Large Bank Reserves As A Market Factor

Posted by barkand on November 7, 2010 under Cash | Be the First to Comment

The Federal Reserve made their official announcement last week to pump $600 billion into the U.S. banking system over the next half a year or so. Although the plan, affectionately known as “QE2″, was widely anticipated, the stock market nevertheless ran to 2-year highs within days of the announcement.

All that money has to go somewhere. In theory, banks would loan it to businesses and consumers to make and buy things. And in theory there is no difference between theory and reality. But in reality there is. So what happens when banks are sitting on a huge pile of cash? I dug up this New York Times article from 1904, which describes a similar situation back in the day. A sample size of n=1 is not usually very helpful. But it is an interesting example of history repeating itself (or does it rhyme?).

Interestingly, the article points out that excess bank reserves were initially thought to be a positive for the stock market, but more and more people were beginning to focus on the negative aspects. It was a symptom of a weak economy. The NYT article characterized trading as a “cessation of business”.  And you can see it on my chart below. The bulls and bears slugged it out for several months before the market finally sprung in July of 1904. By March of 1905, a year after the article was published, the DJIA was 57% higher.