How To Interpret The Money Stock Numbers

by: John M. Mason

It is the time of the month that I do my monthly review of Federal Reserve activity. Looking just at the Federal Reserve statistics (the Fed's H.4.1 release), I see little new to talk about.

One might think that with all the activity in the bond markets over the past month or so that something different might show up on the Fed's balance sheet. But, there is nothing that is showing up.

Excess reserves in the commercial banking system rose about $80 billion in June, rising to a level of about $1.94 trillion. In May, excess reserves rose by about $94 billion; in April by about $71 billion; and in March by about $81 billion. In this respect, June seems little different than the three months preceding it.

The securities held outright by the Federal Reserve have also risen in a relatively steady pace. Over the past 13-week period, the securities held outright by the Fed rose by almost $270 billion, a pace of about $90 billion per month. Over the past 4-week period, this total rose by $87.8 billion, up from a total of $77.8 billion in the previous 4-week period. During the past 13 weeks, about half of the net increase was in US Treasury securities with the other half of the net increase coming in mortgage-backed securities.

The only major operational movements on the Fed's balance sheet came from flows of funds out of and into the Treasury's General Account as tax monies collected in April were removed in May. In June there was another buildup in the General Account, but this did not appear to put any pressure on the reserves of the commercial banking system as the effective Federal Funds rate in June actually fell from the average rate attained in May, which was 11 basis points. Three out of the four weeks in June, the average effective Fed Funds rate was 9 basis points. In the fourth week the average was 10 basis points. Apparently the commercial banking system was under no pressure on reserves in June.

Year-over-year the change in Treasury deposits at the Federal Reserve was relatively minor. That is, for all we can tell, movements in and out of the Treasury accounts were seasonal and had little or no impact on the behavior of commercial banks.

It seems as if the recent exodus from the U.S. Treasury market had an impact on the Fed's balance sheet. As pointed out in a comment on this post by Salmo trutta, foreign central banks sold off Treasury issues during this time and apparently used the funds to reduce the amount of central bank liquidity swaps by more than $26 billion, most of which came in the April 24 to May 29 time period. And, as mentioned in my post, "Holdings of U.S. Treasuries held at the Fed on behalf of official foreign institutions dropped a record $32.4bn to $2.93tn, eclipsing the prior mark of $24bn in August 2007. It was the third week of outflows in the past four."

The question for economic activity, however, is how is the Fed's activity affecting commercial banking? Again, we find that the behavior of the banking system over the past year has changed very little. Total reserves in the whole banking system rose by about 32 percent June 2013 over June 2012 due to all of the Fed's purchases of securities.

Required reserves, however, only increased by a little less than 19 percent. This is consistent with the fact that demand deposit accounts at commercial banks rose by about 20 percent, pretty well in line with the increase in required reserves. We see that demand deposits at commercial banks are continuing their rapid rise.

Note, that in June 2012 the year-over-year rate of increase in the demand deposit figure was about 36 percent and in June 2011 the year-over-year rate of increase was roughly 26 percent. Thus, the primary reason why banks have needed more required reserves is because their demand deposit totals have been increasing.

Yet, over the same period of time -- including the past 12 months -- commercial banks have not been increasing their lending to any degree. So, what is happening?

As with most of the past four years, individuals, households, and businesses have been moving their funds from other assets, especially short-term assets, into transactions accounts. They have done this for two reasons. First, short-term interest rates have been so low that it has not really been worthwhile for people to put money in short-term assets. Second, with all the economic uncertainty and lack of economic activity, people have kept funds "handy" in transactions accounts so that they will have the funds available for spending, as it is needed.

People also move their funds into currency if they are troubled economically and needs funds for transactions purposes. Over the past three years we have seen currency in circulation grow at historically high rates: in June 2011, the year-over-year rate of growth of currency in circulation was in excess of 9 percent; in June 2012 the rate of increase was 8.5 percent; and in June 2013 currency in circulation was expanding at almost 7.5 percent year-over-year.

Evidence of this movement of funds into assets immediately available for spending comes from the Fed's statistics on Retail Money Funds and Institutional Money Funds, which show sharp declines over the past four years. Only in the past year have these categories shown any stability and in June of 2013 are only modestly ahead of where they were in June of 2012.

Furthermore, time accounts at commercial banks and thrift institutions have only shown modest increases in recent years. For example, the non-M1 component of M2 is up only 5 percent in June, year-over-year. In 2012, the year-over-year figure was just over 7 percent and in 2011 it was just over 4 percent.

People have moved money into very liquid transactions accounts because short-term time and savings accounts and money market funds are not paying them enough to make it worthwhile to keep their money anywhere else.

As a consequence, the M1 measure of the money stock has been growing over the past three years at a pace almost twice that of the M2 measure of the money stock. I have heard some people argue that they are not worried about the inflationary impact of what the Federal Reserve has been doing because the rate of growth of the M2 measure of the money stock is not that great. This implies a connection with this growth rate and the Fed's quantitative easy.

I believe that these people have it all wrong, for this implies that the commercial banks are lending money. My argument has been that for three years or so, because of the economy and because of the very low short-term interest rates, people have been moving assets from interest bearing assets, especially of a short-term nature, into transactions accounts. Thus, the M1 money stock measure is growing very, very rapidly, while the M2 money stock measure is growing at a relatively moderate rate of growth.

Unless one argues that the Fed has created the low interest rate environment to get people to move their funds into these transactions accounts, the relative growth rates of the money stock has very little to do with the monetary policy the Federal Reserve is following. And, it has very little to do with what the Federal Reserve is doing because the commercial banks are not really lending yet.

Thus, the Federal Reserve continues along its pathway of quantitative easing, which is having very little impact on the economy. So, much of what I have written in this post is just a continuation of what I have been writing for the past three years or so. Up-to-this-date, the data just do not support another conclusion. For right now, I don't see a near-term future that is much different from the situation that exists today.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.