First, I discovered that in this information-saturated age, I need no longer buy Barron’s every Friday to obtain my data. The Fed itself would give me all the data I could ever want. Just go to www.research.stlouisfed.org and you will see the chart below.
The second surprise was that after nearly 50 years, suddenly in 2008 an aberration occurred. With hindsight, it seems obvious that the crisis of that year stressed the banking system, and we can see a blip as net borrowed reserves break away from the norm and hit $500 billion (negative!).
And then, well, the whole system disconnects. Free reserves skyrocket to more than $1.5 trillion. What does this tell us? On the most simplistic level, it tells us that the stock market will be in a bull phase for a long time. Perhaps that’s all we need to know.
Did you know that in 2007 the Fed changed its policy and allowed eligible institutions to borrow at the discount window for 30 days rather than just overnight? Then a few months later desperate financial organizations were allowed to borrow for 90 days! The discount rate dropped from more than 6% to half a percent. Free money! And yet that was not enough, because there was no confidence. Banks wouldn’t lend to other banks. The system froze.
In response, the Fed started to print money and make any amount available. So from deep borrowed reserves, free reserves soar into the sky.
Under the old rules, most probably the banks would have had a field day lapping up all that available credit -- not just overnight, but for 90 days. Nice!
Ah, but then enters the government prompted by President Obama. The Dodd-Frank Consumer Protection Act was passed by Congress. More rules and regulations and, most interestingly, a restriction on the Fed discount window. Though lawmakers are now seeking to repeal the clause, one provision of Dodd-Frank limits access to the discount window for banks that use derivatives.
So no more 90-day money -- just back to the way it was before 2007. That is, funds once again were available to a limited number of qualified banks overnight only. Adding and subtracting all these factors makes it easy to understand why free reserves have arrived at 1.5 trillion. We no longer have the same system that we had from 1960 until 2006.
The existing enormous level of free reserves will ultimately find its way into the general economy and guarantee a bull market for two to three years, at a minimum. Coupled with this, the US, or perhaps I should say North America, will shift from an importer of crude oil to an exporter. We may well see the balance of payments going positive!
On March 6, 2013, the headline in the International Herald Tribune read, “Dow Jones hits a record high in amazing bull market – since the low point in 2009 some shares have doubled, thanks in part to the Fed.” Will the Dow index double again in the next four years? Will the press be waiting for the index to break through the 30,000 level? Free reserves are telling us the answer. The answer is it will. To 30,000 and beyond. The ride has only just begun.