On the Myth of Exploding U.S. Money Supply

[Jordan]

@Everyone - Unless the banks are using their reserve money to buy Treasuries (they aren't) then the inflation is happening only at the bank reserve level, where it has been contained for more than a year despite calls for hyperinflation.

As I said above, interest on reserves keeps this money out of circulation, and there is always the role of reserve requirements in hampering any future inflation.

@Hugo, what don't you get about the difference between bank reserves and M2? Further, why don't you use your brain and compare the amount of loans to the change in excess reserves to the change in M2 money supply and realize that there has been no inflationary increase?

Also, why not also consider that the assumption that this money will eventually flow outside the bank reserve level is met equally with the understanding that the Fed controls both the interest payments on excess reserves and has in its arsenal also the ability to increase reserve requirements.

@cubical - Yeah, I realize that. Notice that I said that banks would have to withdraw these excesses as currency and buy gold. And yes, obviously that money does not disappear. However, it would 1) significantly decrease the effect of the money multiplier you people freak out about on a near daily basis and 2) not be in a bank's interest as reserves are earning a risk-free yield and 3) reserve ratios can be deployed as a method for curbing inflationary pressure.

 

[cubical]

Why can't dollars that a bank uses to buy whatever end up back as reserves at the fed?

the risk free .25%? that isn't increasing the money supply much. Are you saying keeping money there is inflationary now?

Yeah, the fed can do things like raise reserve requirements, but that's not what we were discussing. You were arguing that the money supply is only increasing via loans(or at least the seeking alpha guy was).

 

[Jordan]

Why can't dollars that a bank uses to buy whatever end up back as reserves at the fed?

the risk free .25%? that isn't increasing the money supply much. Are you saying keeping money there is inflationary now?

Yeah, the fed can do things like raise reserve requirements, but that's not what we were discussing. You were arguing that the money supply is only increasing via loans(or at least the seeking alpha guy was).

1) They can, but are they? No.

2) Actually, I'm not going to keep answering stupid rhetorical questions. Unless there is inflation at the money supply level that you and I and everyone else can spend then there isn't any inflation at the present time.

That was the position of the SeekingAlpha guy, and I'm sure it wasn't that he was making that sole argument, instead he was making basic logical assumptions. Of course, in making assumptions you tend to get people who want to challenge the basic logical flow of an argument instead of the argument itself. In a broad sense, he argued quite simply that despite a vast increase in reserve level money supply, there is no change in the money supply statistics that are important.

It's a shame that we're not discussing reserve ratio requirements, which are just as much a logical step as is impending hyperinflation, if not substantially more logical. However, as we've seen in the past 40 posts, it's quite clear that the only assumption to be made is inflation, and changes in reserve ratios are not also an adequate assumption. A slight uptick in reserve ratios could sequester more cash than has been "printed" and return the potential money multiplier maximum to a number lower than before the QE. Oh, and such action would also allow the Treasury to borrow massive amounts of money at effectively zero percent, since most of the Fed's profits are turned back to the Treasury each year.

I hope people realize that just because there is a massive amount of money at M0, that this money does not immediately scale by a multiple of ten. In fact, take a look at excess reserves over time: http://research.stlouisfed.org/fred2/series/EXCRESNS Just by looking at that we could declare that the money supply grows fastest not when there are lots of excess reserves, but when there are very few. Obviously that's not logical, but it is the inverse of the inflationist argument that the M0 expansion allows for a total expansion of 10X the QE amount, when even before QE there was plenty of room for M2 growth. Reserve ratios, again, reduce potential growth in M2 without causing any shocks to the system, as there are already ample excess reserves at a 10% reserve requirement.

 

[Mogambo Guru]

What would interest rates be without QE? I have to believe they would be higher?

Also, why is the RMB appreciated about 20% against the $$ the last 5 years if their money supply is exploding compared to ours?

 

[cubical]

1) They can, but are they? No.

2) Actually, I'm not going to keep answering stupid rhetorical questions. Unless there is inflation at the money supply level that you and I and everyone else can spend then there isn't any inflation at the present time.

That was the position of the SeekingAlpha guy, and I'm sure it wasn't that he was making that sole argument, instead he was making basic logical assumptions. Of course, in making assumptions you tend to get people who want to challenge the basic logical flow of an argument instead of the argument itself. In a broad sense, he argued quite simply that despite a vast increase in reserve level money supply, there is no change in the money supply statistics that are important.

It's a shame that we're not discussing reserve ratio requirements, which are just as much a logical step as is impending hyperinflation, if not substantially more logical. However, as we've seen in the past 40 posts, it's quite clear that the only assumption to be made is inflation, and changes in reserve ratios are not also an adequate assumption. A slight uptick in reserve ratios could sequester more cash than has been "printed" and return the potential money multiplier maximum to a number lower than before the QE. Oh, and such action would also allow the Treasury to borrow massive amounts of money at effectively zero percent, since most of the Fed's profits are turned back to the Treasury each year.

I hope people realize that just because there is a massive amount of money at M0, that this money does not immediately scale by a multiple of ten. In fact, take a look at excess reserves over time: http://research.stlouisfed.org/fred2/series/EXCRESNS Just by looking at that we could declare that the money supply grows fastest not when there are lots of excess reserves, but when there are very few. Obviously that's not logical, but it is the inverse of the inflationist argument that the M0 expansion allows for a total expansion of 10X the QE amount, when even before QE there was plenty of room for M2 growth. Reserve ratios, again, reduce potential growth in M2 without causing any shocks to the system, as there are already ample excess reserves at a 10% reserve requirement.

1. How do you know

2. There is, but the real point is that there is much more to come.

3. What % is held at the fed now? This is a real question, because I don't know. It is far more than 10%.

You are also looking at inflation in a vacuum. What about the trillions(in dollars and treasuries) held in reserves around the world. If anything is done to tighten money supply the government would surely default causing people to get out of the dollar pronto. Not to mention the fact that we have been running deficits in the tens of billions for years and years. That means there is a lot of dollars out there that are ready to be used. So that will go into commodities(as long as they are priced in dollars) and into our goods, which is a lot, but not compared to the dollars outstanding.

 

[japes]

1) They can, but are they? No.

2) Actually, I'm not going to keep answering stupid rhetorical questions. Unless there is inflation at the money supply level that you and I and everyone else can spend then there isn't any inflation at the present time.

As long as you're sure there is no lag in the M0/M2 numbers then I guess you're right, there is no inflation. Assuming for the sake of argument the numbers are up to the minute accurate, isn't this a total QE failure by the Fed? Doesn't the Fed want this money in the system so we can use it? I know they don't want hyperinflation but they do want modest inflation. It seems to me, as gonefishin has said before more eloquently, there is a lot of water building up behind the dam and the Fed continues to build up the pressure. I think it's healthy to be concerned whether or not the Fed can keep the dam from breaking and causing out of control destruction.

 

[jclay2]

As long as you're sure there is no lag in the M0/M2 numbers then I guess you're right, there is no inflation. Assuming for the sake of argument the numbers are up to the minute accurate, isn't this a total QE failure by the Fed? Doesn't the Fed want this money in the system so we can use it? I know they don't want hyperinflation but they do want modest inflation. It seems to me, as gonefishin has said before more eloquently, there is a lot of water building up behind the dam and the Fed continues to build up the pressure. I think it's healthy to be concerned whether or not the Fed can keep the dam from breaking and causing out of control destruction.

Very well put. Although inflation is now at a fairly high rate (9% according to shadowstats), the real concern is the permanent increase in M0 baked in by QE. As of the most latest data M0 is up 200% since the start of the crisis. With the Fed needing to cover at least half of the budget deficit yearly, expect the M0 to be up at a minimum 400% from the start of the crisis 2 years from now. That is a mighty big dam. Should it ever break or just weaken confidence over seas expect huge inflation.

 

[heavenlyboy34]

In The Know: Should The Government Stop Dumping Money Into A Giant Hole?
http://www.theonion.com/video/in-the-know-should-the-government-stop-dumping-mon,14289/

LMAO!!! That's a classic!^^^

 

[teacherone]

ok...

explain to me how in the middle of this great recession, with official unemployment numbers at ~9% (read ~19%) and millions of homeowners with underwater mortgages, and nearly everyone in massive debt, that we can have such price inflation in nearly every commodity?

we should be experiencing HUGE deflation right now -- demand SHOULD have dropped tremendously.

it hasn't, we aren't.

why?

 

[hugolp]

@Everyone - Unless the banks are using their reserve money to buy Treasuries (they aren't)

@Hugo, what don't you get about the difference between bank reserves and M2?

Ok. Enlighthen me. Where is the money the banks are using to buy Treasuries coming from?

Further, why don't you use your brain and compare the amount of loans to the change in excess reserves to the change in M2 money supply and realize that there has been no inflationary increase?

Again, enlighthen me and tell me exactly this thing I am not seeing.

Also, why not also consider that the assumption that this money will eventually flow outside the bank reserve level is met equally with the understanding that the Fed controls both the interest payments on excess reserves

Which do not remove any liquidity from the banking system, on the contrary it just adds more (interst payments). It can only dealy the money from being loaned.

and has in its arsenal also the ability to increase reserve requirements.

You would have to see how all the banks cope with this. There are already banks going broke in record numbers because they can not cope with the present reserve requirements. What do you think it will happen if they go up? Also, it would send interest rates way up.

 

[jclay2]

ok...

explain to me how in the middle of this great recession, with official unemployment numbers at ~9% (read ~19%) and millions of homeowners with underwater mortgages, and nearly everyone in massive debt, that we can have such price inflation in nearly every commodity?

we should be experiencing HUGE deflation right now -- demand SHOULD have dropped tremendously.

it hasn't, we aren't.

why?

Because RPF members as well as the rest of the world are the biggest suckers who are going to get killed in the commodity BUBBLE./endsarcasm

Hey Jordon, if you are so confident in your inflation call, why don't you short silver/gold/oil/grains/base metals/etc. Surely, you could make a killing?

 

[Jordan]

1. How do you know

2. There is, but the real point is that there is much more to come.

3. What % is held at the fed now? This is a real question, because I don't know. It is far more than 10%.

You are also looking at inflation in a vacuum. What about the trillions(in dollars and treasuries) held in reserves around the world. If anything is done to tighten money supply the government would surely default causing people to get out of the dollar pronto. Not to mention the fact that we have been running deficits in the tens of billions for years and years. That means there is a lot of dollars out there that are ready to be used. So that will go into commodities(as long as they are priced in dollars) and into our goods, which is a lot, but not compared to the dollars outstanding.

1. Because I can read the charts of the changes in money supply, and excess bank reserves and compare them to the asset purchases of the Federal Reserve. Something few people here seem capable of doing.

2. There hasn't been any inflation in the M2 numbers. Again, that's what this whole discussion is about.

3. Take M2 + M0 and divide it by M0.

I don't understand any of the flow in that paragraph. I'm sure it made sense in your head, but I could read that a million times and fail to see how the four or five subjects you touched on are related.

As long as you're sure there is no lag in the M0/M2 numbers then I guess you're right, there is no inflation. Assuming for the sake of argument the numbers are up to the minute accurate, isn't this a total QE failure by the Fed? Doesn't the Fed want this money in the system so we can use it? I know they don't want hyperinflation but they do want modest inflation. It seems to me, as gonefishin has said before more eloquently, there is a lot of water building up behind the dam and the Fed continues to build up the pressure. I think it's healthy to be concerned whether or not the Fed can keep the dam from breaking and causing out of control destruction.

Why would there be lag in the Fed's M2 numbers? Price inflation tends to lag changes in money supply, if that's what you mean. But there has been no real increase in money supply, therefore there is nothing that the inflation numbers can lag.

You tell me, is it a failure?

ok...

explain to me how in the middle of this great recession, with official unemployment numbers at ~9% (read ~19%) and millions of homeowners with underwater mortgages, and nearly everyone in massive debt, that we can have such price inflation in nearly every commodity?

we should be experiencing HUGE deflation right now -- demand SHOULD have dropped tremendously.

it hasn't, we aren't.

why?

Why don't you go back and read what I wrote earlier?

I said that the Fed can, by purchasing indirectly treasuries from primary dealers, reduce the current rate of interest without affecting greatly the total supply of money. Post-QE2, rates are lower, and M2 supplies are unchanged. And as I mentioned earlier, a reduction in interest rates certainly creates a massive change in the amount of demand for negative carry investments, particularly commodities as covered calls allow for income generation over and beyond the cost of borrowing.

I don't know why you can't understand that.

Also, it is important to realize that there are several other things that drive most commodities (energy and food). These are the current worldwide shortage in food supplies and concern over the future of oil supplies.

Ok. Enlighthen me. Where is the money the banks are using to buy Treasuries coming from?

Again, enlighthen me and tell me exactly this thing I am not seeing.

Which do not remove any liquidity from the banking system, on the contrary it just adds more (interst payments). It can only dealy the money from being loaned.

You would have to see how all the banks cope with this. There are already banks going broke in record numbers because they can not cope with the present reserve requirements. What do you think it will happen if they go up? Also, it would send interest rates way up.

I don't know, why don't you bother to find some connection between currency orders by banks from the Fed and Fed treasury purchases? Even gonegolfin, who supports your position, admits that banks are not taking delivery of currency for excess reserves. Someone should email him, I feel like a generally more informed discussion might ensue.

Given that the central bank has control over reserve ratios, that's of little concern to me. And clearly of little concern to the Fed.

And that's a new one on me. Care to show me where American banks are faltering over the reserve ratios? That's a pretty incredible claim given that 1) you're concerned about an oversupply of reserves and 2) the rate for lending bank reserves is something like...oh, I don't know... half a percent? I'm sure half a percent in positive interest would absolutely murder already overcapitalized banks.

Because RPF members as well as the rest of the world are the biggest suckers who are going to get killed in the commodity BUBBLE./endsarcasm

Hey Jordon, if you are so confident in your inflation call, why don't you short silver/gold/oil/grains/base metals/etc. Surely, you could make a killing?

You keep spelling my name wrong. Try harder.

Silver/gold/oil/grains/base metals aren't rising on inflation, they're rising on what is essentially zero interest rate policy, which has come about as a result of a net increase in M0 but not M2 money supply. When the cost of borrowing goes so low, it makes sense to arbitrage the difference in borrowing costs and the risk premium in writing options...just amazing how the market responds to changes. I think oil is actually one of the best investments out there in, and I'm plenty happy to have plenty of exposure to it. But I do so because I know oil benefits not only from negative real rates, but also from growth in the economy. The others aren't nearly as interesting to me, though you may be happy to go explore my very positive words for other metals like palladium, which have exposure to automotive growth as well as negative real interest rates.

It's not that I see commodities as such a poor play, I just see better opportunities in commodities that aren't almost entirely driven by speculation. When I buy something, I see it as an entry into a myriad of other industries, businesses, and economic institutions, not as the investment itself.

Secondly, I know the markets can stay irrational longer than I can stay solvent. I'd want to limit downside, given that bubbles can rise to astronomical heights, and I don't like the amount of volatility that is priced into the market. Therefore, I stay out. Better opportunities exist elsewhere. Just like they did last summer, you know, when you said "no go" to buying BP at bottom. Bummer.

 

[cubical]

1. Because I can read the charts of the changes in money supply, and excess bank reserves and compare them to the asset purchases of the Federal Reserve. Something few people here seem capable of doing.

2. There hasn't been any inflation in the M2 numbers. Again, that's what this whole discussion is about.

3. Take M2 + M0 and divide it by M0.

I don't understand any of the flow in that paragraph. I'm sure it made sense in your head, but I could read that a million times and fail to see how the four or five subjects you touched on are related.

1. The US banks are not the only holders of US dollars.

2. Wrong, there has been. It's getting to the point where people think things are going to explode. Heck it's making new high in the worst recession in the last 50 years.

btw, from zerohedge

as for my gibberish, I was referring more to the dollar being devalued. But that comes goes along with inflation.

 

[cubical]

3. Take M2 + M0 and divide it by M0.

I didn't think M0 took into account reserves at the fed. It does? According to wiki it does not, but I am not an economist and may be reading it wrong.

Better opportunities exist elsewhere. Just like they did last summer, you know, when you said "no go" to buying BP at bottom. Bummer.

Show me another BP right now.

 

[jclay2]

You keep spelling my name wrong. Try harder.

Silver/gold/oil/grains/base metals aren't rising on inflation, they're rising on what is essentially zero interest rate policy, which has come about as a result of a net increase in M0 but not M2 money supply. When the cost of borrowing goes so low, it makes sense to arbitrage the difference in borrowing costs and the risk premium in writing options...just amazing how the market responds to changes. I think oil is actually one of the best investments out there in, and I'm plenty happy to have plenty of exposure to it. But I do so because I know oil benefits not only from negative real rates, but also from growth in the economy. The others aren't nearly as interesting to me, though you may be happy to go explore my very positive words for other metals like palladium, which have exposure to automotive growth as well as negative real interest rates.

It's not that I see commodities as such a poor play, I just see better opportunities in commodities that aren't almost entirely driven by speculation. When I buy something, I see it as an entry into a myriad of other industries, businesses, and economic institutions, not as the investment itself.

Secondly, I know the markets can stay irrational longer than I can stay solvent. I'd want to limit downside, given that bubbles can rise to astronomical heights, and I don't like the amount of volatility that is priced into the market. Therefore, I stay out. Better opportunities exist elsewhere. Just like they did last summer, you know, when you said "no go" to buying BP at bottom. Bummer.

Why not longer dated put options. Limited risk and allows time for the markets to crash. Oh and I did congratulate you and say that you were correct on your bp call if you don't remember.

Oh and zero interest rate environment is not the reason for 30-40 percent moves in commodities. We have been in zirp since the end of 2008. Why have commodities been on a tear since the end of August? Maybe, that is when QE light was announced and expectations of QE2 were baked into the market.

 

[Jordan]

@ cubical - My apologies, I thought we were trying to find the ratio of cash to m2 to see a net change in withdraws from bank reserves.

No BPs out there right now, but ADGF is an excellent long-term, small cap value stock. My favorite, actually. Trades just over book, wickedly low PE, and it's products keep getting better. Exceptional management and a timely acquisition of the Yes! brand means the company has plenty of room for growth, especially when you consider that two brands = twice the retail space in pro shops. Brand continues to develop as well, and their products win awards, their sponsored players win tournaments. Cash = 25% of their market cap.

@ jclay2 - Long-dated still isn't good enough for time, and as I said, too much volatility is priced in. And I know you did, I brought it up only to say that some times even the best investments just don't make sense. Nothing wrong with that.

http://www.moneycafe.com/library/ratecharts/ratecharts3.gif <- That shows a lot. Right after the summer bump in rates...1-year LIBOR falls, speculation ensues. http://www.moneycafe.com/library/libor.htm

Money gets cheap, risk and yield arbitrage, then late institutional and retail money until *pop*

 

[hugolp]

I don't know, why don't you bother to find some connection between currency orders by banks from the Fed and Fed treasury purchases? Even gonegolfin, who supports your position, admits that banks are not taking delivery of currency for excess reserves. Someone should email him, I feel like a generally more informed discussion might ensue.

I dont know why there should be a direct connection between government spending and the demand for cash. The point still stands: there is a short term inflationary effect of QE2.

Btw, I have emailed gonegolfin for your peace of mind.

Given that the central bank has control over reserve ratios, that's of little concern to me. And clearly of little concern to the Fed.

And that's a new one on me. Care to show me where American banks are faltering over the reserve ratios? That's a pretty incredible claim given that 1) you're concerned about an oversupply of reserves and 2) the rate for lending bank reserves is something like...oh, I don't know... half a percent? I'm sure half a percent in positive interest would absolutely murder already overcapitalized banks.

So I guess this is not really happening: http://www.fdic.gov/bank/individual/failed/banklist.html

That some banks are over-capitalized and have excess reserves, does not mean that all of them do. The AGGREGATE result is that there are excess reserves, but that does not mean ALL banks have excess reserves.

 

[teacherone]

curious how the fed's central bank dollar swaps fit in here.

when the fed creates new dollars and swaps for other currencies that new cash is exported and obviously not counted in M2.

however it drives up prices of commodities which as we know are all priced in dollars.

 

[japes]

...You tell me, is [QE] a failure?

If the point of QE was to get money into circulation AND it's not getting into circulation (because it's stuck in bank reserves) then yes it's a complete and utter failure.

On the other hand, if the point of QE was to fill an elite group of reserve accounts with massive amounts of new money, ready to explode at a moments notice with no Fed tool left to pull it back in, then QE has been a total success story. Something for the history books and all central planners to emulate.

So I'd love to know what you think about QE Jordan. You are arguing that QE has not been inflationary (dollar inflationary) but that doesn't mean you think it's a good thing, right?

 

[Jordan]

Hugo, excess supplies of reserves in the aggregate means there are ample supplies to be lent from one bank to another. Earlier I remarked that the very low cost of borrowing these reserves means it is highly unlikely for a bank to go broke in search of excess reserves from other banks. That list is irrelevant; you claimed that reserve requirements caused bank failures...that isn't the case at all. I do not support the position that banks aren't failing; however, that doesn't mean I believe failed banks went broke because reserve requirements were too stringent.

Japes, I don't think QE1 or 2 is anything to write home about. The very simple observation is that the economy is contracting for reasons unrelated to borrowing costs--I don't think the difference between 4.5% and 5% is what is keeping entrepreneurs at bay. I think there are far more important policy considerations that need be made by Congress, not by the Fed. A permanent decrease in corporate-side FICA would be a reasonable solution, as would a repatriation holiday for foreign holdings of corporate cash.

Despite the generally negative environment, I think there are definitely some greenshoots to have come from recent policy. The explosion in angel/VC money out west is particularly encouraging because it is these young start-ups that bring excellent paying jobs, and many of which provide a good or service that increase efficiency across the board. Tech is alive and well, and though I am hesitant to say that the boom in valuations in online media aren't in bubble territory, there's a lot going on in the world of technology that gives me good vibes about the future economic outlook. Every service in 10 years will be done "in the cloud." In the past month, I've never been around so many entrepreneurs interested in growing, expanding, and furthering their businesses through the internet. Several businesses are looking to expand, though it seems that the boom is localized temporarily to business to business entities.

We'll have to see how it all plays out, but generally speaking, I would favor much more aggressive supply-side structural changes to tax policy over additional quantitative easing. However, given the appetite for Treasury debt, allowing the Treasury to virtually self-finance isn't such an awful deal either. Inflation costs once, debt costs for...well, ever. But no, I am no QE applauder, but I'm not worried about extreme levels of inflation, either. I guess I'm a moderate in a forum of extremism.