US Gov. is a $12.2B/mon drain on liquidity

March 06, 2013, 10:09 am ET, BY Thomas H. Kee Jr- Editor, Stock Traders Daily| Editor: Thomas H. Kee Jr. (Follow on LinkedIn)

There are major risks in our economy, no one seems to care about them, but they are real, and they will surface soon.  One of the risks is based on Liquidity, and this might actually be the biggest one of them all.  The notion on the street is that the system is being flooded with Liquidity, so why wouldn’t the market continue to increase.  Without a doubt, this has been exactly true for the past few years, every since the credit crisis began, but officially, as of January 1, 2013, that changed.  In addition, after the Sequester, it has even gotten much worse.  This is primarily due to the Fiscal Policy.

On one side of the ledger we have the FOMC and US Treasury.  I am categorizing them like this because they influence the liquidity in the financial system within our economy.  We all know that the FOMC is printing $85 Billion of new money every month, and yes that is stimulative, but it is also offset by the operations of the Treasury.  Every month the US Treasury both redeems old bonds, and then issues new bonds.  The twist is in the difference between the redemptions and the new issuance.

Before I continue, when the Treasury redeems bonds it is adding liquidity to the system, and when it issues new bonds it is draining liquidity from the system, so, in our real world example, we can use that to determine the Treasury’s influence over liquidity.  I have detailed documentation on my website, but the conclusions will satisfy most readers here.  We all know that the US debt has ballooned, there is no end in sight, and that can be seen directly in the operations of the US Treasury.  The US Treasury issues far more new bonds every month than it redeems, and when it does this it drains liquidity from the financial system.  The net influence of the combined efforts of the FOMC and Treasury on the liquidity in the Financial system is stimulative, but not at an $85 Billion monthly rate.  Instead, the net stimulus from this side of the ledger is only about $11.2 Billion. 

We will address the other side of the ledger of course, but do not be alarmed by this number.  During QE2 the actual stimulus was far less than the $100 Billion face value too, so this is not a surprise to most people who have been doing the math.  What is a surprise is that the other side of the ledger, the Fiscal Policy side, is completely offsetting the stimulus mentioned above.

With tightening Fiscal Policy liquidity is being drained out of the economy at a rate much faster that what is being infused into the Financial system.  Starting with the January 1 tax hikes, about $16.4 Billion was essentially being drained from the hands of consumers every month.  In addition, after the Sequester, we know that an additional $7 Billion average monthly drain will soon be realized.  Therefore, while one side is realizing added liquidity, the other side is realizing a drain.  To be more exact, the drain from the Fiscal Policy side of the ledger is about $23.4 Billion.

Therefore, if you add it all up, we have $11.2 Billion in Stimulus, and $23.4 Billion as a drain on liquidity, for a net monthly drain of about $12.2 Billion.  This is the first time we have had a net drain since the credit crisis began, but no one sees it yet because the drain has not yet showed up in the data.  It will, in fact we should see the first glimpse of that when we get the Q1 2013 initial GDP readings, but right now no one cares.  The Financial system is seeing added liquidity, the data does not show the drain yet, so the market is in an odd place, they just want to push it higher, and they do not have reason to be concerned yet.  Most people are not seeing this warning, but it is real.

We are now officially in an equity asset bubble.

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