Financial System Liquidity & Monetary Policy

QE 2 ended 6/30/11. It did increase liquidity substantially and there was a booster shot from the
Fed's temporary $100 bil. currency swap deal late in 2011. Through Jan. 2012, my broad
measure of financial system liquidity or funding was up 5.6%, close to the 6% level adequate
to fund a moderate economic expansion. Here in Aug., the yr/yr change in the same measure is
only +2.4% and trending downward.

With real estate lending, the major interest earning asset category for banks, flat as a pancake,
the bankning system remains flush with balance sheet liquidity and has been able to finance
private sector credit demand with marginal incremental funding. The US is over three years into
economic recovery and banks still remain significant net buyers of Treasuries!

Because I focus on the banking system and its funding operations, I do not count money market
funds in my financial system liquidity measure. If I did, then the yr/yr % change in total liquidity
would come in well below the 2.4% mentioned above.

The key liquidity category helping the economy stay afloat has been the more narrow measure
of monetary liquidity or cash and checkables. At year end 2011, the yr/yr growth of this
indicator was a powerful 20%. Now, with no new QE by the Fed, the yr/yr growth is down to
9.5% and could fall to 5% by year's end 2012.

Ninety years of monetary and credit data suggest the US has entered a stern trial of whether
there will be adequate funding to support continued economic expansion. I say this because
the recoveries of private sector credit demand and bank funding capacity have been too slow
so far and without a sharper pick up ahead the economy may well be prone to fail if the Fed
continues to stand idly by.