The Federal Reserve continues to pump funds into the banking system. Reserve balances at Federal Reserve banks reached $1.3 trillion on March 2, 2011. This is up from $1.1 trillion on
February 2 and up from $1.0 trillion on December 29, 2010.
These balances serve as a relatively good proxy for the excess reserves in the banking system which averaged $1.2 trillion over the two-week period ending February 23, 2011.
As we have reported before, there are two drivers of this increase in bank reserves. The first, connected with the Fed’s program of quantitative easy, is the acquisition of United State Treasury securities.
Over the past four weeks the Federal Reserve has added almost $100 billion to its portfolio of Treasury securities. Only about $18 billion of these purchases were offset by maturing Federal Agency issues and mortgage-backed securities.
Since the end of last year, the Fed has added $220 billion to its Treasury security portfolio. In this case the Fed was replacing a $48 billion decline in the other securities that were maturing.
And, in the past 13-week period, Almost $320 billion were added to the Treasury portfolio, replacing about $80 billion in maturing Agency issues and mortgage-backed securities.
The second driver has been the action surrounding Treasury deposits with Federal Reserve banks. Since these deposits are a liability of the Fed, a reduction in these deposits increases reserves in the banking system. There are two important accounts here, the Treasury’s General Account and the Treasury’s Supplementary Financing Account.
The Supplementary Financing Account has been used for monetary purposes and in the current case, the Treasury has reduced the funds in this account by $100 billion. All of this reduction came in February.
The Treasury’s General Account is used in conjunction with Treasury Tax and Loan accounts at commercial banks and is the account that the Treasury writes checks on. Generally tax monies are collected in the Tax and Loan accounts and then are drawn into the Federal Reserve account as the Treasury wants to write checks. When the Treasury writes a check, it is deposited in commercial banks, so that bank reserves increase.
Over the past four weeks, the Treasury’s General Account has dropped by almost $70 billion. Thus, between this account and the Treasury’s Supplementary Financing Account the Fed has injected almost $170 billion reserves into the banking system in February.
I need to call attention to the fact that funds moving into and out of the General Account can vary substantially. For example, since the end of the year (which includes the February change) this account has only fallen by $39 billion. Over the last 13-week period, the account has actually increased by $4 billion. Tax collections build up toward the end of the year and then are spent during the first quarter of the year preparing for another buildup around April 15, tax collection time.
The bottom line, the Federal Reserve is seeing that plenty of reserves are being put into the banking system. But, the commercial banks seem to be holding onto the reserves rather than lending them out.
Still, the growth rates of both measures of the money stock seem to be accelerating. The year-over-year growth rate of the M1 measure of the money stock was growing by about 5.5% in the third quarter of 2010. The growth rate increased to 7.7% in the fourth quarter and is growing at a 10.2% rate in January 2011.
The M2 measure of the money stock has also accelerated, going from a year-over-year rate of increase of 2.5% in the third quarter to 3.3% in the fourth quarter to 4.3% in January.
On the surface these increases in money stock look encouraging in terms of possible future economic growth. However, we are still seeing the same behavior of individuals and businesses in the most recent period that we have observed over the past two years.
The growth rates of both measures of the money stock still seem to be coming from people that are getting out of short term “investment” vehicles and are placing these funds in demand deposits or other transaction accounts, or in currency.
The first piece of evidence of this relates to the reserves in the banking system. The total reserves in the banking system have remained roughly constant over the past year. Yet, the required reserves of the banking system have increased by 10% year-over-year. This situation could only happen if demand deposit-type of accounts, which require more reserves behind them, were increasing relative to time and savings accounts, which have smaller reserve requirements.
Looking at the individual account items we see that demand deposits at commercial banks rose at a 20% year-over-year rate of growth in January. The non-M1 part of the M2 measure of the money stock rose by only an anemic 3% rate. Thus, the substantial shift in funds from time and savings accounts to transaction accounts continues. There is no indication of a speeding up of money stock growth connected with the reserves that the Fed is injecting into the banking system.
An even more dramatic shift can be seen if we include institutional money funds in the equation and look at what has happened in the banking system over the past nine weeks. The non-M1 portion of M2 increased by $22 billion over this time period. However, funds kept in institutional money funds declined by roughly $40 billion. This means that accounts that Milton Freidman would have labeled “a temporary abode of purchasing power” actually declined by $18 billion since the start of the year.
Demand deposits and other checkable deposits rose by about $21 billion. One could note that currency in the hands of the public also rose by $16 billion.
The public continues to move money from relatively liquid short-term savings vehicles to assets that can be spent by check or cash. This is not the kind of behavior one gets in an economy that is confident and expanding. This behavior can roughly be called “defensive”.
So, another month has gone by. The Fed is aggressively executing its program of quantitative easing. Yet, it still seems to be “pushing on a string.” Why is it I retain the feeling that the Federal Reserve’s effort is just spaghetti tossing, seeing what might stick to the wall?
The longer this policy continues, the less confidence people seem to have in both Ben Bernanke and the Federal Reserve. I shutter to think what Bernanke and the Fed will do to us when the banking system actually does start lending again.
Note that some members of the Fed’s Open Market Committee are suggesting that QE2 end abruptly at the end of June when the current program is slated to expire. (See "Policy Makers Signal Abrupt End to Bond Purchases in June": http://www.bloomberg.com/news/2011-03-04/fed-policy-makers-signal-abrupt-end-to-bond-purchases-in-june.html.)
Does everyone in the Fed seem “tone deaf” to you? They just seem to act on pre-conceived ideas and have no sense or feel of the banking system and financial markets. Another confidence raiser.
Showing posts with label money supply. Show all posts
Showing posts with label money supply. Show all posts
Friday, March 4, 2011
Tuesday, December 7, 2010
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).
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).
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