There are signs here and there that the economy is gathering strength. Note especially the figures on industrial production and capacity utilization. Although we have not returned to the levels reached earlier, the movement in these measures is definitely up.
Unfortunately, we are not seeing this movement in the monetary statistics relating to individual and banking behavior. As has been reported in my posts bank credit extension continues to decline. And, the way people are handling their money does not indicate any change in how people are handling their assets.
For example, the year-over-year rates of increase in the various measures of the money stock indicate that people are still holding a great deal of their assets in transaction accounts in banks and continue to keep as liquid as they can. This kind of behavior is defensive in nature and can be interpreted as showing that the public remains so uncertain about the future that they want to be prepared for contingencies, like becoming unemployed.
As mentioned in an earlier post, the public began moving large parts of their wealth into cash and transactions in the latter part of 2007 and into 2008. We can see this movement in the change in year-over-year growth rates in the M1 and M2 measures of the money stock. The M1 measure began to accelerate in early 2008 and the M2 measure began to grow more rapidly in the first part of 2009. Looking further into 2009 and 2010, however, we see that M1 money stock growth has remained relatively strong whereas M2 money stock growth tapered off substantially. (Click charts to enlarge)Two points can be made: First, the Federal Reserve was pumping reserves into the banking system throughout this period, yet given the performance of the banking system and the M2 measure of the money stock it is obvious that this injection in reserves did not account for the changes in money stock growth. The behavior of the banks and the public lead one to refer to this as a liquidity trap as banks piled up excess reserves during the time period to the total of about $1.2 trillion.
Second, and perhaps more convincing, there is evidence of massive shifts of funds from less liquid assets to the most liquid of financial assets throughout this time period. For example, in September 2009, the year-over-year decline in small denomination time and savings accounts at commercial banks and thrift institutions was about 5%. In February 2010, these accounts were declining by more than 21%, year-over-year. Retail money funds were declining at about a 16% rate last September; now, they are declining by more than 26% year-over-year. Institutional money funds are declining in February at almost 16% year-over-year whereas they were increasing last September.
The point of this is that people are moving these assets into accounts that are transaction accounts, like demand deposits and money market or checkable deposits. Most of these accounts are counted in the M1 measure of the money stock and not in the non-M1 portion of the M2 money stock. This is the reason for the divergence in the growth rates of the two measures of the money stock.
For example, demand deposits at commercial banks rose by more than 14%, year-over-year, in February. This is down from about 20% in September. Other checkable deposits at commercial banks rose by around 19% in February, up from about 16% in September. And, savings deposits (which include money market deposit accounts), at both commercial banks and thrift institutions rose by about 14.5% in both February 2010 and September 2009.
The conclusion: People are still scared about their future and continue to act in a very protective way. There is little or no borrowing going on, at least, not enough to cause the lending totals at commercial banks to rise. One can certainly argue that the lack of bank lending is due to a lack of demand as well as the unwillingness of banks to lend.
Furthermore, money stock growth has not come from Federal Reserve initiatives to expand the bank lending. The growth being experienced by both measures of the money stock are coming from people re-arranging their asset portfolios and not from monetary policy.
The big unknown still remains the Federal Reserve and its “exit” policy. If and when people begin to borrow again and begin to spend again, bank credit extension should start to accelerate. This will lead to real money stock growth. The question is, how will the “undoing” of the Fed impact this loan growth and any subsequent monetary growth. Obviously, if too many of the excess reserves previously pumped into the banking system by the Fed gets into the various measures of the money stock, there could be some serious long run inflationary problems.
Consequently, it is necessary to continue to watch these money numbers to see what people and the banks are doing.