Sudden Demand For Cash

If seems a sudden demand for cash has given the markets a bit of a problem. Many want cash but there is no cash to be found. This is odd because just yesterday someone told me the markets would soar because of all the "sideline cash". I will get to the sideline cash myth in a moment but let's first consider ECB Offers Unlimited Cash as Bank Lending Costs Soar.

The European Central Bank, in an unprecedented response to a sudden demand for cash from banks roiled by the subprime mortgage collapse in the U.S., loaned 94.8 billion euros ($130 billion) to assuage a credit crunch.

The ECB said it would provide unlimited cash as the fastest increase in overnight Libor since June 2004 signaled banks are reducing the supply of money just as investors retreat because of losses from the U.S. real-estate slump. BNP Paribas SA halted withdrawals from three investment funds today because the French bank couldn't value its holdings. Stocks in the U.S. and Europe fell, a turnaround from the past three days when investors concluded that credit market risks were abating.

"There seems to be a hole in the balance sheet of World Inc. that will have to filled by government intervention," said Peter Lynch, chairman of private equity fund Prime Active Capital Plc in Dublin. "The ECB is treating this like an emergency; it might make traders even more afraid."

The ECB said today it provided the largest amount ever in a single so-called "fine-tuning" operation, exceeding the 69.3 billion euros given on Sept. 12, 2001, the day after the terror attacks on New York.

"This is an old-fashioned credit crunch," Chris Low, the chief economist at FTN Financial in New York, said in a report today. "This is not a small thing. A credit crunch, when the short-term credit markets seize up, is extraordinarily serious, almost always the precursor of a significant recession."

"Somewhere out there, there are several people that are in trouble -- it's hard to put your finger on it," said Andrew Busch, global foreign-exchange strategist at BMO Capital Markets in Chicago. "I cannot name names. We know BNP has issues with three funds. But you do not see a movement in overnight rates like that unless there is a huge concern about liquidity and funding."

Wow. There's a bigger demand for cash now than the day after 911. That's rather amazing given all the sideline cash that I'm hearing about. Where is that cash if everyone seems to need it?

The Financial Times is reporting Liquidity fears spark volatility in global markets.

Earlier in the day the European Central Bank injected €94.8bn into money markets to shore up confidence in the financial system. Intervention on that scale had not been seen since the aftermath of the terrorist attacks on New York in 2001.

The trigger to the action was a sharp rise in overnight interest rates moving them to a six-year high of 4.7 per cent, well above the ECB’s main rate of 4 per cent.

"This liquidity-providing fine-tuning operation aims to assure orderly conditions in the euro money market. The ECB intends to allot 100 per cent of the bids it receives," the central bank said.

The unprecedented level of intervention followed a statement from BNP Paribas, the French bank, earlier on Thursday that it had decided to suspend redemptions on three investment funds, with an estimated value of €2bn, because of the deterioration in the credit markets.

The French bank blamed a “complete evaporation” of liquidity for the drastic step.

There were also concerns that one of Germany’s largest banks may have also been affected. Earlier the Bundesbank was forced to deny rumours that it was holding emergency talks to discuss problems at WestLB, the German bank.

“You have to think the odds of this becoming a systemic problem have gone up and it’s an appropriate response by the market to price in a near term rate cut,” said Jim Caron, co-head of global interest rate strategy at Morgan Stanley. “The big problem is we just don’t know how bad things could get. It will take more than one trading day to work through this.”

"This liquidity-providing fine-tuning operation aims to assure orderly conditions in the euro money market. The ECB intends to allot 100 per cent of the bids it receives," the central bank said.

I find it interesting that the biggest injection of cash in ECB history is now labeled "fine tuning". Heaven help us should the need arise for "coarse tuning".

The above statement by the ECB is interesting for another reason. Let's see if I can find it. Ah yes, here it is in Counterfeiting Money - Crime or Good Economics? written February 8, 2007.

If you have not yet read that (or even if you have) you might want a review. It's all about "legal counterfeiting". But the snip I was looking for pertains to the ECB.

Weber: European Central Bank council member Axel Weber said investors shouldn't expect central banks to bail them out in the event of an "abrupt" drop in financial markets. "If you misprice risk, don't come looking to us for liquidity assistance," Weber said in an interview in Davos, Switzerland at the annual meeting of the World Economic Forum. "The longer this goes on and the more risky positions are built up over time, the more luck you need."

Trichet: Current conditions in global financial markets look potentially "unstable", suggesting that investors need to prepare themselves for a significant "repricing" of some assets, Jean-Claude Trichet, president of the European Central Bank. "We are currently seeing elements in global financial markets which are not necessarily stable," he said, pointing to the "low level of rates, spreads and risk premiums" as factors that could trigger a repricing.

Poole: "The Fed can provide liquidity support but not capital".

....

The most important facet of all of this is that monetary claims very likely exceed the pool of real funding by several orders of magnitude. When push comes to shove, this house of cards will eventually collapse in some way.

So we have the biggest "fine tuning" in history even though the ECB said "If you misprice risk, don't come looking to us for liquidity assistance".

Where the heck is the cash?

With that out of the way, where the heck is all the cash if so much of it is sitting on the sidelines?
For starters there is always "sideline cash" (well sort of but not exactly). The "sort of" is that for every stock buyer there is a seller. If there is a billion dollars on the sidelines waiting to buy stocks there will be still be a billion dollars on the sidelines after those stock purchases because for every buyer there is a seller. So the sideline cash theory is just circular logic. A better way to look at things is mutual fund cash levels. They have never been lower. And with massive hedge fund withdrawal requests there are more looking to get out than get in.

But is that really cash that's sitting on the sidelines in the first place? It looks like it but it's a mirage. (This is the "not really" side of the argument.) It is really sideline credit. And the opposite side of the credit ledger is debt. There is staggeringly little cash relative to credit. I talked about this recently in Fleckenstein (and others) State the Deflation Case.

The top is only beginning to wobble. When people tell me "there is so much money out there" I tell them that no, there is so much credit out there. This will be a muli-year process of debt reduction and deflation to correct what the Fed has wrought.

The above snip is thanks to Minyanville's Mr. Practical.

Here is a second snip from Fleckenstein (and others) State the Deflation Case. This one is from Trotsky.

[Credit vs debt is at the root of the misunderstandings of the inflation vs. deflation debates]. Because credit is used as a money substitute in the financial markets, it acts as an inflationary force in the asset markets (and this spills over into the real world as the imaginary wealth thus created leads to overconsumption and malinvestments), but it is all ephemeral - in the end, it is still credit, not money. As soon as money is needed in lieu of credit, such as has now happened in the CMO and CDO markets, it becomes clear that the money simply isn't there."

So there you have it. There is actually very little real cash out there relative to credit. The "sudden demand for cash" is in fact the world's biggest margin call to date. And in spite of saying they wouldn't fund a mispricing of risk the ECB is attempting to do just that. The Fed will too. But it won't work for the simple reason it can't work. Credit far exceeds both underlying asset values and real cash. Sideline cash is really sideline credit and in such cases problems occur when the pool of greater fools runs out and/or credit funding is cut off for those fools. Look at canceled IPOs for the score. Also look at M3 compared to base money supply to see just how out of whack things are. The implications are certainly not inflationary. All it takes to tip over the wobbling top is a change in attitude toward risk and a repricing of a significant portion of assets. Both are happening now.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/