Quantitative Easing: Money Supply Is Actually Decreasing 31 comments
- Brian Kelly's articles on Seeking Alpha
- Visit: Perception is Reality
- Visit: Subscribe to Newsletter
- See me at The Money Show, May 11-14
an article to
-
Font Size:
-
Print
- TweetThis
The Federal Reserve has officially embarked upon quantitative easing and inflation hawks are concerned this increase in the money supply will lead to hyper-inflation. The financial world has changed since the days when Friedman and Schwartz analyzed the missteps of the Great Depression. The definition of money has changed as well.
Credit is money and thus can be considered money supply. The securitization market allowed both corporations and individuals to monetize assets. Credit card companies increased cash by tapping the asset backed securities markets, car companies sold cars and received cash by issuing securities backed by auto loans, and individuals used their homes as ATMs through the alchemy of the home equity line of credit. In the middle of this game of musical chairs were, and still are, the financial institutions, both bank and non-bank entities (shadow banks).
US “Aggregate” Money Supply - Issuance of Unconventional Money
(Billion $USD)
Click to enlarge:
Source: CMSA, Asset Backed Alert, SIFMA, Federal Reserve
The “aggregate” money supply includes all instruments that enable monetization. This open definition admittedly leaves room for multiple interpretations. It could be argued that credit default swaps and even equity IPOs are forms of monetization. However, using the issuance of the “big three” (CMBS, ABS, and RMBS) as a proxy for the “shadow” banking system, can provide a simple and crude estimate of the “aggregate” money supply.
When the non-conventional sources of “money” are included, the money supply is actually decreasing, not increasing. Including other instruments like CDS and equity would result in an even steeper decline in money supply. From the peak in 2007, the aggregate money supply has declined $1.9 trillion dollars or 18.5%. As measured by M2, money supply fell by 33% during the Depression. Once again, broadening the definition of money would easily result in a contraction in money supply of at least 33%.
As of March 11, 2009, the Federal Reserve’s balance sheet had increased by $1.02 trillion. To restore the aggregate money supply to 2007 levels the Fed needed to increase its balance sheet by another $880 billion. That is, current aggregate money supply ($8,486b) less 2007 aggregate money supply ($10,408b).
The FOMC announced on March 18, 2009 that it would increase its balance sheet by $1.15 trillion; approximately $270 billion more than is required. Recall that the “aggregate” money supply is a crude estimate and assumes that only CMBS, RMBS, and ABS are considered money. This simple assumption likely underestimates the real “aggregate” money supply.
Nonetheless, the increase in the Fed’s balance sheet is exactly what was needed to combat a deflationary spiral like the one that occurred during the Great Depression. Indeed, it was Milton Friedman himself, who declared the Fed did not increase money supply during the Depression and thus exacerbated the impact of the downturn.
Monetarists Rejoice!
Disclosure: none
Related Articles
|
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largestSee all
increase in followers
in the last 7 days
Fastest Climbers » -
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most active
Instabloggers.-
1
David Fry
-
2
TraderMark
-
3
Don Dion
-
4
Cliff Wachtel
-
5
Mike Havrilla
Top Instabloggers » -
1
-
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
A few more details: Money Supply contraction is helped along by the liquidity trap caused by decreasing real asset values and corporate profits combined with low starting interest rates (per Keynes and Fisher learnign from the Great Depression.)
The concentration of assets in banks described by Moon Kil Woong above is characteristic of this and is not due to any political motive. The concern about toxic assets might be politically motivated as it is hard to believe that any of Obama's economists belive that removing these assets from bank balance sheets will restart lending given the systemic issues. For example, during the Great Depression Canada did not have any substantial banking crisis but had a similar economic decline so a banking system fix is unlikely to get things going by itself.
Actions like the Fed Trillion Dollar expansion are on target.
As I see it, the goal of these programs should be to rebuild the financial infrastructure which has been badly damaged. This will take a while and the financial landscape will look vastly different when we are through rebuilding, but if done properly it could provide a very solid foundation for growth.
On Mar 23 11:53 AM Alphameister wrote:
> Excellent, highly insightful article and follow-up comment, Brian.
> It seems to me, though, that people are resistant to radical change.
> If and as panic subsides and consumers have achieved marginal improvements
> in their balance sheets, that propensity to consume will find them
> gradually increasing their spending both through cash and credit,
> increasing both the money supply (through credit) and the turnover
> rate (velocity) of money. I think the goal of these programs is
> not to push consumers and companies still deeper into debt but rather
> to allow the restoration of balance sheets to take place gradually
> rather than precipitously. Any comments?
Adding non-money derivatives to money does not increase money. It merely points out the unsustainability of the financial system circa 2000 - 2006. Those amounts were the bubble, the highly leveraged unsustainable bubble.
Helping the "too big to fail" companies will recreate what the Japanese did - keep zombie banks in operation that were not necessary for the new conditions. I call it government sponsored unsustainability.
Your optimism regarding a solid foundation for future growth is unwarranted. The zombies we are now creating will continue to provide no growth and will continue to hemmorhage losses for another several years, adding to unemployment and the national debt.
I'm not too worried about hyperinflation. I see the toxic assets as quicksand, swallowing the new money as fast as it's poured in.
I hope I'm wrong. I would love to see this mess get fixed and the return of economic good times. Unfortunately, I see no economic data or trends to support that premise.
When a credit instrument is issued, it is an IOU given in exchange for existing money. If the IOU is written off, it is simply a recognition that the debt is unlikely to be repaid -- however no "money" has been destroyed in the process. Both a receivable and a payable effectively vanish from the system. Where do I go wrong in my thinking?
I agree that keeping these institutions alive is simply repeating the mistakes of the past. Until the Govt and the banks admit they made bad loans then we will continue to wallow. Unfortunately, we got another program today (PPIP) that keeps the denial alive.
On Mar 23 01:10 PM axelrod608 wrote:
> >> "As I see it, the goal of these programs should be to rebuild
> the financial infrastructure which has been badly damaged. This will
> take a while and the financial landscape will look vastly different
> when we are through rebuilding, but if done properly it could provide
> a very solid foundation for growth." >>
>
> Adding non-money derivatives to money does not increase money. It
> merely points out the unsustainability of the financial system circa
> 2000 - 2006. Those amounts were the bubble, the highly leveraged
> unsustainable bubble.
>
> Helping the "too big to fail" companies will recreate what the Japanese
> did - keep zombie banks in operation that were not necessary for
> the new conditions. I call it government sponsored unsustainability.
>
>
> Your optimism regarding a solid foundation for future growth is unwarranted.
> The zombies we are now creating will continue to provide no growth
> and will continue to hemmorhage losses for another several years,
> adding to unemployment and the national debt.
>
> I'm not too worried about hyperinflation. I see the toxic assets
> as quicksand, swallowing the new money as fast as it's poured in.
>
>
> I hope I'm wrong. I would love to see this mess get fixed and the
> return of economic good times. Unfortunately, I see no economic
> data or trends to support that premise.
A good example is a home equity loan. Excess equity is simply the perception of an increased value of a home. It is money only in the sense that you can go to a bank and get cash (line of credit) that you previously did not have.
When the asset price falls ,the value of money falls, since the value of that money was initial priced from the value of the asset.
This is circular logic that got in this mess.
On Mar 23 01:50 PM Barbarous Relic wrote:
> I'm trying to understand why credit instruments should be added to
> conventional money supply measures to get a truer picture.
>
> When a credit instrument is issued, it is an IOU given in exchange
> for existing money. If the IOU is written off, it is simply a recognition
> that the debt is unlikely to be repaid -- however no "money" has
> been destroyed in the process. Both a receivable and a payable effectively
> vanish from the system. Where do I go wrong in my thinking?
I doubt that will last.
Will China and Japan be buying any of the $1 trillion worth of US treasury and agency debt? What will China and Japan do with their existing US notes?
These are the critical factors that will drive inflation. If there are no foriegn buyers for our debt and we continue to print money, we will have inflation.
This example merely describes a bank making me a loan. Under our fractional reserve system this does represent new money creation. I totally agree with that.
But if we then add that $100 IOU on the bank's balance sheet to the $100 I now have in my pocket to get $200, it seems to me that we're double counting. If the IOU ultimately gets written off, I still have the $100 I borrowed -- no money was destroyed. What am I missing?
When the IOU is written off, whoever holds the paper no longer can claim that as an asset - therefore this asset cannot be securitized and thus "money" is destroyed.
In terms of double counting, I think what you may be referring to is the multiplier effect. i.e. each dollar in the system is used for many purposes.
I hope that clarifies/answers? My apologies if I have made it more confusing.
On Mar 23 03:11 PM Barbarous Relic wrote:
> Brian Kelly - "The IOUs written are not against existing cash they
> are a way to pull cash out of an asset, in this way the asset is
> said to be "monetized". A good example is a home equity loan. Excess
> equity is simply the perception of an increased value of a home.
> It is money only in the sense that you can go to a bank and get cash
> (line of credit) that you previously did not have."
>
> This example merely describes a bank making me a loan. Under our
> fractional reserve system this does represent new money creation.
> I totally agree with that.
>
> But if we then add that $100 IOU on the bank's balance sheet to the
> $100 I now have in my pocket to get $200, it seems to me that we're
> double counting. If the IOU ultimately gets written off, I still
> have the $100 I borrowed -- no money was destroyed. What am I missing?
All the charts in the world and all changing definitions change nothing.
The problem is that the "phantom" dollars that exist on balance sheets are being replaced with "real" dollars. When the deleveraging stops, these "real" dollars will be re-leveraged and cause the inflation everyone is so concerned about. The very very thin line that the Fed is walking is knowing when to turn off the spigots at the right time and take this money out of circulation at the proper pace. Good luck...
With $182.5B YTD and assuming a constant run rate and a 3 to 4 multipling factor we need to add between $540-730B to the M2. This gives a revised value between $8,840B and $9,030B. Bad, but not as bad as without the annualization.
As this has dried up, economic activity has slowed. In a world with 3 billion people living on $2.50 a day or less and pandemic excess capacity, "money" must again be created, and supply capacity expanded WHERE IT IS NEEDED. This will require US companies to aggressively and creatively integrate foreign markets and suppliers into their business so they can take margin for their IP and trade promotion.
Given this excess capacity, I don't see hyperinflation, though we will certainly be paying more for oil in the future. But alternative energy will limit this increase in the end.
> TERRIBLE and FLAWED notions contained herein. Credit is NOT money!!
> It is actually negative to the money supply, given that debt is never
> free -- i.e., it will cost you more for the same purchase paid via
> credit than paid with cash. The mistaken notion that credit is money
> is THE REASON WE ARE IN THIS MESS TODAY!!!
Exactly. Not much more needs to be said except that that credit is vaporizing right in fron of our eyes and the government, lead by Mr. Paulson and now Geithner, are working as rapidly as possible to make sure that it disappears out of the taxpayer's pockets and not their friends on Wall Street. We are being fleeced and I have to wonder at what point we cease to put up with it and see the French Revolution replayed here in America.
First, money can be rationally defined in terms of its ability to buy or control assets. Credit gives the person the right to buy certain things without liquidity generated by the person; so does leverage buying, or margin buying. Include in this concept “purchasing power,” and the ability to demand goods with the promise of future payment. Asset monetization gives the asset owner the right to purchase. Somebody creates the money against this asset. According to the article, the financial institution does that by opening what might be called a “checking account” (or some method of exercising the right to buy) to the owner of the asset which has been pledged against that money. The economy should be seen as an intricate navigation network with large reservoirs, gates, locks, and navigation channels. The money supply does not automatically even itself out causing all boats to float in such a system.
The article is quite good in explaining subtle ways in which money supply increases in the financial markets. But it should be interpreted with the above paradigm in mind. Thus, when the music stops, tons of liquidity vanishes because there’s not enough real liquidity to pay off all debts. Real liquidity is the money that doesn’t disappear from the system, as opposed to debt created liquidity which grows and decreases as debt is paid off, and more debt is created. At some point, as the man said, the music stops, and debt created liquidity ends, and we have huge liquidity problems.
At the same time, real liquidity has been flooding the real economy, as the financial market profits have been shifted to it as financial market gurus pulled out their profits. (Remember the size of the financial market in relationship to the rest of the economy-when last assessed before the crash, it was around 35%; that says large pools in the financial markets have drained into the real economy).
Moon Kil Woong clearly points out money migration to what are obviously divisible sectors of economic activity. The key is to determine the migration of money, as it would in a navigation system. If one could see where the money was concentrating, then, a real assessment, and solution could be devised.
From here, the question becomes what should be the volume of money supply at any given time. Modern methodology which involves primarily macro-economic manipulation of interest rates and money supply by the sale and purchase of securities by the Fed has shown to be utterly inadequate, since it is not the only source of liquidity nor does it have sufficient control of the volume that can be created within the financial community, particularly with the monetization of assets; furthermore, the value of these assets is un-assessable in a tangible sense, depending only on the value acquired in trade.
The nature of money itself is irrelevant except in term of purchasing power. Thus, credit and leveraging through margin purchases, become money, albeit often short lived, unless it is kept going by building on it… until the music stops; then, sudden contraction.
Therefore, there new debt-free money must come into existence, at least periodically. For example, the Fed will buy in excess of a trillion in government securities. Where will the Fed get this money? It will simply create a checking account in the seller’s name, the offsetting entry being the Fed’s securities held asset account. Whether it’s outright printed or added in someone’s account it becomes new, debt free money.
At present the system is emotionally driven. In fact, it is generally emotionally driven with a tad of possible factual (mathematical) information. So long as the system is predominantly debt monetized, it will continue to be emotionally driven. So no amount of bailout or cash infusion will pacify the population unless the system becomes transparent to the rank and file.
Another point in the article is revealed here, and I paraphrase, When the non-conventional sources of “money” are included (add other instruments like CDS and equity) the money supply is actually decreasing, not increasing, in an even steeper decline.
This clearly implies that the money supply in the real economy is indeed increasing, and is what explains the continuing inflation, answering once more to the “navigation system” paradigm: Money concentrate in economic segments; it does not evenly divide as in a swimming pool economy.
We should refine the question to, how much liquidity should exist in the financial markets and financial infrastructure. The underlying fundamental is that the financial markets are or should be a reflection of the real economy, as it us upon real assets in the real world created by the real economy that the financial markets rest. Therefore, the liquidity in the financial markets should not exceed the growth ration of the growth of the real economy. You can’t trade securitized paper based on a million worth in real estate, and assume the value will double and triple while the real estate being built and sold is doing so at about 3-6% annually. In other words, an increase in value must be accompanied by an equal increase in real wealth. As this was not the case, the increase in profits was only due to the inflationary effects within the financial markets. So the numbers got bigger, while the real values didn’t change, which ends up blowing up the real economy by increasing its money supply through profit taking in the financial markets. For example, something that can be tracked is the luxury real estate market which went up higher because of huge bonuses paid to people in the financial community. Hong Kong was an interesting place to study it. Now, with so many in the financial community without work, homes have dropped in price at a higher rate than the common real estate markets. Another funnel of huge flow of money into the real economy from the financial community was the real estate developers, who built more houses at higher and higher prices. All that liquidity contributed to the inflation in the real economy. Add to that Bush’s war, and the huge amount of liquidity paid to these companies that produced war supplies and components, and we end up with the so called “crisis.”
But where’s the missing chair, when the music stops? The key element to the monetization problem is the interest charged for the credit. Why, it’s the only thing that is not backed by a tangible real asset, and it itself is not monetized. So it’s a sum of money, a huge sum of money, which is to be paid back by the all borrowers to the lenders. And this money has to come from some place, and when the velocity of money can’t cope with the volume required… well, the music stops, and defaults galore.
So we are trying to tweak a faulty system by stimulus packages, and bailouts, and are ignoring the basic flaws in the system. Before any adjustments to the flow in the navigation system can work, the navigation system itself must be adequately restructured; money creation and credit can’t be left in the hands of the financial community or the Fed. There must be broader participation and decision on how and why and to where money is to be distributed. Productivity is NOT big profits obtained from manipulating the system. This is theft. Productivity is the provision of real goods and services that don’t end up with most people losing their wealth.
We need to change the system radically and fundamentally.