I wrote a few days ago that the amount of currency held by the public is a very good measure of the public’s level of fear about the stability of the banks and financial system. The numbers are produced weekly by the Research Department of the Federal Reserve Bank of St. Louis.

The chart above shows that the level of fear is still very high. People have taken about $90 billion of $20 and $100 bills out of their bank accounts to keep at home under the mattress.

 

The increase in currency holdings appears to be abating, however, as you can see in the chart above, which measures the increase over month earlier levels. Withdrawals, which had been running $10-$15 billion per month, have now decelerated to less than $5 billion in April.

These numbers bear watching. Whenever people conclude that the all-clear whistle has blown and banks are not going to fail there is going to be a flood of money being re-deposited into banks. That will make bank reserves swell even higher. It will give banks an additional $90 billion of zero cost deposits and the resulting $5-$10 billion of increased earnings, And it will be the signal for the next round of bank stock price increases.

I am heavily invested in financial stocks today for these reasons.

JR

Currency held by the public is the single best measure of people’s level of fear about the stability of the financial system. When people worry their bank might fail they withdraw cash from their bank accounts and keep it at home in coffee cans or under the mattress. About one year ago people freaked out, as you can see in the chart below, which measures the increase in currency holdings over year earlier levels. The most recent figure shows that people have taken a massive $90 billion of currency out of the bank over the past year. To put that number in perspective, a year ago the entire US banking system held only $90 billion in total reserves. Since a dollar of currency withdrawn from the bank reduces bank reserves by exactly one dollar that means people have taken 100% of the country’s reserves out of the banking system over the past year.

A closer look, however, shows that the increase in currency holdings has run its course and that people are beginning to exhale. Withdrawals peaked a few months ago and have fallen sharply since then. The most recent figure actually fell a bit from $850.1 billion to $849.6 billion for the week ending April 27.  This shows an increase in confidence–or reduction in fear–that may be a factor in the recent stock price increase. At some point, when people return to normal levels of worry, they will likely re-deposit the entire $90 billion into their bank accounts. When that happens the economy will grow again and stocks will soar.

You can keep track of these numbers at the Federal Reserve Bank of St. Louis website where they are published every Thursday afternoon.

JR

The chart below shows the amount of currency held by the public through last Friday. Can you detect a pattern? When people get scared, as they are now, they pull money out of the bank, out of money funds, and out of their brokerage accounts and stick it under the mattress.

 

 
When this happens, the initial impact is to shrink bank reserves by draining off increases in the monetary base outside the banking system. This is important because (at least until 2 weeks ago)the monetary base was growing quite slowly. During the period 9/27/07 to 8/27/08 the monetary base increased at a 2.6% annual rate, while bank reserves increased by just 0.9%. Both are too low to allow banks to provide working capital to their growing business customers, let alone to solve a credit freeze. That’s why I have been complaining about the Fed’s sterilization policy and that’s why I have been advising the administration, in a series of White House conference calls, that the rescue plan cannot succeed unless it has the proper Fed policy to support it.

Over the past 2 weeks, of course, all this has changed. The Fed has nearly doubled reserves, from $98.3B on Sept. 10 to $166.3B on Sept. 24. It is too soon to tell if this is a new policy (i.e., if they have abandoned sterilization), or if it is a one-time hail Mary pass. It would help if the Fed would clarify this in writing.

The increase in currency holdings also highlights one more thing. I think it is dereliction of duty for policy makers and political leaders to use fear as a weapon. Can you imagine Winston Churchill, or FDR, or President Reagan intentionally scaring people? In my book, a real leader helps people remain calm in difficult situations and helps them marshall their energies to fix whatever issues need to be addressed. At least since 9/11, we have used fear as a tactic for mobilizing public support for various policies and for manipulating people’s behavior. But fear, over long periods of time, is physically and psychologically debilitating. And fear tactics undermine the public’s willingness to respond when there is a genuine problem. I can’t help wondering how much of today’s fear is a reaction to that history.
JR