Is the Fed Really Printing Money?

1) The Skyrocketing Monetary Base
2) The Mattress Full of Excess Reserves
3) Stable Money And Deleveraging
4) Moderate CPI with Lots of Slack
5) Should Goldfinger be Chairman of the Federal Reserve?

Is the Federal Reserve Board (Fed) really printing money? Is inflation inevitable? Continuing last week’s theme of inflation vs deflation, let’s take a close look at what’s really going on with the US money supply.

1) The Skyrocketing Monetary Base
Haters of Fed Chairman Ben Bernanke claim the Fed is running the printing presses in overdrive and this will soon produce severe inflation. Simply put: If we increase the number of dollars in circulation without producing more goods, we'll have too many dollars chasing too few goods and prices will rise - that's inflation.

The graph below, of the US base money supply, seems to support the argument that Bernanke has been increasing the supply of dollars. The "base money supply" or “monetary base” is a measure of circulating currency and commercial bank reserves held at the Federal Reserve. It’s also called “high-powered money” because banks can quickly loan out the reserves and cause credit expansion and possibly inflation. For the best explanation of money and inflation, read the first few chapters of Milton Friedman's "Money Mischief."

2) The Mattress Full of Excess Reserves
Yet the “monetary base” is like gunpowder. Unless the banks actually loan the money out, the money doesn’t increase spending. The banks might as well be storing all that money under a giant mattress. Here’s a look at the excess reserves that banks are holding with the Fed. Taken with the graph above, its clear that the Fed has greatly increased liquidity in the banking system, but most of that liquidity has been given back to the Fed in the form of excess reserves.



3) Stable Money and Deleveraging
The net effect of the increase in monetary base with the increase in excess reserves has been a modest increase in real money “M2”. M2 is a measure of what we usually think of as money: currency, checking and savings deposits, and money market accounts. As you can see from the graph at the bottom-left, M2 grew fairly consistently over the last 20 years, but as the bottom-right graph shows, it has actually been slightly negative over the last 9 months. It’s worth repeating: the amount of money in the US has shrunk slightly over the last 9 months, and only increased moderately in the year leading up to that.

So why has money (M2) been so steady if the Fed is running the printing presses? We already saw that a lot of the money the Fed is printing is just ending up as excess reserves, but that’s just part of the story. The graph to the bottom-left shows the “velocity of money”, a measure of how quickly a dollar gets spent. Consumers are holding on to cash and paying down debt, which has a similar effect to destroying money. The bottom-right graph shows the effect of consumers paying down debt. Consumer credit outstanding is shrinking as banks cut credit lines and consumers voluntarily reduce their debt.

4) Moderate CPI With Lots of Slack
So enough about money, what about prices? The graph below is of monthly changes in the Consumer Price Index (CPI). We've had moderate inflation over the last few months after significant deflation in Q4 2008. Inflation occurs when demand for goods exceeds supply at the old price. Sometimes this happens because of a supply shock (e.g. global oil shortage), but usually it occurs because central banks have been printing money and increasing the supply greater than the creation of actual goods and services. In this case we also have to consider the fiscal side. Programs like “Cash For Clunkers” pull future demand forward to today, artificially increasing the demand for goods in the short-term.


I’ve got one last graph to share with you, and that’s “capacity utilization”. “Capacity utilization” is a measure of how busy we’re keeping our factories, mines, and utilities.

The low level of capacity utilization suggests that we could rapidly increase the supply of many goods, reducing the risk of broad inflation. None of this is meant to suggest that we can’t get severe inflation in the future. All those “excess reserves” could quickly get loaned out and produce a dramatic increase in real money (M2) before the Fed could pull it back. Whether that happens will depend on the “animal spirits” that animate business leaders and bankers and the political will of the Fed.

This is why so many Fed officials are trying to talk about a "credible exit strategy" - they want to signal to markets and bankers that they will lower reserves just as things pick up, but not so fast as to hurt growth and cause a second recession. Read a recent speech about that here.


5) Should the Evil Bond Villain Goldfinger be Chairman of the Federal Reserve?
In the James Bond movie "Goldfinger," the villain Auric Goldfinger has a plot to detonate a nuke at Fort Knox to irradiate much of the US gold supply. The precious metal supporting the United States' greenbacks would be unusable and effectively destroyed; the ratio of paper dollars to government gold would increase. This would cause the USD to crash (relative to other currencies) and gold prices to skyrocket. It turns out we didn't need Goldfinger's evil plot. In 1968, 4 years after "Goldfinger" was made, the US could no longer support it's gold peg and the price of gold skyrocketed.

Some investors believe Bernanke has a plan that will similarly devalue the US dollar. Henry Ford once said,

It is well that the people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.

The bizarre thing about the populist anger today is that the gold bugs and anti-inflationists tend to be just the people who would actually benefit from inflation. William Jennings Bryan was fighting for the “toiling masses” when he famously said, “You shall not crucify mankind upon a cross of gold.”

A gold standard and 0% inflation benefits richer lenders/creditors and hurts poorer borrowers/debtors. Inflation redistributes wealth from the rich and the “fat cat” bankers to people living paycheck to paycheck and to debtors. Want to screw over the wealthy, the banks, and the credit card companies? Tell Bernanke to send the printing presses into overdrive.

Note: These generic e-letters are not an offering for any investment. It represents only the opinions of the Risk Over Reward blog and its writers Alpha and Vega. Any views expressed herein are provided for information purposes only and should not be construed in any way as an offer, an endorsement, or inducement to invest with any RIA, CTA, fund, or program mentioned here or elsewhere. Before seeking any advisor's services or making an investment in a fund, investors must read and examine thoroughly the respective disclosure document or offering memorandum.

Comments

[Ferdinand E...:]

I'm not aware of anyone being crucified on a cross of gold. A cross of ignorance is more like it, and I suspect that it/they were manufactured on the assembly lines of Mr Ford.

Oct 18 09:37 AM

[logicalthought:]

>>Inflation redistributes wealth from the rich and the “fat cat” bankers to people living paycheck to paycheck and to debtors.<<

It's not that simple. Yes, inflation does remove wealth from the "rich" and "fat cat bankers", but it doesn't help a poor NON-debtor "living paycheck to paycheck" because the paychecks never quite keep up with the rising prices. And, of course, a highly inflationary environment discourages capital investment (due to the unpredictability of "real" future returns), and thus makes it much less likely that "Mr. Paycheck-to-Paycheck" will even HAVE a paycheck. And what about a retired person who has virtuously saved for an entire lifetime? That person may or may not benefit from inflation, depending upon whether or not interest rates are set higher or lower than the rate of inflation.

Oct 18 10:09 AM

[InnocentsAb...:]

Will someone please highlight where it is possible to get data on

(1) the distribution of the holders of money market funds (banks vs insurance cos., vs. thrifts, vs. tech cos.

and

(2) how to get weekly (or even daily) data on the rates paid on excess reserves ?

Sorry to place this in theis nice article. I'm going to be looking about, but SA has so many good resources (writers) that I am wondering if I missed an article outlining this).

Oct 18 01:20 PM

[Faisal Humayun:]

It will surely be very interesting to see how the Fed manages to increase the money supply in a system where debt esentially creates new money....Since businesses and individuals are de leveraging the process of new money creation is not happening from the private banking sector...

As a matter of fact...the private banking system created most of the new money in the system...But since they are not lending..nor are the businesses too eager to borrow it will be a difficult task to create new money...

So the process would just be printing more money (electronic money) in order to keep the debt cycle and debt servicing going...

Oct 18 02:19 PM

[Smarty_Pants:]

"Inflation redistributes wealth from the rich and the “fat cat” bankers to people living paycheck to paycheck and to debtors. Want to screw over the wealthy, the banks, and the credit card companies? Tell Bernanke to send the printing presses into overdrive." -

Ah, that explains why President Robert Mugabe is having such a hard time making ends meet in Zimbabwe while his citizenry are living high on the hog.

Printing money helps the bankers and politicians because they get to use the new money FIRST, before its appearance drives up the prices of things in the economy. By the time the extra money 'trickles down' to the average Joe, prices have already been increased because the banksters and politicians bid them up while spending that 'extra' money.

The people who get the shaft from inflation are small savers and those who lend at fixed interest rates (not credit cards, whose rates float just above some index like the libor, which would rise during serious inflation).

A closer look at the M2 chart also shows an increase from around 7700 to around 8300 in the past year which works out to a 7.8% increase. Not exactly what one might call 'moderate' given that gub'mint COLAs were set to 0.0% recently.

Note that M2 has increased by over 31% (from 6300 to 8300) in the past 5 years or roughly a 5.7% annual rate of increase. (I don't recall hearing any sort of gub'mint report for CPI increasing anywhere near that rate.)

It also appears that the most recent part of the chart, while decreasing, is still above the straight line made by extending the data on the left of the chart. We're still working out the effects of the huge 'bubble' of money the gub'mint threw at the bank problem in the last two years, we haven't begun to address the long term accumulation of extra money we've been printing in the past decade.

There are more inflationary effects to come. Wait and see.

Oct 18 05:50 PM

[flow5:]

Go back to school stupidl. "It’s also called “high-powered money” because banks can quickly loan out the reserves and cause credit expansion and possibly inflation"

Banks don't loan out excess reserves, the monetary base is not a base for the expansion of the money stock, income velocity is a contrived calculation, the evidence of inflation cannot be conclusively deduced from the monthly changes in the price indices, you can't eat gold. Why does Seeking Alpha publish this garbage?

Oct 18 10:05 PM

[sethmcs:]

Could the market crash drive up M2 and the 50% rally drive down M2? My guess is no matter what the Fed or the Treasury does no one will be happy. 2010 mid-term elections should favor the elephants. People will be tired of the current jackasses.

Oct 19 01:20 AM

[Vega:]

You make a lot of excellent points. Thanks for commenting.


On Oct 18 05:50 PM Smarty_Pants wrote:

> "Inflation redistributes wealth from the rich and the “fat cat” bankers
> to people living paycheck to paycheck and to debtors. Want to screw
> over the wealthy, the banks, and the credit card companies? Tell
> Bernanke to send the printing presses into overdrive." -
>
> Ah, that explains why President Robert Mugabe is having such a hard
> time making ends meet in Zimbabwe while his citizenry are living
> high on the hog.
>
> Printing money helps the bankers and politicians because they get
> to use the new money FIRST, before its appearance drives up the prices
> of things in the economy. By the time the extra money 'trickles down'
> to the average Joe, prices have already been increased because the
> banksters and politicians bid them up while spending that 'extra'
> money.
>
> The people who get the shaft from inflation are small savers and
> those who lend at fixed interest rates (not credit cards, whose rates
> float just above some index like the libor, which would rise during
> serious inflation).
>
> A closer look at the M2 chart also shows an increase from around
> 7700 to around 8300 in the past year which works out to a 7.8% increase.
> Not exactly what one might call 'moderate' given that gub'mint COLAs
> were set to 0.0% recently.
>
> Note that M2 has increased by over 31% (from 6300 to 8300) in the
> past 5 years or roughly a 5.7% annual rate of increase. (I don't
> recall hearing any sort of gub'mint report for CPI increasing anywhere
> near that rate.)
>
> It also appears that the most recent part of the chart, while decreasing,
> is still above the straight line made by extending the data on the
> left of the chart. We're still working out the effects of the huge
> 'bubble' of money the gub'mint threw at the bank problem in the last
> two years, we haven't begun to address the long term accumulation
> of extra money we've been printing in the past decade.
>
> There are more inflationary effects to come. Wait and see.

Oct 19 11:21 AM

[flow5:]

M2 erroneously includes MMMFs in its definition (a sizable #). MMMFs are the customers of the commercial banks. They are financial intermediaries/credit transmitters.

Monetary savings are never transferred from the commercial banks to the intermediaries; rather are monetary savings always transferred through the intermediaries. Whether the public saves or dis-saves, chooses to hold their savings in the commercial banks or to transfer them to intermediary institutions will not, per se, alter the total assets or liabilities of the commercial banks; nor alter the forms of these assets or liabilities.

Financial intermediaries (MMMFs) lend existing money which has been saved, and all of these savings originate OUTSIDE of the intermediaries (depend on an inflow of savings to finance loans).

The utilization of these loan-funds, or the activation of monetary savings held by these financial intermediaries, is captured thru the velocity of their transactions in the commercial banking system (bank debits/withdrawals), and not thru the volume of their bank deposits.

I.e., from the standpoint of the economy, MMMF deposits never leave the MCB System. And the growth of the MMMFs is prima facie evidence that existing funds/savings have already been saved/invested/spent, i.e., transferred/transmitted by their owners/savers/creditors to borrowers/debtors.

I.e., this currently (but not for ever) represents a double counting of the money stock, and will continue to be so, as long as these intermediary financial institutions aren't capable of creating new money in their lending operations.

Same goes for these institutions inter-bank demand deposits (a double counting).

Oct 19 01:42 PM

[flow5:]

The M1 figure overstates the quantity of the means-of-payment money. This upward bias is the consequence of classifying Savings and Loan & Credit Union Deposits as commercial banks (but not Mutual Savings Bank deposits), as demand deposits, rather than inter-bank demand deposits. M1 thus includes both the Negotiable Order of Withdrawal (NOW) account balances, and the thrifts’ balances, in the commercial banks – again, a double counting of our means-of-payment money.

Oct 20 04:45 PM

[richard_e_n...:]

Yes, the Fed is really printing money. When the Fed purchases treasurys as in its 300 billion purchase progam it debits treasurys and credits Federal Reserve notes outstanding on its balance sheet thus monetizing the treasury debt. The Fed has nearly exhausted its pledge so it has "printed" nearly 300 billion on this program alone.

Oct 22 11:30 AM

[Think-About-It:]

"Inflation redistributes wealth from the rich and the “fat cat” bankers to people living paycheck to paycheck and to debtors."

This line killed your credibility and I was going to get into it but "Smarty Pants" stated it admirably.

As Bill Fleckenstein says "In a social democracy with a fiat currency all roads lead to inflation."

Investing for deflation or low inflation is a high risk strategy with limited upside if you are right and a ton of downside if you are wrong...

Oct 23 12:39 AM

[Mark Anthony:]

The FED is printing money. That is a fact that can be easily derived from a few piece of public information.

First, the M1, M2 and M3 (they no longer publishes M3) money supply statistics does not include the dollar held by foreigners. There are massive amount of hot money flow to countries like China, and be held by the foreign central banks. Those US dollars is not counted for. They will flood back to the US market at some point, as foreigners do not want to hold our dollars.

Second, from Sep. 30, 08 to Oct. 30, 09, our national debt clock ticked up from $10T to $12T, a $2 Trillion increase. Some ones are buying our debts to the tune of $2 trillion. Let's not ask who is buying, the FED itself or foreign government, or misterious Carribean bankers. Whoever buys, has tended $2 trillion in US dollar cash. Where did that $2T money come from? Most have got to be freshly printed US dollars.

Third exactly who bought the $2T new US debts? It's un-accounted for. Foreign holdings of US treasuries increased only $0.415T. So where did the remaining $1.585T come from? A big chunk has got to be the FED buying the US debts directly or indirectly:

www.treas.gov/tic/mfh.txt

A government gets its spending money only through one of three ways:
1. Taxation.
2. Borrowing.
3. Print money.

If the government deficit is not accounted for in borrowing, then it's got to be printed money. Simple logic.

Read why it is no longer physically possible to avoid the collapse of the US dollar, regardless what the government does:
seekingalpha.com/autho...

Nov 01 08:34 PM