For One Bank, This Is ‘The $3 Trillion Question’

In “Epic, Extreme Analogs’ And Ostensibly Stingy Banks,” I speculated about what might happen in the US economy in the event pandemic-era savings dynamics reverse as the services sector reopens following the assumed achievement of herd immunity.

To quickly recapitulate, some suggest that once the pandemic abates, quite a bit of liquidity could be unleashed. When you consider the prospect that elevated savings levels (e.g., due both to consumer retrenchment and stimulus checks) could be drawn down once employment in key areas of the economy bounces back (assuming it does bounce back), you can conjure an “interesting” scenario, where “interesting” means inflationary, at least for some critics of the current monetary/fiscal policy conjuncture.

Banks, one assumes, will eventually ramp up lending. The standout chart from the article linked above showed that loans as a percentage of total assets have plunged below 50%. As BofA’s Ethan Harris reminds us, “banks are willing to hold excess reserves because they pay a small interest rate and they help meet liquidity requirements, but they have virtually no impact on lending decisions.” Rather, “the binding constraints on lending are capital requirements and the bank’s appetite for risk.” Clearly, risk appetite was curtailed by the pandemic, and while last quarter’s big bank earnings suggested the worst case wasn’t realized, management commentary admitted of palpable trepidation around the outlook.

In any case, as a kind of addendum to the article mentioned here at the outset, I wanted to highlight a few quick points BofA’s Harris delivered in a note out last week.

Commenting on the relationship between monetary aggregates and economic output, Harris pointed out that to the extent “high holdings of transactions balances were a sign of strong spending ahead” in the decades prior to 1980, the relationship eventually broke down due to a number of factors including the concept of money as an asset class. In modernity, it’s almost impossible to say what elevated money balances signal, assuming they signal anything at all. Harris emphasized as much, noting that “it has become hard to distinguish between two signals: (1) high money balances as a sign of strong spending power and (2) high money balances as a sign of risk averse investment.”

The former would suggest stronger growth might be just around the corner. The latter might well mean the opposite, depending on whether the thesis behind savers’ preference for cash (as an asset) turns out to be correct.

(As a quick aside, note that I used the word “modernity” above to describe ~1990 and beyond. That’s pretty amusing and reminds me of how surreal it sometimes feels when I read media bylines or notes from analysts, and realize we’re now getting our market insights from people who weren’t old enough to drive when Lehman collapsed.)

Getting back to Harris (who was old enough to drive, and then some, during Lehman), he posited a “return to relevance” for money aggregates. After cataloguing the factors that have led to the pandemic surge in liquid savings, he described the US as “on its own planet.”

“Comparing actual M2 growth to trend growth in M2 we estimate that there is about $3 trillion of excess bank deposits in the US compared to $0.6 trillion in Europe,” he wrote, adding that “not only is this unprecedented in a global comparison, but it is also unprecedented in US history.”

There is, of course, all manner of nuance germane to this discussion, not least of which involves speculating about the behavior of shellshocked households and consumers coming out of the biggest economic downturn since the Great Depression.

While Americans aren’t exactly known for being scrupulous with their savings and spending, the pandemic dealt a severe psychological blow. That won’t simply go away overnight, herd immunity or no.

Still, it’s worth pondering what BofA’s Harris called “the three trillion dollar question,” which he described as follows:

What happens to all these liquid savings when (1) the service sector reopens and (2) people become increasingly confident about the outlook? Our forecast assumes a sharp acceleration in spending, with the Fed achieving both of its short-term goals next year—full employment and 2% core PCE inflation. Keep in mind, however, that our current baseline assumes only $1 trillion in additional stimulus and a much higher number is becoming increasingly likely. It’s getting interesting.

It is indeed. Getting interesting, that is.