In May, 2012, the
year-over-year rate of growth of the M1 money stock was just about 16 percent
within the 16 to 18 percent range the year-over-year growth rate this measure
of the money stock has grown in the first five months of this year.
The M2 measure of the money
stock grew at a 9.5 percent rate of year-over-year increase, a rate consistent
with its behavior since the end of last year.
These measures are growing as
rapidly as they are, not due to the monetary stimulus of the Fed working its
way through the lending of the banking system, but because people continue to
shift assets in their balance sheets away from short-term interest bearing
assets to transactions balances that pay little or no interest.
This shift in funds, as I
have argued for over the past two years or so, should not be interpreted as a
sign that people are buying things. On
the contrary, people are still moving their funds from short-term interest
bearing assets to transactions balance for two reasons. First, many people are without jobs or
without full-time jobs or who face housing problems need to keep their money in
a form that can provide for daily needs.
Second, with interest rates so low people are not earning enough in the
short-term interest paying assets to justify them to keeping their funds there.
In the first case, the
currency component of the money stock is still increasing at historically high
rates, 8.5 percent, year-over-year in May, and this I continue to interpret in
a pessimistic way. People need to hold
cash when times are tough.
In addition, the demand
deposit component of the M1 money stock is increasing at a 36 percent annual
rate in May, an extraordinarily high year-over-year rate of growth. Where are these funds coming from?
Well, small time deposit
accounts are down over 17 percent, year-over-year, retail money funds are down
3.5 percent, year-over-year, and institutional money funds are down slightly
more than 8 percent, year-over-year.
People are taking funds out of short-term interest bearing accounts and
putting these funds into demand deposits.
The increase in demand
deposits is not being generated by the commercial banks lending out money to
support consumer or business spending!
We can see the effect of this
on bank reserves. Total bank reserves
have actually declined year-over-year by slightly less than 2 percent. However, required reserves have risen by 31.5
percent over the same time period. The
increase in required reserves is a result of the shift in other bank accounts
that have lower reserve requirements to demand deposit accounts that have a
much higher reserve requirement.
The interesting consequence
of this is that excess reserves in the banking system have actually declined
over the past year. They have not
declined by much, but the have declined sufficiently to cover the amount of
reserves the banks’ need to cover the increase in required reserves to back up
the rise in demand deposits.
This decline in the excess
reserves in the commercial banking system is matched by a similar decline in
the reserve balances commercial banks keep at Federal Reserve banks.
Overall, in comparing where
the Federal Reserve was last year with where it is at the present time there
are two things that stand out in terms of the actions of the central bank.
First, the Fed supported the
substantial increase in the demand for currency in the economy. In this matter, the Fed supplies currency to
the public “on demand”. That is, the Fed
exercises no control over the amount of currency that is in the economy.
Second, there were substantial
actions on the part of the Fed over the past year to combat what was going on
in the rest of the world. Three major
line items on the Fed’s balance sheet relate to this: central bank liquidity
swaps; dealing in assets denominated in foreign currencies; and reverse
repurchase agreements with “foreign official and international accounts.”
This second area that stands
out is not surprising given all the problems that have been faced in Europe and
elsewhere. The Federal Reserve has
provided help when and where it can.
Otherwise, the other activity
that the Federal Reserve has engaged in over the past year can fundamentally be
called “operating transactions.” That
is, the Fed acts to offset seasonal or special transactions to maintain
relatively steady reserve balances. For
example, when cash flows out of the banking system in the
Thanksgiving/Christmas time period, the Fed usually injects reserves to cover
the outflow. After the first of the year
when cash flows back into the banks the Fed will reverse their previous
injection.
These actions are call
“operating transactions” because they help to stabilize the movement of funds
in and out of the banking system that are just routinely operational. And, these operations still have to be
maintained even in the face of all the excess reserves that now exist within
the banking system.
Bottom line: very little has
changed in the banking system in recent months and, hence, the Federal Reserve
has been relatively quiet. There still
remains a contingent of individuals in the financial markets that are calling
for the Fed to engage in a third effort at quantitative easing. My guess, however, is that QE3 will not be
forthcoming, even in the face of the lower revised numbers for GDP in the first
quarter of this year.
There are three reasons for
this. First, further quantitative easing
will have little or no effect in stimulating faster economic growth. There are just two many structural problems
in the economy for the United States to achieve faster economic growth at this
time. What would the banking system do
with more than $1.5 trillion in excess reserves?
Second, the handling of the
insolvency problems within the United States banking system is going very
smoothly. (See my post on “The Condition of the Banking System”.) Right now, there is nothing else the
Federal Reserve can do to help this process go any better. Thus, the Fed needs to leave well enough
alone.
And, third…this is an
election year. The Fed has been
criticized in the past for attempting to ease monetary policy to support a
sitting President. It does not want to
look political in its actions.
The Federal Reserve does not
have unlimited capabilities. The
officials at the Fed need to know when to act, but they also need to accept the
fact that there are times when they can do little or nothing to help a
situation. In these latter cases they
need to back off.
To me, now is a time when the
Fed need to stay quiet, continue to execute its routine “operating” duties, but
still stay alert. There is very little
benefit that the Fed can achieve now through further actions, but there are
potential costs of attempting to be too active.
