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. 

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.

Federal Reserve Exit Watch: Part 8

Looking at the Federal Reserve statistics these days is rather boring. As has been reported over the past month or two, the Fed has gotten its balance sheet in position for the “great undoing.” And, now it is just waiting.

One can divide the Fed’s balance sheet into three components: the “regular” portion which is roughly equivalent to the asset side of the balance sheet of the Fed in the “good old days”; the portion of the balance sheet that consists of line items related to the “new” facilities created to combat the financial collapse; and the “liability” side of the balance sheet which includes Treasury deposits and reverse repos, the account the Fed has stated it will use in the “undoing” of the excess reserves it has injected into the banking system.

The “regular” portion of the Fed’s statement now represents over 90% of the assets of the central bank. Almost $2.0 trillion of these assets are in the form of securities that the Fed has purchased on the open market and holds outright. The only real movement here is in the Fed’s holding of mortgage-backed securities which, on March 3, 2010, amounted to slightly more than $1.0 trillion. The Fed has stated that this account will reach $1.25 trillion by the end of March.

The Federal Reserve has added, net, $175 billion of the mortgage-backed securities to its portfolio over the last 13-week period, roughly $70 billion in the last four weeks.

In terms of the “new” facilities, the Fed is letting these items run off as the assets run off, are written off, or are sold. Over the last 13 weeks, since December 2, 2009, these accounts have declined by slightly more than $100 billion. Over the past month, since February 4, 2010, they have declined by $30 billion.

Overall, therefore, the Federal Reserve has supplied roughly $76 billion to the building of reserve funds over the last 13 weeks and slightly more than $30 billion over the last 4 weeks. Rather a non-event if you ask me.

In terms of factors absorbing reserve funds, the interesting item here is the Supplementary Financing Account of the United States Treasury. I wrote about this account on February 24, 2010 for it seems to be something that the Fed/Treasury is also planning to use during the “undoing”. For more on this see my blog post: http://seekingalpha.com/article/190404-the-treasury-s-latest-maneuver-with-the-fed.

What has happened in this account is that it has been increasing. It reached a low early this year at $5.0 billion, as the Congress had to approve an increase in the federal debt limit. Since February 4, 2010 this account has increased by $20.0 billion. The Federal Reserve announced that an agreement had been reached with the Treasury Department that the Fed will borrow $200 billion from the Treasury and leave the cash on deposit at the central bank. As explained in my post, this borrowing will be used by the Fed to help it “undo” excess reserves in the banking system. It seems as if the Fed is starting to build up this facility slowly so as not to be disruptive to the banking system.

If we combine all the factors supplying reserve funds to the banking system and factors absorbing funds from the banking system we find that commercial bank’s Reserve Balances with Federal Reserve Banks increased by roughly $70 billion in the last four weeks and over the last 13 weeks: thus, very little changed in the banking system over the last quarter of a year.

If we look at the statistics from the banking system itself, we see that excess reserves in the banking system rose by about $110 billion.

What the Fed did, as it has for an extended period of time now, went directly into the excess reserves of the banking system. Commercial banks, as a whole, are just sitting on their hands and doing nothing. This allows the Fed to do all its repositioning in order to prepare for the “great undoing” without throwing any more uncertainty into financial markets.

The Federal Reserve is still “sitting on the fence”. Its dilemma is that the banking system still remains extremely week…except, of course, for the big banks. For more on this see two of my recent posts: “The Struggles Continue for Commercial Banks”, http://seekingalpha.com/article/190191-the-struggles-continue-for-commercial-banks, and, “The Banking System Continues to Shrink”, http://seekingalpha.com/article/188566-the-banking-system-continues-to-shrink. The Fed cannot move too fast to remove excess reserves from the banking system for fear that this “undoing” may result in many more bank failures among the small- to medium-sized banks.

Of course, the economy remains weak and the Fed has used this excuse for not removing reserves from the banking system and raising short-term interest rates. This may be a cover for their real concern over the systemic weakness of the small- and medium-sized banks in the United States.

On the other side there is the continuing fear over the possibility that sooner or later the excess reserves in the banking system will turn into bank loans which will result in an expansion of the money stock measures which will result in a worsening of inflation. With over $1.1 trillion in excess reserves in a banking system that used to carry less than $100 billion in excess reserves there is substantial doubt that the Fed can smoothly remove all of these reserves thereby preventing possible inflation or even hyperinflation. Nothing like this has ever been experienced in history before.

So, we sit and wait.

The good news is that things within the banking system seem quiet now. The FDIC continues to close banks without major disruptions to banking markets or local economies. The focus of financial markets seems to be on Greece, Spain, Italy, the Euro, and California, New York and other political entities. That is good for the banking system!

Some have pointed to a potential problem arising from the sale of assets recently conducted by the FDIC. The argument is that now that these assets have a price, will other banks have to “mark-to-market” similar assets that they carry on their balance sheet? And, if they have to mark these assets to market, will this speed up the number of banks actually failing or force banks that seem to be doing OK into insolvency?

In the circumstances we now find ourselves, boring is good! Let’s hope it stays boring. Or hope that the situation becomes even more boring.

Federal Reserve Exit Watch: Part 5

Something new this week: the Fed started to see how the financial markets would accept its strategy for reducing the size of its security portfolio. At the close of business on Wednesday December 9, 2009 the Federal Reserve showed $180 million on its balance sheet under the line item “Reverse repurchase agreements”.

The Federal Reserve had warned us that it was going to start “testing” the use of reverse repos as the mechanism for reducing the size of its securities portfolio. It had also informed us that a “test period” would begin last week.

It has begun, albeit in a very small amount.

Reserve balances with Federal Reserve Banks changed by only an insignificant amount last week.

Reserve balances did rise over the past 4 weeks and the past 13 weeks. In the last 4-week period reserve balances rose by a little more than $60 billion, $52 billion coming from factors supplying reserves and a negative $10 billion from factors absorbing reserves.

The $52 billion increase in factors supplying reserves was centered on an $85 billion increase in securities held outright ($79 billion in Mortgage-backed securities and $6 billion Federal Agency securities) and a $36 billion reduction in two accounts associated with the insertion of funds into the banking system early in the financial crisis last year. The Term Auction Credit Facility (TAF) dropped by almost $24 billion in the last four weeks and Central Bank Liquidity Swaps fell by about $13 billion.

The rest of the items connected with the innovative market facilities that the Fed created during the time of financial distress changed very little.

So the “Special Facilities” continue to wind down and the Fed continues to substitute marketable securities in its portfolio for the funds that were injected into the banking system to stem the crisis.

In terms of factors absorbing reserves at this time, the general account of the U. S. Treasury Department, its operating account at the Fed (it pays its bills out of this account), dropped by about $8 billion and this added reserves to the banking system and was the primary factor in the additional $10 billion increase in Reserve Balances mentioned above. The Treasury writes checks, they get deposited in banks, and bank reserves increase.

Over the longer term, the last 13 weeks, the government accounts have played a big part in the injection of reserves into the banking system. There is an account titled “U. S. Treasury, Supplemental Financing Account” which has been around since October 2008 (and reached a maximum of about $560 billion in November 2008 (Connected with TARP?). This account declined by $185 billion over the last 13 weeks.

The U. S. Treasury general account rose by $51 billion during this time, apparently the funds from the supplemental account were transferred to the general account so that they could write checks on it. Consequently, the net of the two, $134 billion got into the banking system and ended up as a part of Reserve Balances with Federal Reserve Banks.

During this 13-week period, the Fed also supplied $100 billion in reserves to the banking system through open-market purchases. To do this the Federal Reserve added $281 billion to the securities that it bought outright. The purchases were across the board: $229 billion in Mortgage-backed securities; $33 billion Federal Agency securities; and $19 billion in Treasury securities.)

The run-off in the special accounts over the past 13 weeks is obvious. The Term Auction Credit Facility (TAF) declined by $126 billion and Central Bank Liquidity Swaps fell by $45 billion, a total of $171 billion.

Primary bank loans from the discount window also fell by $10 billion so, over the past 13-week, period the Fed supplied reserves by buying $281 billion in securities and this was offset by a decline in “crisis” accounts of $171 and $10 in bank borrowing so that $100 billion additional funds reached Bank Reserves.

Conclusions:

1. The Federal Reserve continues to let accounts connected with the financial crisis run off. This appears to be going along quite smoothly.
2. The Federal Reserve continues to substitute funds from open-market purchases to replace the funds that are running-off. This appears to be going along quite smoothly.
3. The Fed is now testing the mechanism, Reverse Repurchase Agreements, by which it means to reduce its portfolio of securities and drain excess reserves from the banking system. The first test went along quite smoothly.
4. The U. S. Treasury supplemental financing account is now just $15 billion and will probably not be a big factor in changing bank reserves in the future.
5. The Federal Reserve is going to be facing a lot of “operating factors” over the next month that may cloud up any other actions that the Fed may be taking. These “operating factors” relate to government deposits and the increased use of currency in circulation during the holiday season. These disruptions should end by the middle of January 2010.

Note: Excess Reserves in the banking system still are running above $1.1 trillion. There is little evidence yet that banks want to do anything with these reserves other than hold onto them: this, in spite of the efforts of the Obama administration to get banks lending, especially to small business.