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Mountains of cash are still on the sidelines

As a follow-up to this morning's post, here are some charts that survey the state of liquidity in the U.S. economy. It's unambiguously the case that the public is still desperate for the safety of cash and cash equivalents, and risk-aversion (e.g., a preference for bonds over stocks) is still very high. Liquidity is in abundant supply; the Fed has supplied trillions of cash to a dollar-cash-hungry market; bank loans are expanding; consumer credit is expanding; savings deposits in U.S. banks are still increasing at double-digit rates. Taxable bond funds continue to receive $5-6 billion in net inflows every week, while equity funds are still experiencing net outflows.

Banks are definitely lending again. In fact, lending has been increasing since October 2010. Commercial & Industrial Loans (i.e., bank lending to small and medium-sized businesses) are up $170 billion, and they are up at a robust 15.8% annualized pace over the past three months. Consumer Credit (second chart above) is experiencing a similar increase, up by $240 billion, for an annualized rate of increase of 9% in the three months ending January 2012.

M2 is growing above its long-term average annual rate of 6%, even though the economy is 12-13% below its long-term trend. Strong demand for money is the explanation, with a lot of that dollar demand likely coming from the Eurozone. Money demand is likely to begin to decline going forward, however, now that the Eurozone crisis is beginning to fade.

By far the biggest source of growth in M2 is savings deposits. These have increased by over $2 trillion since late 2008, and have grown at a blistering 15.7% annualized pace over the past three months. This is unusually strong growth that can only reflect great fear and caution on the part of investors everywhere, especially when one considers that savings deposits pay virtually no interest.

According to ICI, taxable bond funds in recent months (through February '12) have experienced strong net inflows, while domestic equity funds have experienced net outflows. No sign here of any unusual enthusiasm for stocks on the part of investors. Indeed, the strong preference for bond funds reflects unusual caution.

This all adds up to a pretty clear picture of a market that continues to be dominated by caution and a strong preference for cash, cash equivalents, and relatively "safe" assets such as bonds. Should the strong performance of equities, the continued signs of economic growth, and the recent sharp selloff in Treasuries manage to change investors' preferences, the consequences could be difficult to imagine given how much cash is parked on the sidelines.

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