Recent Monetary Policy and the Growth of the M1 Money Stock

Since the end of June 2011, excess reserves held by commercial banks have declined by about $107 billion. (Remember in August 2008 when excess reserves in the banking system totaled only $2.0 billion…for the whole banking system!) For the two-week period ending November 30, 2011, excess reserves averaged almost $1.6 trillion.

Reserves balances held at Federal Reserve banks dropped by about $110 billion over the same period of time. On December 7, 2011, reserve balances were slightly under $1.6 trillion.

Excess reserves held by the banking system and reserve balances at the Federal Reserve tend to move in the same direction and in about the same magnitude.  The reason for focusing on reserve balances held at Federal Reserve banks is that this number comes from the Fed’s balance sheet and can be related the movements of line items that appear on the balance sheet.

This decline in reserve balances has not been overtly driven by Federal Reserve actions.  In fact, three factors have dominated this decline, and each of the three is independent of what the Federal Reserve might be overtly doing. 

The first two factors relate to components of the Federal Reserve’s portfolio of securities.  After the Fed’s holdings of U. S. Treasury securities, the largest part of the portfolio is made up of mortgage-backed securities.  From the end of June through the current banking week, the amount of mortgage-backed securities on the Fed’s balance sheet dropped by $82 billion and represented maturing securities. 

The Fed’s holdings of Federal Agency securities also feel by almost $11 billion during this same time period again from the run-off of maturing issues. 

The third factor that helped to decrease reserve balances was a $31 billion increase in currency in circulation outside the banking system.  That is, when currency is drawn out of the banks and moves into the hands of individuals, families, and businesses, bank reserves go down…unless these outflows are offset by other actions of the Federal Reserve. 

Just these three factors alone resulted in a $124 billion reduction in bank reserves.  Some open market operations as well as other operating factors offset this decline, but the net result, as mentioned above, was that overall excess reserves in the banking system decline by more about $110 billion over this time period.

While these excess reserves were declining, however, we observed during the same time period, a sizeable change in the speed at which the money stock was growing.  For example, in June, the year-over-year rate of growth of the M1 measure of the money stock was about 6 percent.  In July, the rate of growth increased to 16 percent, in August it was slightly more than 20 percent where it has stayed. 

The M2 measure of the money stock did not show such dramatic increases, since the M1 measure is a subset of the larger total, but it, too, increased during this time period.  In June, the year-over-year rate of growth of the M1 measure was about 6 percent.  In July the growth rate of this measure rose to 8 percent and then jumped to 10 percent in August where it has remained. 

In July and August, the banking system experienced huge gains in demand deposits while in June, July, and August savings deposits at depository institutions rose dramatically. 

These movements along with the continued strong demand for currency in circulation can still be used as evidence that the economy remains very weak.  The $31 billion increase of currency in circulation mentioned above has resulted in the currency component of the money stock measure showing a year-over-year rate of growth by the end of October of almost 9 percent, which is a very high figure historically.  

The movements taking place in the money stock figures point to the weak economy in two ways.  First, with people under-employed, with people trying to stay away from debt, and with businesses trying to build up large stashes of cash, the demand for currency and for transaction balances at financial institutions rises.  Weak economies cause economic units to keep more of their wealth in a form that is readily accessible and spendable.

The second piece of evidence, however, is the extremely low interest rates associated with the weak economy.  With interest rate so low, it just does not pay for people to keep funds in interest-bearing accounts. Over the past five months, savings deposits at financial institutions have dropped by almost $75 billion and funds kept in institutional money funds have dropped by $160 billion over the same time period.  A large portion of these funds has apparently gone into currency and transaction balances.   

People are still getting out of short-term assets and placing their funds, more and more, in transactions-type accounts.  This is a sign of the weak economy and not of economic growth or a successful monetary policy. 

This is “debt deflation” type of behavior. (http://seekingalpha.com/article/307261-debt-deflation-is-it-a-possibility) It is a type of behavior that the Federal Reserve has not yet been able to over come. And, having the Fed toss more “stuff” against the wall does not seem to be the policy to turn things around.

Federal Reserve officials keep talking about up the fact that they have not run out of things that they can do to continue to try and stimulate the economy.  Unfortunately, it seems to me that fewer and fewer people are listening to their pleading. 

With a banking system that is still much weaker than the authorities are willing to talk about; with a consumer sector and business sector that, for the most part, are still trying to reduce their debt load; and with a public sector that is sorely out-of-balance and doesn’t seem to know where it wants to go; people are confused and uncertain about their future and about what to do.  

In this kind of environment, people want to hold onto what they have and want to avoid as much risk as they can.  They don’t want to borrow if they don’t have to and they want their assets to be as liquid as possible.

This is what the Federal Reserve is facing. 

Post QE2 Federal Resserve Watch: Part 3

I didn’t post a “Post QE2 Federal Reserve Watch” last month because I was on vacation.  You have to go back to September 12 to get Part 2 of the “Post QE2” watch. (http://seekingalpha.com/article/292986-post-qe2-federal-reserve-watch-not-much-banking-system-activity)

Early in September, the excess reserves in the banking system totaled around $1,570 billion.  At the beginning of November, excess reserves were about $1,515 billion. 

A $55 billion drop in excess reserves might seem huge, especially when total excess reserves averaged around $2.0 billion, but in these days decreases or increases of this size don’t really seem to amount to a lot.

Federal Reserve policy for the past two years has basically been to throw all the “spaghetti” it can against the wall and see what sticks.  So far, very little of the “spaghetti” has stuck as total bank loans have not increased that much over the past year although business lending has picked up some at the larger banks (http://seekingalpha.com/article/303929-business-lending-is-increasing-especially-at-the-largest-u-s-banks)

On the money stock side, however, growth has picked up substantially over the past six months or so.  The M1 money stock growth (year-over-year) has risen from just over 10 percent six months ago to more than 20 percent in recent weeks.  

The growth rate of the non-M1 component of the M2 money stock measure also accelerated during this time period, more than doubling from around a 3 percent growth rate in early April to well more than 7 percent in late October. 

The reason for this acceleration seems to be a pick up in the movement from low interest bearing short-term assets like retail money funds and institutional money funds to bank deposits and a pick up in the demand for currency in circulation.  Movements of funds into currency holdings continue to rise at a rapid rate.

The movement of funds from other short-term, interest bearing accounts can be explained by the extraordinarily low interest rates being maintained by the Fed and because of the financial stress being felt by so many families and businesses who want to keep their funds in highly liquid form.  A number of large corporations are also holding onto large cash balances for purposes of acquisitions or their own stock repurchases. 

None of these actions contribute to bank loan growth or economic expansion.  All of these reasons are anticipatory of the need to have liquid assets “near-at-hand” in order to transact.  These are not signs of a real healthy economy.

As far as the banking sector is concerned, the increase in demand and time deposits has resulted in a need within banks to hold more required reserves.  Hence, over the past six months the required reserves of commercial banks have risen $4.5 billion to $96.4 billion from $91.9 billion in early September. 

   

Over the past six months, the required reserves at commercial banks have risen by just under $19 billion. 

This increase in required reserves seems to be the biggest operating factor that the Federal Reserve has had to deal with over the past six months.  Thus, although excess reserves at commercial banks have dropped over the past three months, they have risen over the past six months. 

The item on the Federal Reserve’s statement of “Factors Affecting Reserve Balances of Depository Institutions” (Fed release H.4.1) that is most closely associated with excess reserves in the banking system is called “Reserve balances with Federal Reserve Banks.”  This figure has risen by about $46 billion from May 4, 2011 to November 2, 2011.  The increase came about through a rise of $102 billion in “Total factors supplying reserve funds” and a $56 billion increase in “Total factors, other than reserve balances, absorbing reserve balances.”  The $46 billion is the difference between these latter two amounts. 

The $102 billion increase in factors supplying reserve funds came primarily from Federal Reserve purchases of U. S. Treasury securities, which exceeded the run-off from the Fed’s portfolio of Federal Agency securities, Mortgage-backed securities and the decline in other operating factors that supply reserves to the banking system.

There are two interesting factors that absorbed bank reserves during this time period.  The first interesting factor is the rise in “Currency in Circulation”, which increased by roughly $33 billion from May 4 to November 3.  This movement is a drain on bank reserves and hence causes reserves at commercial banks to decline.   This increase is interesting because currency in circulation usually increases during the summer months due to vacations but decreases in the fall.  Over the past three months, from August 3 to November 3, currency in circulation actually increased by more than $15 billion.  This just adds strength to the argument made above for the increase in currency outstanding.

The other interesting factor is that the Fed’s reverse repurchase agreements to foreign official and international accounts increased by almost $68 billion over the past six months, by $56 billion over just the last three.  This increase also reduces bank reserves. 

Here the Federal Reserve is selling securities under an agreement to repurchase the securities at some stated future time period. These are international transactions and the Fed uses U. S. Treasury securities, federal agency debt, and mortgage-backed securities as collateral in the transactions.  The timing of these transactions are interesting because of the events that have taken place in Europe of the last six months. 

My summary of these movements remains much the same as in previous months.  The Federal Reserve has done just about all it can at the present time to preserve the banking system and allow the FDIC to close as many banks as it has to without major disruption. 

The Fed has thrown just about everything it can into the financial system.  Given the economic weakness in the housing market, the desire of families and businesses to continue to reduce the financial leverage on their balance sheets, and the high level of underemployment in the economy, the demand for loans from commercial banks is very weak, so total bank loans are remaining relatively constant.  A further indication of weakness is the continued movement of wealth into currency holdings and bank deposits, a movement that has resulted in the rapid growth of the money stock measures.  Throwing more “spaghetti” against the wall at this time would not change the behavior of these people or businesses to any degree. 

The Fed may just have to wait until the deleveraging is completed before it sees people starting to borrow again or to hire new workers.  That is, unless the situation in Europe explodes and further ‘search and rescue” missions are needed to preserve western civilization.         

Growth Accelerates in Money Stock Measures

Let’s start with another interesting fact from the commercial banking industry: 92 percent of the banks in the country hold 10 percent of the total banking assets in the country as of March 31, 2011 (FDIC banking statistics) but this total ($1,181.0 billion in total assets) is only 60% of the cash assets in the whole banking system on August 3, 2011 (Federal Reserve H.8 release) and only72 percent of the Reserves at Federal Reserve Banks on August 3, 2011 (Federal Reserve H.4.1 release) and only 74 percent of the Excess Reserves in the banking system for the two-week average ending August 10, 2011 (Federal Reserve H.3 release).

In other words, the total assets residing in 92 percent of the commercial banks in the United States is substantially less than the amount of excess reserves pumped into the banking system by the Federal Reserve since August 2008. (For more comparisons see my post of August 15, 2011, http://seekingalpha.com/article/287494-foreign-related-financial-institutions-continue-to-suck-up-u-s-excess-reserves.)   

Now let’s look at the recent behavior of the money stock measures.  Both measures of the money stock (M1 and M2) experienced accelerating rates of growth over the past year, with the acceleration increasing over the past several months. 

The M1 money stock measure was growing at a year-over-year rate of 16.1 percent in July, up from 10.0 percent in January 2011 and 5.4 percent in the summer of 2010.  The M2 money stock measure is growing year-over-year in July 2011 at 8.3 percent, up from 4.3 percent in January and around 2.5 percent in the summer of 2010.

Is this a sign that the Fed’s quantitative easing (QE2) is working or is it a result of something else going on in the economy? 

Generally when the money stock measures are growing, commercial bank lending is fueling the growth.  Banks loans are put into demand deposits to spend and this spending spurs on the economy.

It is hard to find much loan growth in the commercial banking sector at this time. (See my post http://seekingalpha.com/article/287494-foreign-related-financial-institutions-continue-to-suck-up-u-s-excess-reserves.)  Thus, it is hard to conclude that the increase in the growth rates of the two money stock measures results from the Fed’s injection of reserves into the banking system.

The path that I have been following over the past two years is that the extremely weak condition of the economy and the extremely low interest rates are causing a “dis-intermediation” of sorts as people move their funds from interest bearing assets into transaction-related accounts to either be able to pay for necessities because cash flows are low due to unemployment or other situations of financial distress, or, because interest rates are so low on savings or money market accounts that it is doesn’t pay for wealth-holders to keep money in these latter types of accounts.

What we see is that demand deposit accounts at commercial banks have exploded.  In July, the year-over-year rate of growth of this component of the money stock has increased dramatically to over 37.0 percent, up from just 21.0 percent in March of this year.  Other checkable deposits at depository institutions have also increased by not at such a rapid pace. 

Along with this we still see substantial drops in “savings” categories.  Small-denomination time deposits have fallen at a 20.0 percent rate, year-over-year.  Retail money funds have dropped by over 6.0 percent, year-over-year, and institutional money funds are still declining at more than a 4.0 percent, year-over-year rate. 

Funds are still moving from (formerly) interest earning accounts to transaction-type accounts. 

One further indication that some of this is due to “economic stress” is that the amount of currency in circulation is increasing.  In July, currency in circulation was more than 9.0 percent higher than it was a year ago.  This is up from around 7.0 percent earlier this year.

My basic point here is that although the growth rate of both money stock measures are increasing, that this information does not indicate that Federal Reserve monetary policy is working or that economic growth will benefit from this expansion.

The money stock measures are experiencing increasing rates of growth due to the fact that the economy is extremely weak and that interest rates are extremely low.  People…and businesses…are just re-allocating their funds so that their money is easier to get for spending purposes (distress) or that other assets are earning so little it doesn’t pay to keep funds in those accounts…or both.

In my view, there is no cause for hope for an economic recovery in the current monetary statistics. 

Federal Reserve QE2 Watch: Part 8

I usually do the “QE2 Watch” post in the first week of the new month, but in this coming month I will be a little tied up.  I am having hip replacement surgery on June 28 and will be a little preoccupied for a few days.  I will also write a post on the condition of the banking system that I will post tomorrow.  Then I go “on vacation” for a while.

Chairman Bernanke and the Federal Reserve have signaled that QE2 will definitely end on June 30 and they have indicated that QE3 is not in the works…at least at the present time. 

The stated plans for QE2 included the new purchase of $600 billion in Treasury securities and the purchase of a possible $300 billion more in Treasury securities to replace securities maturing in the Fed’s portfolio of Federal Agency issues and the Fed’s portfolio of mortgage-backed securities. 

From Wednesday, September 1, 2010 to Wednesday, June 22, 2011, the Federal Reserve’s holdings of United States Treasury issues have risen by roughly $816 billion.  During this time period, the dollar volume of Federal Agency issues on the Fed’s balance sheet has dropped by $38 billion and the dollar volume of mortgage-backed securities has declined by $189 billion…a combined total of $227 billion. 

The “net” increase in securities held outright by the Federal Reserve has been $589 billion, pretty close to the $600 billion “net” increase promised. 

Reserve balances at Federal Reserve banks, a proxy for excess reserves in the banking system, have increased by $584 billion to $1,594 billion over this time period.  Actual excess reserves in the banking system averaged $1,610 billion for the two-week period ending June 15, 2011.

Almost all the increase in excess reserves can be attributed to the Fed’s purchase of United States Treasury securities. 

Other factors affected reserve balances within this time period but they tended to be minimized over the period as a whole.  For example, in the first quarter of 2011, the United States Treasury Department reduce its “Supplemental Financing Account” at the Fed by $195 billion, a not inconsequential amount of funds.  This reduction added reserves to the banking system.  However, over time, this movement was offset by other factors and hardly had any net effect on the total amount of reserves being supplied to the banking system.

And, what was the total impact of QE2 on the commercial banking system?

All the reserves the Fed crammed into the banking system went into excess reserves!

Yet deposits in the banking system continued to increase. 

Demand deposits in particular rose at a very rapid pace.  From the second quarter of 2010 when demand deposits at commercial banks increased at a 6.3 percent rate year-over-year, these accounts rose by 8.5 percent in the third quarter and 14.3 percent in the fourth quarter.  But this rate of acceleration jumped to 20.4 percent year-over-year in the first quarter of 2011 and in the month of May was showing a rate of increase of almost 27 percent!

What is happening here?

Demand deposits at commercial banks are increasing at a very, very rapid pace, yet commercial banks do not seem to be lending much at all (more on this tomorrow) and everything the Federal Reserve is pushing into the system seems to be going into excess reserves.  What’s going on?

Basically, what’s going on is the same thing that has been going on for the last 18 months or so.  Because of the poor economic climate and because of the excessively low interest rates people and businesses are moving funds out of interest bearing accounts and into transactions accounts.  These latter accounts are where people are locating their “liquidity” these days so as to pay for necessities and other important things to keep on living. 

For example, Institutional money funds are still losing money…perhaps not as fast as they were a year ago, but they are still contracting by more than 5 percent, year-over-year.  Retail money funds are still declining at a rate in excess of 8 percent year-over-year and small time accounts are declining by more than 20 percent, year-over-year. 

All non-M1 money stock money included in the M2 money stock measure has risen only modestly over the past 12 months and most of this has come in the money market deposit account s included in the aggregate category titled savings deposits.

The result is that the M1 money stock measure is increasing rather rapidly at around a 12 percent year-over-year rate in the last three months.  The M2 money stock measure is increasing by less than 5 percent over the same time period.  The rate of growth of the M2 money stock measure has only increased modestly over the last four quarters. 

People are putting their money into accounts from which they can transact.  They are moving their money into these accounts because they need to stay liquid in order to pay for their daily needs. 

The other indicator of this behavior is the rapid increases that have been made in the demand for coin and currency.  In the second quarter of 2010, the currency in circulation was rising by only about 3.5 percent, year-over-year.  This steadily increased through 2010 until it reached a total of over 7.0 percent in the first quarter of 2011.  That is, the coin and currency in circulation more than doubled its growth rate over this time period.  In May 2011, the year-over-year rate of increase in the currency component of the money stock was rising at almost 9.0 percent year-over-year. 

In the slow economic growth climate we are in, people do not increase their holdings of coin and currency in order to generate new spending.  They increase their holdings because they need these funds to buy necessities in the face of unemployment, foreclosure, and bankruptcy!

The information from the financial system is not very encouraging.  The Fed has tried to push all the funds it can into the banking system.  The banking system is not lending it…both because the banking system is still not in that good of a shape…and because people are not in very good financial condition and are not borrowing.  Thus, reserves pile up at commercial banks. 

If QE2 was supposed to get the economy growing faster, it has failed miserably.  If QE2 served other purposes, like allowing the FDIC to close banks in an orderly fashion, then it has succeeded.  If the Fed used the economy as an excuse to explain QE2 while it was assisting the FDIC in its efforts to close banks in an orderly fashion then it was duplicitous.  It might have done this to avoid people getting overly worried about the condition of the banking system.

But, the more I think about this last statement the more I chuckle because I don’t think that the Fed is that good.

Federal Reserve QE2 Watch: Part 6

The Federal Reserve continues to pursue its Quantitative Easing 2 exercise.  Over the four-week period ending May 4, 2011, the Federal Reserve purchased $84 billion of U. S. Treasury securities.  About $18 billion of the acquisitions went to offset mortgage-backed securities and Federal Agency issues running off.

Since September 1, 2010, the Fed has purchased $656 billion in Treasuries, with $208 billion to offset mortgage-backed and Agency issues maturing.

Mr. Bernanke indicated at the start that the Fed would increase its holdings of the Treasury securities by $600 billion outright and then purchase about $300 billion more Treasury issues to cover the run-off of Agencies and MBS securities. 

In recent weeks, Mr. Bernanke has stated that the Fed will continue QE2 through the end of June.  It seems as if they are right on target 

Reserve balances at the Federal Reserve totaled $1,473 billion on May 4, 2011 up from $1,019 billion on December 29, 2010 and $1,011 billion on September 1, 2010. 

Excess Reserves at commercial banks (from the Fed’s H.3 release) averaged $1,433 for the two weeks ending May 4, 2011 relatively close to the Reserve Balance total. In December 2010 excess reserves averaged $1,007 billion and in August 2010 excess reserves averaged $1,020 billion. 

Cash assets at commercial banks (from the Fed’s H.8 release) averaged about $1,565 billion for the month of April 2011 while the banks averaged $1,043 for the month of December 2010 and $1,185 for the month of August 2010.

Thus, for the commercial banking system, all measures of vault cash and bank deposits at the Federal Reserve and excess reserves are closing aligned. 

The basic result of QE2, therefore, is that the Fed has injected a little more than $450 billion in excess liquidity into the banking system since the beginning of September 2010, most of the injection coming since 2011 began. 

The net effect of this liquidity on the commercial banking system?

The volume of Loans and Leases on the books of commercial banks have declined by about $132 billion from the beginning of September 2010 through the end of April 2011, and have declined by about $78 billion from the beginning of 2011 to the present. 

The volume of Loans and Leases at commercial banks appeared to remain relatively constant throughout the month of April.

This trajectory seemed to be similar for both the largest 25 domestically chartered commercial banks in the United States and the rest of the domestically chartered commercial banks.

Of the cash assets at commercial banks in the United States, Foreign-Related Institutions held about 50 percent of the $1,565 billion cash assets in the banking system in April.  (For my comments on this see http://seekingalpha.com/article/265481-large-foreign-related-banks-now-hold-77.) 

So,

The Federal Reserve’s QE2 efforts have not stopped the decline in bank lending, and,

About one-half of the excess reserves the Fed has injected into the banking system have gone to foreign-related banking offices.

Good job!

Looking at the money stock measures, the growth in the M1 and M2 money stock continue to rise. 

The year-over-year rate of growth of the M2 measure of the money stock has risen from 3.5 percent in December 2010 to 4.6 percent in March 2011 and 5.1 percent in April.

The year-over-year rate of growth of the M1 measure of the money stock has risen from 8.4 percent in December 2010 to 10.4 percent in March 2011 and 16.6 percent in April. 

How is this growth happening if bank loans are decreasing?

Well, economic units are still getting out of assets that are earning very little interest and are not counted in the two measures of the money stock and placing the assets in accounts or cash that can be spent when needed which are included in these measures of the money stock.  In several previous posts I have taken this as a negative sign, a sign that people want to keep their assets ready for spending because they are without jobs or without sufficient income or see other assets being underwater.  They are keeping assets in transaction accounts so that they can spend the money when needed. 

This movement to assets the economic units can transact with is seen in the increase in the holdings of currency, which has gone from a year-over-year rate of expansion of 6.3 percent in December 2010 to 7.7 percent increase in March 2011 and an 8.2 percent rise in April.

The year-over-year rate of growth of demand deposits has risen from 15.7 percent in December 2010 to 20.9 percent in March to 21.8 percent in April. 

Non-M1 portions of the M2 money stock have hardly increased within this time frame.

So, the Federal Reserve continues to push on a string.  The commercial banks aren’t lending.  Economic units aren’t borrowing.  And these latter economic units continue to move their assets from longer-term, less liquid assets to shorter-term, transaction-type assets. 

The evidence here still indicates that the banking system is not fully engaged in economic recovery and the efforts of the Federal Reserve system have accomplished little more than spur on the “carry” trade in international financial and commodity markets.  And, it also indicates that consumers and small businesses, in aggregate, continue to keep their assets where they can spend them through a period when they cannot meet current spending needs with their incomes and cash flows being weak.    

Federal Reserve QE2 Watch: Part 3.1

I usually don’t write up Fed actions within the month unless something seems to be going on. Last week, bank reserve balances at the Federal Reserve went up by $108 billion. I thought that this increase was significant enough to warrant some notice.



There was really only one “factor” supplying reserve funds this past week. This was a net increase in U. S. Treasury Securities held outright by the Fed of almost $30 billion, which brought the Fed’s holdings of Treasury securities up to $1.167 trillion. The portfolios of Federal Agency securities and Mortgage-backed securities did not change a bit.



Furthermore, Thursday afternoon, February 10, the Federal Reserve announced that it would purchase about $97 billion in U. S. Treasury securities in the upcoming week. This total would include about $17 billion to replace the runoff in the Fed’s holdings of mortgage-backed securities, implying that there would be a “net” increase in securities holdings that would be a part of QE2.





The question we can’t answer is whether or not there will be other operating factors on the Fed’s balance sheet that the Fed needs to deal with.



This past week, the banking week ending February 9, 2011, there were substantial movements in two of the Federal Reserve accounts of the United States Treasury. The first movement was in the Treasury’s General Account and this amounted to a little more than a $55 billion reduction in the account.



This movement seems to be seasonal in nature, but was not offset this year, as it often has been in the past, by offsetting sales of government securities. That is why the decline contributed $55 billion more to bank reserves.



In 2009 there was a seasonal year-end buildup in the Treasury’s General Account which peaked in January 2010 and then dropped off to its spring low in April. This year the General Account built up to a peak again in early January before beginning to drop off.



Year-end tax receipts build up at the Fed which causes the peak to occur in early January. From these accounts the Treasury pays out more than it receives thereby causing bank reserves to increase. The difference is that this year the Fed did not sell Treasury securities to withdraw the reserves from the banking system. That would be counter to QE2 if they did..



The other actor in this play is the Treasury’s Supplemental Financing Account. (For a discussion of this see my post of April 19, 2010 (http://seekingalpha.com/article/199444-the-fed-s-new-exit-strategy). The Treasury’s Supplemental Financing Account reached a total of $200 billion in May 2010 and remained at this level until the banking week ending February 9, 2001. The account dropped by $25 billion which reduced the balance in the account to $175 billion. Reducing this account, like reducing the General Account, puts reserves into the banking system.



The Fed allowed an amount of $80 billion to flow into the banking system in the banking week ending February 9, 2011, all from government checks from the Treasury’s deposit balances at the Federal Reserve. There were roughly $3 billion offsets to this on the balance sheet so that only a net of $77 billion actually ended up in the banking system through this activity.



So, the actions were relatively “clean” this week and they resulted in $108 billion going into bank reserves at the Federal Reserve, roughly $30 from the Fed’s purchase of securities and $77 billion coming from government checks from the Treasury’s deposit balances at the Fed going into the private sector.



To my knowledge the $1,187 billion of reserve balances at the Federal Reserve at the end of business on February 9, 2011 is that largest total this account has ever reached!



The question this raises is this…are the reserves being pumped into the banking system getting into the private sector? Is all this Federal Reserve activity having any impact on the money stock numbers?



I am afraid I cannot give any different answer to this question than I have over the past year. The money stock measures are increasing but the reason for these increases still seems to be that people continue to move balances from other earning assets into assets that they can use to transact with. That is, people, in general, are reducing asset balances that were held for a rainy day or were part of their savings and have moved them into assets that they can use for daily purchases of goods and services.



I continue to think this is not a good sign. It is a sign that people are drawing down savings to have cash on hand to pay for daily needs. It is a sign that many people and businesses do not have sufficient income or cash flow to maintain their transaction balances and so have to bring money in from their savings in order to buy food, housing and so forth.



The good new is that bankruptcies and foreclosures are not increasing as fast as they once were.


The bad news is that they are still increasing at close to record rates.



How does this show up in the monetary statistics. Well, currency holdings by the public were increasing in January at a rate, almost 7%, that was roughly twice the rate of a year ago. These year-over-year increases are not near the heights that were reached in the darkest period of the Great Recession, over 11%, but they are high historically.





Demand deposits are also increasing at a fairly rapid pace. The year-over-year rate of growth of demand deposits was about 14% in the fourth quarter of 2010. In January, this figure reached 20%. The highest it reached during the Great Depression was something over 18%.



Note that the growth of the non-M1 part of the M2 measure of the money stock has increased over the past year, but at a very tepid rate. In the fourth quarter of 2010, the year-over-year rate of growth of this component of the M2 money stock measure was slightly over 2%. In January 2011, the year-over-year rate of increase rose to almost 3%, the highest level it had been in several years.



The reason is that the rate of decline in small time accounts and retail money funds slowed dramatically. In the first quarter of 2009, each of these accounts were falling at a 25% rate. In January 2011, the rate of decline in small time accounts was 21% and the rate of decline in retail money funds was around 13%. So, the non-transactions account part of the money stock measures have not declined…have even picked up…but the accounts associated with savings have experience a decline in their rate of decline.



So where are we? About where we have been for two years or so. The Fed keeps trying to push on the accelerator…and the private sector continues to scramble for survival.



What is amazing is that consumer spending and consumer sentiment seem to be picking up. Again, I can only argue that the American society has split. The wealthier, those that are still employed, still live in their own homes, and still have sufficient cash flows are spending. Those that are not fully employed, that have lost their homes or businesses, and those that must rely on their past accumulations of savings are in pretty poor shape. This is the only way I can explain the statistics I see on a daily basis.

America Continues to "Go Liquid"

The monetary story of the “Great Recession” is that the two most watched measures of the money stock, M1 and M2, have continued to grow, year-over-year, throughout the downturn and slow recovery. The problem with this is that the money stock measures have grown because Americans have almost continuously been moving their funds from less liquid assets into assets that can be used for transactions purposes.


In other words, Americans have wanted their assets where they can immediately spend them.


This is very obvious when we compare the year-over-year growth rates of the M1 and M2 money stock measures. For the last seven months, M1 growth has averaged around 6% (down from around a 13% average for the previous year). The M2 growth rate has been around 2.5% for the same time period (down from about 6% for the previous year).


The non-M1 component of M2 has grown at about 1.5% for the past seven months, much slower than the rate at which M1 grew over this same time period. The average growth of this measure for the previous twelve months was hardly different from zero.


This continued relative movement into “transaction accounts” is not a positive signal that the economic recovery will pick up soon. Americans still seem to be putting their funds into currency and checkable deposits because they need “ready” cash to spend on necessities. They are not saving for a rainy day for, to these people, the rainy days are here.


Another indication of the desire of Americans to have money available for spending is the continued high growth rates in the currency component of the money stock. Through much of the 2000s up until September 2008, the year-over-year rate of growth of the currency component of the money stock rose by less than 2.0%. For much of the time it was below 1.0%.


Beginning in September 2008, more and more Americans wanted cash on hand. At one point, the year-over-year rate of growth of currency rose to about 12.0%. Although the demand for currency has dropped off, the year-over-year rate of growth was in excess of 5.0% in October 2010 and around 6.0% in November 2010. This is another indication of the need for people to have money “ready-to-spend.”


This movement of funds is also reflected in the numbers for bank reserves. Total reserves in the banking system have actually declined, year-over-year, in the past two months. In November, total reserves were actually down by about 9.0%, year-over-year.(In the first quarter of 2010, total reserves were up 120.0%!)


Required reserves in the banking system, however, were actually up during this two month period. In November, required reserves showed a year-over-year increase of about 5.0%. This shows how the deposits at financial institutions have moved from time and savings accounts to checkable deposits that have higher reserve requirements.


As a consequence of this shift, excess reserves at commercial banks have declined slightly over the past several months. This decline has not been initiated by the Federal Reserve, but has resulted from the shift in deposits within the commercial banking system.

The Federal Reserve was highly criticized for the way it reacted to the period known as the Great Depression. As Milton Friedman showed, at one time, the Federal Reserve had allowed the M2 money stock to decline by about one-third. He attributed the Great Depression to the fact that the monetary authorities allowed the money stock to decline by such a massive amount.


The year-over-year growth rate of the M2 money stock measure has never dropped below zero over the past four years. This can be seen in the accompanying chart. In late 2008, this growth rate accelerated as people moved money into currency and checkable deposits. You can see the drop off as the most dramatic movements resided. The important thing, however, is that the growth rate of the M2 money stock measure never turned negative.


What are we currently watching for in these measures of money stock and reserve growth?


We are interested in an acceleration of economic growth. This acceleration will not take place until two things happen in the money stock measures. First, the movement of funds from assets that serve as a “temporary abode of purchasing power” (a term coined by Milton Friedman) to checkable deposits must be reversed. The movement from these interest bearing assets to checkable deposits indicates the weaknesses that exist on balance sheets and the need to keep funds available for current spending.


Second, commercial banks must begin making loans again. Banks, in the aggregate, still do not seem to be too willing to make loans and expand business and consumer credit. (See http://seekingalpha.com/article/235487-the-banking-system-seems-to-be-dividing-large-vs-small-commercial-banks.) Until this starts to happen we will not see the checkable deposits at commercial banks beginning to rise again for reasons other than that people want to hold more checkable balances.


And, if time and savings accounts do not stabilize and begin to increase and banks do not start increasing their lending, the year-over-year rate of growth in the M2 measure of the money stock will continue to remain lethargic. This will be one indicator that the economy is not picking up steam.


If consumers, businesses, and banks do not start to change their behavior I cannot be optimistic about the success of the Fed’s efforts at quantitative easing, i. e., QE2 (see post of December 6, “Federal Reserve QE2 Watch: Part 1”: http://seekingalpha.com/article/240224-qe2-shifted-mortgage-backed-securities-to-treasury-securities).

What Money Stock Growth is Telling Us

The year-over-year rate of growth of the money stock measures has never declined during the Great Recession of 2008-2009.

The recession began in December 2007. In January 2008 the year-over-year rate of growth of the M2 measure of the money stock was 6.0%; the M1 measure was growing at 0.5%. Currently, the M2 measure is growing at a 3.0% year-over-year rate of growth; the M1 measure is growing at 6.3%

The interesting thing about the behavior of these money stock measures is what happened within each measure. I have regularly reported on this behavior over the past 18 months or so. (See, for example, “The Recent Behavior of the Monetary Aggregates”: http://seekingalpha.com/article/218818-the-recent-behavior-of-the-monetary-aggregates.)

Looking at the monetary aggregates over this period of time reveals two movements. The first movement is the transferring of funds from small time and savings deposits and short-term money funds into transaction balances. The second movement is the transferring funds from thrift institutions to commercial banks. These movements can be attributed to the low interest being paid on these accounts and in these funds and to the employment uncertainty that hovers over many families in the United States. This is not a real positive sign in terms of a country attempting to get its economy going again.

Over the past three months, the Federal Reserve System has ended its “exit strategy” and taken a more neutral stance with respect to monetary policy. (See http://seekingalpha.com/article/233760-federal-reserve-non-exit-watch-part-3.) At the present time, the world seems to be waiting for another effort at Quantitative Easing. (See http://seekingalpha.com/article/233773-bernanke-s-next-round-of-spaghetti-tossing.)

Regardless of what these “grand” strategies are and what they might accomplish…or, not accomplish…it is still instructive to see what people actually seem to be doing with their money.

Basically, when looking at the monetary aggregates we see the same behavior over the past several months that we have seen exhibited by the private sector over the past twenty-four months. People continue to transfer their wealth into transactions balances and currency holdings while reducing wealth held in the smaller savings deposits and in retail money funds.

That is, the families and individuals still believe that they can most be prepared for the future by keeping their money is ways that can be spent without having to transfer funds from other accounts in order to be able to spend them. Any interest that might be earned on these latter balances is just too small to warrant these people from being any more less liquid.

Overall, the M1 measure of the money stock in the third quarter of 2010 was 5.3% higher than it was one year ago. The quarterly year-over-year growth rates for M1 fell during the year, averaging 7.9% in the first quarter of 2010 and 5.5% in the second quarter.

The M2 measure remained relatively constant in the first and second quarter of this year, averaging 1.9% and 1.6% respectively, but increased at a 2.5% rate in the third quarter. The non-M1 component of the M2 measure only increased at a 0.5% year-over-year rate of growth in the first quarter; it rose to 0.7% in the second quarter; and rose by 1.8% in the third quarter.

The biggest change contributing to the rise in the non-M1 component of M2 was the slowdown in the rate of decline in money held in Retail Money Funds. In the six months of the year, these accounts declined at a rate slightly more 25%. However, the rate of decline dropped to about 22% in the third quarter. Overall, retail Money Funds dropped by more than $160 billion from September 2009 to September 2010.

The decline in small time deposits stayed around 22% all year. Small time deposits fell by almost $280 billion from September 2009 to September 2010.

Where have these funds gone? Primarily into transaction balances.

The growth rate of demand deposits at commercial banks has remained relatively robust over the past year. This growth, connected with the decline in small time accounts and retail money funds, is the reason why the rate of increase in the M1 measure was greater than the growth rate of the M2 measure.

Demand deposits rose at a 7.6% year-over-year rate of increase in the first quarter of 2010; the growth rates for the rest of the year were 6.3% in the second quarter and 8.5% in the third quarter.

The interpretation of all this is as follows: people have, once again, begun re-allocating more of their wealth into transactions balances and currency. Although this movement slowed earlier this year, it began to pick-up once again in the third quarter.

In a real sense, this is not encouraging. To me this movement is what happens when people and businesses transfer their wealth into forms that are convenient for daily needs in order to purchase necessities. This deposit growth is not coming because the Federal Reserve is pumping a lot of base money into the banking system. The growth is not coming because the commercial banks are lending…they are not lending. This movement of funds seems to be to purchase the basic goods needed to live and survive.

The good news is that the money stock measures are growing. The not-so-good news is that the money stock growth is growing because people and businesses need to keep their funds very liquid for the purpose of daily living.

I cannot believe that a new round of quantitative easing is going to change this picture.

NOTE: Money going to Institutional Money Funds actually began to increase in absolute value in July 2010 and continued to increase through September. The year-over-year rate of decline in these monies is still quite large (-23% in the third quarter) but it is a smaller decline than from the first two quarters of the year.

Federal Resere Non-Exit Watch: Part 3

It is Halloween…is that QE2 I see lurking in the shadows? Oh, my…I’m scared!

Here we are in the third month since the Federal Reserve declared that their program to withdraw all the liquidity they had injected into the banking system was at an end. Of course, during the exit program excess reserves in the banking system rose substantially as total reserves and the monetary base continued to rise.

Funniest “exit” strategy I have ever seen. But, what else can we expect from the current leadership of the Federal Reserve System?

Now the Fed is engaged in a “non-exit” strategy with many analysts believing that the second round of quantitative easy will begin on Wednesday, the day after the mid-term elections. (No politics here!)

In preparation for any changes in monetary policy that might take place in the near future, we still need to get current with how the Fed has been behaving in the recent past.

Over the past thirteen-week period, the Excess Reserves held by commercial banks have declined by about $40 billion. This is consistent with the figures derived from the Federal Reserve data on the Federal Reserve’s H.4.1 release “Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks.” In terms of the actual data for the end of the banking week, the comparable figure, reserves with Federal Reserve Banks also declined by about $40 billion over the past thirteen weeks.

Over the past four-week period, however, the reserve balances at Federal Reserve banks rose by more than $26 billion, a number we shall examine below. The excess reserves held by banks also rose over this time period.

The banking system still remains very liquid although this seems to be just what the commercial banks want.

In terms of the money stock statistics, monetary growth actually increased at a relatively steady pace over the last thirteen weeks. The most closely watched measure of the money stock, the M2 measure, was rising at a year-over-year pace of 1.8% in July 2010. This year-over-year rate of growth increased to 2.8% in September and stands at about 3.0% near the end of October.

The year-over-year growth rate of the M1 measure of the money stock has also increase steadily into the fall. In July 2010, M1 was increasing at a 4.7% rate. This rose to 5.9% in September and was around 6.3% at the end of October.

Money stock measures are showing steady rates of increase and this is good.

The steady increase in the money stock measures seems to have been little affected by the transactions going on within the Federal Reserve’s balance sheet, and this is good.

The questions that need to be asked is what happened on the Fed’s balance sheet and why?

The first series of questions relates to the $40 billion decline over the past thirteen weeks in the reserve balances held by commercial banks in Federal Reserve banks.

This decline primarily comes from three sources. The first source is a rise in Currency in Circulation of over $19 billion. A movement like this reduces reserve balances as coin and currency is withdrawn by the public from commercial bank accounts. In the last three months the year-over-year rate of growth of currency held by the public has increased from 3.8% to 4.0% to 4.4%. This figure is high relative to the five years before the financial collapse in the fall of 2008 and the fact that it is rising is something to pay attention to. Currency in circulation does not usually go up in the fall season relative to July and August because cash needs are usually high in vacation periods but not in the fall when coin and currency is returned to the banking system.

The demand for cash can rise as people having financial difficulties transfer their wealth into cash balances so that they can pay for the necessities of life. This is not good.

Note that of the $19 billion increase over the last thirteen weeks, almost $9 billion of the increase came just in October. Keep a watch on this number.

The second source of the decline in reserve balances came from accounts on the Fed’s balance sheet related to “bail out” items. Almost $17 billion left the Fed’s accounts related to a decline in these “special” accounts. The Fed plans to allow these accounts to run off as these assets are worked out. Hopefully these accounts will continue to decline at a relatively steady pace.

The third source of decline came in the Fed’s portfolio of securities: specifically, the Fed’s portfolio declined by a little more than $15 billion in the thirteen weeks ending October 28, 2010. Of interest is the fact that the holdings of Mortgage-backed securities declined by more than $66 billion and the holdings of Federal Agency securities declined by almost $10 billion, a total of about $76 billion. The Federal Reserve replaced $61 billion of these securities through the acquisition of U. S., Treasury securities.

Note that the Fed is doing pretty much what it said it would do in this regard. The Fed said that as the portfolio of Mortgage-backed securities and Federal Agency securities declined, it would seek to offset this decline by the purchase of Treasury issues. This is another area that bears close attention in the up-coming weeks.

Finally, we look for an explanation of the $26 billion increase in Reserve Balances at Federal Reserve banks over the past four weeks. The primary mover here is operational in nature. The General Account of the U. S. Treasury at the Federal Reserve declined by about $31 billion during this period. This puts reserves back into the banking system. A movement in this account is usually associated with writing of checks at the Treasury, reducing tax monies that have been collected in the past. The Federal Reserve knows that a movement like this is going to take place and is therefore prepared to deal, operationally, with this drain on its balance sheet.

Very little change took place related to factors supplying reserve funds to the banking system. However, the Federal Reserve continued to see its portfolio of Mortgage-backed securities run off during this period (the portfolio declined by almost $28 billion) and Federal Agency securities (a $4 billion decline) run off. This run off was countered by purchases of U. S. Treasury securities which increased this part of the Fed’s portfolio by $26 billion.

The net decline in the securities portfolio was offset by other small movements in accounts so that factors supplying funds to bank reserves was relatively insignificant.

My interpretation of the actions of the Federal Reserve over the past quarter: basically a holding action. Overall, the money stock measures are showing small but steady increases in growth and this is a positive note. The thing to watch here is how much of the increasing growth rate in the money stock figures is related to a rising use of currency in circulation.

Otherwise, the Fed has been true to its statements (so far) in purchasing U. S. Treasury securities to roughly offset the regular runoff from the Fed’s portfolio of Federal Agency issues and Mortgage-backed securities. Obviously, if Quantitative Easy 2 is executed, the acquisition of Treasury issues will more than offset the runoff of these other securities. Stay tuned!

Interpreting the Recent Behavior of the Monetary Aggregates

All research seems to indicate that, over time and everywhere, inflation is a monetary phenomenon. If this is true then we need to take some account of monetary aggregates in the short run so as to better understand what is taking place and what the current situation implies for the future. Also, it seems as if interest in the monetary aggregates might be surfacing once again. (See my post, http://seekingalpha.com/article/217598-monetary-targets-a-fresh-take.)

Let’s look at the current situation beginning with the quarter that followed the start of the Great Recession, the first quarter of 2008. If one looks at the year-over-year growth rate of the M2 measure of the money stock, things look relatively benign. Growth remained modestly above 6% through the first nine months of

the recession, but rose to over 10% by early 2009. However, this did not signal that monetary policy was working even though the end of the recession has been dated as July 2009. In fact, in looking at all the other monetary measures one could discern some troubling behavior that might indicate a deeper recession and a very slow recovery.

For example, the behavior of this measure certainly did not track the performance of bank reserves or the monetary base. Through the first nine months of 2008, total reserves in the banking system averaged a little under 5%, year-over-year. In the second quarter of 2009, the rate of increase was over 1,800%! The monetary base performed in a similar fashion. For the first nine months of 2008, the monetary base grew around 2.5% year-over-year. This increased to more than 100% in the beginning of 2009.

Of course, we know the reason why these reserve aggregates grew so rapidly while the money stock measure picked up only modestly. Excess reserves in the banking system went from less than $2 billion in the second quarter of 2008 to over $800 billion in the first quarter of 2009. The Federal Reserve was supplying funds to the banking system. However, the banking system was just holding onto them!

There was another movement within the monetary aggregates that was also of interest during this time period. The growth of required reserves, the reserves the banks had to hold behind their deposits, rose throughout 2008 but not nearly at the pace of total reserves or the monetary base. Note, however, that the growth rate of the non-M1 component of M2 remained relatively constant throughout 2008 and 2009 which indicated that a lot must be happening within the M1 measure of the money stock.

Here we see that through the first six months of 2008, the M1 money stock hardly grew at all. However, starting in September 2008 which marked the beginning of the financial crisis, this measure took off and was growing by almost 17% in early 2009. Growth was mainly in the demand deposit component of M1.

Two things were happening here. First, interest rates fell dramatically in 2009; keeping money in interest bearing accounts at banks and thrift institutions did not make much sense. Second, as people lost jobs and the economic environment became more and more uncertain, people and businesses moved assets from less liquid vehicles to transaction balances (demand deposits and other checkable deposits) so as to be able to buy necessities and to pay bills.

It is very important to identify this behavior because it explains a lot about how people were using their wealth at this time and what kinds of pressures they were feeling. This information helps us understand why the economy is performing the way it is and what implications this kind of behavior has for the future.

Taking this analysis into 2010 we see that the growth rate of M2 drops off drastically to less than 2%, yet M1 continued to incease at rates in excess of 5%. This is because people continued to transfer funds from interest-bearing accounts into transaction accounts. This is supported by the information on the growth rate in required reserves which was still above 10%. Note, that because of this the Federal Reserve has needed to continue to supply more reserves into the banking system to handle this increase in required reserves yet maintain the extraordinarly high levels of excess reserves in the banking system, reaching more than $1.0 trillion in the fourth quarter of 2009.

What this indicates to me is that the behavior of people and of the business community has not changed much over the past two and one-half years. People are still scared. Because of the tepid economy, high unemployment, and the uncertainty about the future, economic units still prefer to put their funds into transaction accounts so that they can facilitate their needed expenditures. This kind of information does not give one much confidence.

Furthermore, this kind of behavior is not what is seen before economic recoveries pick up steam. And, with the M2 measure of the money stock growing below 2%, year-over-year, one can only conclude that money is not entering the economy in a way that will stimulate future business expansion. Only when bank loans begin to increase and, consequently, M2 begins to expand more rapidly, then, maybe, confidence in the recovery will grow.

To me, monetary information is very valuable in trying to understand what is happening in the economy and where the economy might be going. However, the analysis of monetary aggregates must not be the kind of “cookie-cutter” analysis done in the 1970s and 1980s. Good analysis of the monetary aggregates is very complex and must include some historical analysis with it.