QE2 Myths Impervious to Facts: 5% Money Growth Isn't Going to Cause Hyperinflation

by: Bob McTeer

QE2 comes to a formal end this month, and just in the nick of time too, since it’s been flooding the markets with newly printed money, making hyper inflation and a collapse of the dollar inevitable. But, wait a minute! What’s that 5 percent all about?

Five percent is the latest estimate of the growth of the M2 money supply from May 2010 through May 2011. The annualized M2 growth rate for the six months ending in May 2011 was 4.9 percent. The rate for the three months ending in May 2011 was also 4.9 percent. Five percent money growth with 9.1 percent unemployment is going to cause hyperinflation?

Rarely has a myth been so impervious to simple facts. Pundits have been talking nonstop about the avalanche of money without bothering to actually look it up and discover that it just isn’t happening.

For the umpteenth time, the Fed’s purchases of Treasuries under the so-called QE2 program have increased bank reserves, but banks have added to their excess reserves rather than creating large amounts of money through lending and investing. The money multiplier—the ratio of the money supply to bank reserves—has remained close to one. There has been no multiple expansion.

If you add those bank reserves to cash outside the banking system, you get a measure usually called the monetary base. That measure has grown rapidly, but that is a measure of the potential money supply, not the actual money supply. In the normal past, the monetary base moved along with other “monetary aggregates” and probably had a reasonably good correlation with economic activity. But not now, or recently, since actual money is not keeping up with potential money.

I suspect that a few critics of explosive money growth may have taken a peak at the actual numbers recently since the vague and undefined word “liquidity” is used more and more rather than money. The Fed is pumping out liquidity, whatever that means.

Last week the fiction was taken a step further by a couple of writers. They had the Fed providing money and/or liquidity to banks directly at near zero interest rates. Not true either, in any substantial volume.

Bank reserves are a liability of the Fed and an asset for the banks. When the Fed lends to banks, the banks owe the Fed. There has been no recent increase in bank borrowing from the Fed. The opposite is the case.

Very short-term money may be borrowed at very low interest rates because of the Fed’s interest rate policy. The Federal Funds rate has been close to zero. But there is a huge difference between borrowing from the Fed at near zero interest rates and borrowing at that rate in the Federal Funds market. The difference is that borrowing from the Fed creates new reserves for the banking system. Borrowing from other participants in the Federal Funds market merely redistributes existing reserves. There has been no burst of Fed lending at the discount window that would expand “liquidity.” The liquidity is just being moved around.