The following video is brought to you courtesy of the Epic Economist YouTube Channel. Click the video below to watch it now.
A remarkable and yet concerning development in the banking sector is signaling the financial system is in big trouble. Severe imbalances between the volume of loans and deposits in all four of the U.S. biggest banks are indicating that the overflow of liquidity issued and pumped into the system by the Federal Reserve over the past 12 months is triggering operational problems for banks and setting the economy up for failure. The loan-to-deposit ratio is a measure of how much money printed by the central bank enters the bank system and how much money is created by private entities, the first being responsible for bad inflation – higher prices for assets and goods, lower growth – and the second by good inflation – boosting economic growth with real money.
The largest US bank, JPMorgan, just released its latest earnings report in which it exposed that in the second quarter its total deposits went up by a staggering 23% year-over-year, to $2.3 trillion. On the other hand, the total amount of loans issued by the bank remained flat, at $1.04 trillion. This means that more printed money is making into the financial system than real money is getting out and going into circulation across the economy. Moreover, the report highlighted that this is the second time in history that in the first quarter, JPMorgan recorded 100% more deposits than loans. In other words, the ratio of loans to deposits is now 50%. The last time such sharp imbalances between the volume of loans and deposits occurred was just before the Lehman crisis, so this is a very alarming situation financial analysts have been closely watching.
However, for Bank of America, this epic divergence is even worse: Deposits hit a new all-time high of $1.91 trillion, despite the fact that the bank’s loans have continuously shrunk at a very alarming, deleveraging pace and are sitting now at $927 billion, roughly $100 billion below their level just before the Lehman crisis. That is to say, Bank of America recorded zero loan growth for the past 12 years, while the bank’s deposits have doubled. The same has happened to Citigroup and even Wells Fargo. Simply put, for the past 12 years, only unbacked money was put into circulation.
There are two major implications resultant from the collapsing loan-to-deposit ratio. The first is that this ratio is a closely watched metric that measures how much lending a bank is doing when compared to its capacity to lend. The second is actually the most fundamental question in modern fractional reserve banking: “what comes first, loans or deposits”? Put it another way, do private, commercial banks create the money in circulation by first lending it out, or is the central bank the only one responsible for money creation? Deposits are coming first because the money supply has exponentially grown in the past year, and everyone knew that eventually, this money would flood financial markets while also pushing the price of assets, goods, and services to sky-highs. For evidence, just note the recent explosion in consumer prices that readjusted inflation expectations to the highest in 13 years. In essence, the recent loan and deposit data mean that the conventional process of deposit creation via loans is terminally broken.
In sum, banks won’t have another alternative rather than issuing a massive amount of loans to offset the massive amount of liquidity injected by the Fed into the financial system. Most importantly, once banks release this huge lending effort the inflation provoked by the Fed’s policies will show its worse effects. Another critical reason why this data is so relevant is that the continued loan destruction is a sign of looming deflation, meaning that prices will stay up while growth will remain flat, so the inflation fueled by the Fed won’t serve its purpose of actually stimulating the economy. But even though everyone has been warning the Fed about the flaws of the current policies, it is very likely that once a deflationary period starts to occur, the government will launch another major reflationary mega stimulus, which will also fail to stimulate benign inflation and keep fueling asset and price bubbles across the financial markets and the economy for another 3 to 6 months, in case they haven’t already burst.
Needless to say, this helicopter money will and once again fail to create benign economic inflation, and every additional liquidity injection will only push us one step closer to uncontrolled asset price hyperinflation as soon as those trillions in newly created printed dollars start flowing right back into the financial market again. We’re on the verge of a new era of painful price hikes and a stagnant economy, and we will be incredibly lucky if a catastrophic financial crisis doesn’t burst in that process.