OK, it is time to put an end to this silliness.
This has evolved into a bit of silliness, relative to what was a good initial post by Toro (I have been away and missed all of this). In context, this would probably be a good time for folks (that are interested in this topic), to re-read my December and January articles. I have a few comments here and will comment on some other posts later. But let me set the record that I also do not believe we are headed for hyper-inflation, but are headed for some painful inflation. The folks that typically scream about hyper-inflation are those that are numbed by the "printing money" headlines they see, but have a misunderstanding of what it actually means. Terral is a perfect example. BTW Terral, I am not a supporter of the Federal Reserve ... I am against it.
http://www.usmessageboard.com/economy/66033-interpreting-fed-policy.html (December)
http://www.usmessageboard.com/econo...y-supply-money-velocity-and-monetization.html (January)
This is a graph of the monetary base. The monetary base is also known as "high-powered money." It is the total amount of currency in circulation, bank reserves and central bank reserves.
The monetary base consists of currency in circulation (M0) plus bank reserves (reserve balances plus bank vault cash). You were probably thinking of central bank reserves as reserves on deposit with the Fed. But these are simply bank reserves, not central bank reserves.
These are the non-borrowed reserves of the banks, that is not borrowed from the Fed and other banks.
And this number was highly negative until the Fed began injecting unsterilized reserves into the banking system (last September).
But first, let us look at what has actually happened to the money supply. With the massive increase in reserves, has there been a corresponding increase in money?
Certainly not ... and this is what I continue to argue in my writings.
M3 is the broadest definition of money. M3 is M2 plus large time deposits, institutional money market funds, large long-term repurchase agreements and large Eurodollar deposits. Unfortunately, the Fed stopped publishing this data a few years back. The conspiracy theorists say they did this to hide the inflation in the system. The conspiracy theorists may be right.
It makes for good fodder. But I do not think that M3 is a good measure of broad money. I think others came to the same conclusion.
"But the actions of the Fed are planting the seeds of future hyperinflation" is what they will say. Yes, that is true, all else being equal. But things are not equal, and this is why.
First, what is known as "monetary velocity" or the money multiplier has collapsed.
Though related, I believe that these are two separate things. The money multiplier is simply money supply (choose your aggregate) divided by monetary base. This gives you an indication of whether or not base money is moving into the money supply aggregates, not the velocity of money itself (although as I said, they are related). Meanwhile, money velocity is measured by GDP divided by money supply (P = M * V), ... where P is Gross Domestic Product. As you stated, it measures the frequency with which a given unit of money is spent, measured in a specified period of time.
Monetary velocity measures the rate at which money circulates in the economy. Think about an extreme example. Let's say the money multiplier fell to zero. That would mean that all transactions stopped.
When the money multiplier declines, it could mean that the Fed is flooding the system with reserves. In this case, money supply could be increasing and the money multiplier would still be falling. I think that the money multiplier is more of a measure of how the additional reserves (in our present scenario) are or are/not translating into the money supply aggregates.
So why is it falling? Remember those graphs of the banking reserves above? It is because banks are hoarding money. And why are banks hoarding money? Because they believe there are more losses to come and they will need the reserves to cover the losses.
Precisely. I think specifically, they (banks) are aware of the commercial real estate shoe that is about to drop. They know full well the quality of these loans and securities (and others) they have on their balance sheets. This is one reason why I have been shorting commercial real estate.
But there are a couple of other supporting reasons. #1 The Fed continues to pay interest (albeit a small amount) on excess reserves. This helps encourage these reserves to stay on deposit with the Fed. #2 The spread between the treasuries (that the banks are willing to invest in) and the interest paid on excess reserves is quite small. Thus, the banks have less incentive to invest their excess reserves into treasuries (which like lending, would increase deposit money and thus M1).
So all those reserves are being held to pay future costs. This isn't inflationary because that money will disappear. In fact, the $1 trillion in estimated losses approximates the expansion of the Fed's balance sheet.
The reserves will not disappear unless the Fed drains them from the banking system (or currency was withdrawn by depositors). The banks using these reserves to offset losses does not change the amount of reserves in the banking system. But it does mean that the banks will be constrained in investing (Ex. treasury purchases) and making new loans ... which are both operations that increase the money supply aggregates.
As an aside, I should say that some of the Fed reserve creation has had the direct effect of creating new deposit money (adding to money supply). Whether or not reserve creation results in simply an increase in reserves (and base money) or an increase in reserves and deposit money (and thus money supply) depends on the nature of the transaction and the counter-party involved. Much of the reserve creation thus far has been directly with domestic banks (and for their own accounts). Thus, no increase in money supply. Some of the operations have also been with primary dealers that are commercial banks (selling from their own account). Again, no increase in deposit money. However, if the primary dealer is simply a broker-dealer (not a bank) or the bank is foreign, deposit money is increased. Additionally, if the counter-party is a non-bank (Ex. a pension fund) ... even when the transaction is settled through a bank, deposit money is created (along with a credit by the Fed to reserves held at the Fed by the member bank).
Is inflation coming? Probably. There will be no inflation if the government starts withdrawing liquidity, i.e. reserves, from the financial system. Historically, however, there has usually been a lag between when monetary policy should and does work. Thus, it is likely that the Fed will wait too long to start tightening the money supply, which would lead to inflation down the road.
I should mention another item here that I do not see folks in the financial community discussing (I touched on it in the December article), which is another avenue for inflation. The composition of the Fed balance sheet is declining in terms of quality. I think that this may ultimately be the more serious problem, as opposed to the sheer size. If the Fed were to drain reserves by selling some of these non short term treasury assets, the price that these assets would fetch would not be enough to drain the amount of reserves initially created when it purchased them. IOW, simply the Fed saying that it will drain reserves (and then execute ... even with perfect timing) is not enough (with the prices of their assets falling). This will become a serious problem as MBSs, longer term treasuries, and other assets held by the Fed decline in value (especially as interest rates rise, which they will).
I think there is a decent chance (as I wrote back in December) that the Fed will eventually issue its own interest bearing debt ... essentially refinancing the liability side of its balance sheet. But this would require congressional approval and a change to the Federal Reserve Act. It would also create a number of interesting new problems. An alternative would be the Fed dumping all of its losses on the Treasury.
BTW, I certainly agree on the Fed lag. Their timing is never on.
Brian
