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Dr. Bernanke-Love, or: How to Learn to Stop Worrying and Love the Fed (Part II) 11 comments
In Part One, I described the mechanisms by which money is created, and provided definitions of the most widely-used measures of the money supply. In this article, I’ll discuss the importance of the money multiplier. I had intended to also address velocity in this article because the two are similar, but that discussion is more involved and would make this article much longer, so that piece will come shortly.
The Money Multiplier
The M1 money multiplier is M1 divided by the adjusted monetary base (AMB); this metric shows the relationship between money the Fed creates and circulating currency, checkable deposits, and travelers’ checks. The differences between the two metrics is that Currency in banks’ vaults and banks’ accounts with the Fed are not part of M1, and deposits and travelers’ checks are not part of AMB.
Between 2000 and 2008, the M1 money multiplier gradually declined from 1.8 to about 1.6, and then was quite stable for the 18 months leading up to August 2008. What happened then is presented below. If a chart can be scary, this is it.
The 10-Year M1 Money Multiplier. Note the drop in velocity just before Y2K as people hoarded cash. Click here for a clear view of the current chart from the FRED database.
The flip-side of this chart – the huge growth of the AMB – is the one you’re more likely to see in an article arguing that inflation is inevitable.
The Adjusted Monetary Base (AMB). Note the spikes related to Y2K and 9/11/2001 as banks accumulated reserves in anticipation of increased demand for cash. Click here for a clear view of the current chart from the FRED database.
Actually, you’re more likely to see this graph on a non-logarithmic scale to accentuate the recent growth. Since the AMB is where Fed action shows up, the argument is that growth in AMB is due to the Fed “printing money.” But this isn’t the case.
The driver of these scary-looking charts was the banks’ deleveraging to build reserves. Starting in September, banks took any steps they could to build up cash. Inter-bank lending through the federal funds market slowed by a third in Q4. Despite deposits increasing by 5.2% in Q3, bank lending declined by 1.5% in Q4. Instead of lending money to generate earnings, banks collected it to increase cash reserves:
12/31/07
6/30/08
12/31/08
Commercial banking reserve balances held at the Federal Reserve (Billions)
$18.2
$30.7
$819.7
Between the end of August and the end of January, banks increased non-required reserves from $2 billion to $798 billion – an increase of more than 38,000%. The previous high was less than $20 billion, in the aftermath of 9/11/2001.
Bank Reserves in Excess of Required Reserves. Note spikes associated with Y2K, 9/11/2001, the start of the subprime mortgage crisis, and Bear Stearns’ failure. Click here for a clear view of the current chart from the FRED database.
Because none of M1, M2, or MZM includes bank reserves, most of this reserve build-up had no impact on the money supply. The multipliers jumped like they were electrified, but that was due to a changing AMB, not changing M’s.
Currency in circulation:
14.7%
AMB:
203.6%
M1:
21.4%
M2:
14.7%
MZM:
15.1%
M3:
10.7% (eyeballed from shadowstats.com)
Annual growth rates, 8/08-3/09
Between August and March, 9% of the growth in the AMB can be attributed directly to Fed action. The remaining 91% was caused by increasing bank reserves. This is not to say that the Fed hasn’t helped the banks increase reserves – it clearly has. My point is that the Fed’s involvement is much more complicated than is generally described, and understanding it requires a deeper analysis of the Fed’s balance sheet (which I'll do in a future article).
The bottom line is this: while AMB has soared, it's because of banks' unprecedented increase in cash reserves, not because the Fed’s printing money. Further, the Fed's balance sheet expansion is a direct response to significant changes in the functioning of the banking system, and because of this will not necessarily cause inflation.
In Part Three I’ll dig into the significance of velocity, what it means and doesn’t mean. After that, a look into the Fed’s balance sheet, then a discussion of what’s happened over the last 18 months that’s different from previous history, and then a look ahead.
[all data unless stated otherwise from the St. Louis Fed’s fantastic FRED database]
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This post has 11 comments:
I have a question though. If I understand correctly most of the money put in the system by the FED is being hoarded by the banks (sharp increase reserve balance held at FED). But what happens if the economy starts to recover again? Is it easy for the FED to withdraw this money again? Isn't this the greatest fear of inflationists that the FED will prove incapable of diminishing the money supply when economic recovery starts?
Thanks for the help.
I also believe that at this point at least a modest degree of inflation would actually be helpful as it would make the real cost of paying down all those bad real-estate loans somewhat lower. For homeowners with underwater mortgages a bit of inflation would be a blessing right now.
Don't Fight the Fed.
In any event, the fractional banking system we have necessitates the slavery of the people through interest, the destruction of real wealth creation through consumer credit spending and the reinforcement of static technological systems at the expense of innovation. This is what the Austrian School and dear Mad Milton in Chicago didn't get. Capital structures serve capital structures, not the businesses supposedly fueled by them!
Fractional money systems are transfer-of-labor engines that move the product of labor (or invention), created wealth, away from the people and into the pockets of the financial elite who own the money franchise.
WAKE UP! 1.5 quadrillion in worthless derivative can't be ignored – these are the ultimate products of this system. It's exactly what it was designed to create: Leverage. Leverage that sucks money away from productive enterprise and into the hands of the managers of LEVERAGE (The FED).
ENJOY THE RENNIASANCE OF THE coming DARK AGES all you FED apologists.
On Apr 29 01:02 PM 1.5 quadrillion wrote:
> ENJOY THE RENNIASANCE OF THE coming DARK AGES all you FED apologists.
On Apr 29 05:04 PM Bull McCashington wrote:
> The dark ages came first and the renaissance was a direct result
> of the Black Plague mobilizing European leaders to rebuild a society
> nearly crumbled to dust both population and technology divestment
> wise. So your analogy suffers.
>
> On Apr 29 01:02 PM 1.5 quadrillion wrote:
You have provided the "cake", I'm interested in the "frosting" on the cake.
Bull: an interesting comparison, Dark Ages=Financial disasters, Plague=Swine Flu, Renaissance=???
Or am being too optimistic?
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