was changed as a result of the information exchanged,  you know that is a lie! If you have ever read anything, or written anything and had your own mind changed by what you have read, or changed someone elses mind by what you have written, you know that is a lie! They expect you to have a sponsor who has ruined their own life, micro-manage yours!They say that politics cannot be discussed, even though the 12 traditions only say that the GROUP  does not endorse or oppose any causes! All issues are political. It is not merely talk of individual politicians that they forbid, they prefer a world view that blocks out everything except their own connection to it, essentially denying the existence and reality of almost the entire world. It is my hope that treatment centers, 12 step program central offices and groups will do a serious 4th step so that they are no longer exacerbating the situation in light of this national crisis!Watch "Neil Young - Needle and the Damage Done" on YouTube* * * * * * * * * * * * * * * * * *Profiteering drug dealers AKA big pharma prevent the cost effective, medically effective alternative of marijuana, CBD and THC preferring to charge people $475,000 to treat cancer! "More recently, scientists reported that THC and other cannabinoids such as CBD slow growth and/or cause death in certain types of cancer cells growing in lab dishes. Some animal studies also suggest certain cannabinoids may slow growth and reduce spread of some forms of cancer. 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Enjoy your pyrrhic victory, as I spend the rest of my life carrying my message to hundreds of thousands of people while destroying your pathetic lives, One. Second. At. A. Time.To any other victims of the American terrorism industry, please publicly thank them on social media. Companies will stop hiring them when they realize how innefective, stupid, and incompetent they are. Please also post the link below.I've been through a hell of a lot worse than this in my life. If it is anything short of a mushroom cloud, you will not intimidate me.The very fact that they are such cowards that they are afraid to communicate directly is solid proof that they are whimps that should be laughed at, and not feared!The intellectually and morally impaired surveillance industry has been surveilling innocent people and selling information on them for profit to other intellectually and morally impaired genetic mutants! They and the people that they sell it to are monsters!What you thought was tinnitus, is probably a 1 nanometer 2 way transistor radio implanted by a doctor without your consent! Watch "Iggy Pop - Lust For Life" on YouTube "Echoes" on YouTube did this happen?!Watch "The Beatles - Live and Let Die" on YouTube "Suicidal Tendencies - You Can't Bring Me Down" on YouTube "R.E.M. - It's The End Of The World" on YouTube
Clowns on Acid Fri, 09/22/2017 - 13:39 Permalink

The "math" in the article leaves out the fact that the Fed can "print" surreptiously (FX Swaps with other CBs, CBs buying the MBS and USTs going off of Fed blance sheet, etc), . Like Mr Yellen said " Like watching paint dry" "will not be another 2007/08 in her lifetime" has to assume that mens that the Fed will put lipstick on their balance sheet for public consumption but that the "correction" in the equity or bond markets will be a controlled 5% or 10 % demolition over a period of years.The CBs are desparate and desperate people do desperate things. Socio-economics be damned.

aqualech Fri, 09/22/2017 - 14:26 Permalink

Why would they sell now?   Probably because the price is peaking.  Buy low, sell high.  It's easiest to do when you can manipulate the price.

rex-lacrymarum Fri, 09/22/2017 - 15:40 Permalink

The official data on "savings" do not describe actual savings. These are all based on fiat money, which as we know is created from thin air by the wagon-load. It is the same with Bernanke's absurd "savings glut" theory. China printed a lot of money, and Bernanke accused it of having "too large" savings. Of course these were just figures in accounts on computers, utterly meaningless in view of China's money supply growth. Besides, how can savings possibly be "too large"? That is just Keynesian balderdash. Anyway, I mainly want to point out that these statistics are essentially meaningless. 

The Real Tony Fri, 09/22/2017 - 16:02 Permalink

 "and undistributed corporate profits peaked in the third quarter of 2010 at just over $800 billion." The truth is all of that was cost cutting and none of it was increased corporate profits. Corporate profits haven't increased since late 2006.