Even After All The QE, The Money Supply Is Still Shrunken

Here are the broadest measures of the US money supply, M3 and M4 as estimated by the Center for Fiscal Stability:

Charts6_amfm1

With the total money supply still at an absolute level lower than its 2008 peak, it is obvious that the Federal Reserve in tripling the monetary base — an expansion by what is in comparison to other components of M4 a relatively small amount — has been battling staggering deflationary forces. And with the money supply still lower than the 2008 peak and far-below its pre-2008 trend, the Fed is arguably struggling in this battle (even though by the most widely-recognised measure, the CPI-U the Fed has kept the US economy out of deflation). 

Those who have pointed to massively inflationary forces in the American economy based on a tripling of the monetary base, or even expansion of M2 clearly do not understand that the Fed does not control the money supply. It controls the monetary base, which influences the money supply but the big money in the US economy is created endogenously through credit-creation by traditional banks and shadow banks. The Fed can lead the horse to water by expanding the monetary base, but in such depressionary economic conditions it cannot make the horse drink.

What does this imply? Well, either the monetary transmission mechanism is broken, or monetary policy at the zero bound is ineffectual.

What it also implies is that hyperinflation (and even high inflation) remains the remotest of remote possibilities in the short and medium terms. The overwhelming trend remains deflationary following the bursting of the shadow intermediation bubble in 2008, and to offset this powerful deflationary trend the Fed is highly likely to have to continue to prime the monetary pump Abenomics-style into the foreseeable future.

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30 thoughts on “Even After All The QE, The Money Supply Is Still Shrunken

  1. The chart shows that the broadest of the M’s increased on the order of 50% during the 5 year period from 2004 to 2009. The analysis shows that much or even most of this increase was caused by credit expansion based on junk securities and provided by shadow banking practices. When the bubble was burst, and it was shown that these securities were worthless or near about, was it really fear of money supply “deflation” back to say a level reached in 2005, which lead to the Feds’ actions? Or was it just crony capitalism in a very base form? Whatever, the assets created by the Fed and which are currently held in reserves at the Fed now belong to private parties and the music plays on.

    • The chart shows that the broadest of the M’s increased on the order of 50% during the 5 year period from 2004 to 2009. The analysis shows that much or even most of this increase was caused by credit expansion based on junk securities and provided by shadow banking practices. When the bubble was burst, and it was shown that these securities were worthless or near about, was it really fear of money supply “deflation” back to say a level reached in 2005, which lead to the Feds’ actions? Or was it just crony capitalism in a very base form?

      For what it’s worth, the pre-existing trend in growth in M4 up to 2009 had been going on since the 1970s, so it wasn’t just a very recent thing.

      Is it cronyism that favours a tiny minority of bankers, financiers, etc? Sure. But was it consistent with the Fed’s price stability mandate? Yes it was. Personally, I think that if the Fed is going to engage in these kinds of operations in future, it needs a different transmission mechanism that doesn’t favour the financial sector.

      • The “Greenspan Put” was established in 1987 and has been continued in spades by Bernanke. It wasn’t and isn’t about “price stability.” (Granted, Its apologists use the lack of price inflation as measured by a favored index as evidence that it does no harm.) It is all about protecting and bailing out the Fed’s friends from the business cycle and credit crunches.

  2. Do you still believe that deflation has been abolished? Your hypothesis below seems to indicate a catastrophic mass default is in the cards. Would that catastrophe result in currency collapse (aka hyperinflation?)

    “How long can America and the world kick the can? As long as the productive parts of the world — oil exporters, and goods manufacturers — allow the unproductive parts of the world — consumers and “knowledge economies” — to keep getting a free lunch. Keynesian economics didn’t abolish defaults in the long run — it just succeeded at making mass defaults much less frequent. My hypothesis is that it also made these moments of default much more catastrophic.”

    http://azizonomics.com/2011/10/31/the-abolition-of-deflation/

    • Do you still believe that deflation has been abolished?

      Without all the QE, it’s foreseeable that deflation would have been much greater than it has been. Fundamentally, the Fed’s mandate is still the abolition of deflation, and that’s still the goal, and Bernanke is just about holding actual price deflation (as opposed to deflation of the money supply) at bay.

      How long can America and the world kick the can? As long as the productive parts of the world — oil exporters, and goods manufacturers — allow the unproductive parts of the world — consumers and “knowledge economies” — to keep getting a free lunch.

      This is still true, but maybe I underestimated the desire of the manufacturing nations to not rock the boat and get into wars, trade wars or proxy wars. After all, they’re amassing a lot of power and wealth just the way things are. The trend is their friend — why blow things up by starting trade wars? And maybe if America makes the best use of the current situation by using technology to create self-sustainability, and so long as mutually assured destruction is still functional then both sides can gain from the trade. But historically these kinds of relationships between manufacturer-creditors and consumer-debtors don’t have a great record at all. They very often result in trade wars and hot wars. This is a very touchy situation, and a very risky one geopolitically.

      Keynesian economics didn’t abolish defaults in the long run — it just succeeded at making mass defaults much less frequent. My hypothesis is that it also made these moments of default much more catastrophic.

      I think I made an error calling it Keynesian economics when really the reinflation Bernanke is undertaking (and the historical use of monetary policy to avoid deflation post-WW2) is fundamentally monetarist — it comes from the recipe book of Friedman and Schwarz. Keynesianism (in this sense, direct government purchases to fight deflation) has really taken a secondary role.

      But I still absolutely agree that monetary interventionism has made mass defaults and widespread deflation much less frequent. The question is how much less frequent. Under the gold standard it was a once-every-ten-or-twenty-years type of thing. Has monetary interventionism made it a once-every-20-or-50-years thing? Once-every-50-to-100-years? Once-every-1000-years? Longer? It’s difficult to say, but basically it has meant that deflationary mass-defaults will happen for nonmonetary reasons, i.e. if a crisis occurs that the central bank cannot control. For example, how can a central bank prevent a physical crisis like a natural disaster, an energy shock, or a war? It can mitigate the monetary factors either by tightening or loosening, but it can’t prevent the actual events. 2008 where deflation was swiftly reversed rather than completely prevented was just the result of a very big credit bubble. How bad could things get in a crisis that cannot be offset just by throwing money at the problem? It’s hard to say.

      This is very much like the forest fire hypothesis from Spitznagel and Taleb. By intervening to halt forest fires, the result is that a buildup such that when a fire that the interventionist cannot prevent occurs, it is on a much greater scale than the ones experienced under a natural cycle. My hypothesis is that large scale monetarist interventionism may have a similar problem. But we don’t know how frequently the uncontrollable fires will occur. My hope is that we transition to a more decentralised model through technology (solar and wind energy, 3d printing/nanomanufacturing, internet, etc) so that when such a shock comes its effects are diffused and not concentrated.

  3. There is an interesting contrast between the expansion and collapse of fiat money (printed paper and its analogs) and that of credit money.

    While fiat money is expanding, it tends to drive up measures like the CPI because the money goes everywhere. However, when credit money is expanded, it can be kept out of the hands of the poor in most areas — one does not loan much money to the poor — so a CPI-like measurement may not reflect the expansion, at least not immediately. The money flows into the things the rich buy or invest in: stocks, precious metals, big real estate, collectibles.

    When people lose faith in the money system, there is also a difference. When they lose faith in fiat money, more and more of it is required to buy or rent goods and labor. Inflation ensues. Governments are confronted with the alternatives of printing every more money, or of withdrawing the money and allowing the economy to seize up.

    However, when people lose faith in credit money, it simply disappears, and we observe deflation, often radical deflation, as in the crash of the housing bubble beginning in late 2005.

    At present, I suppose we are observing a mixed collapse of both fiat and credit money. Whereas it was obvious in the early Naughties that the housing bubble was going to collapse at some point and take much with it, it is not so obvious what will happen now, other than increased volatility. Unpredictable exogenous influences on markets and other elements of the economy, like political upheaval, may become very important. I expect that eventually it will be possible to run the printing presses hot enough to fully compensate for the disappearance of credit and bring about the strong inflation which many seem to desire.

    • While fiat money is expanding, it tends to drive up measures like the CPI because the money goes everywhere. However, when credit money is expanded, it can be kept out of the hands of the poor in most areas — one does not loan much money to the poor — so a CPI-like measurement may not reflect the expansion, at least not immediately.

      For what it’s worth, during the contraction of credit-money/shadow-money and the growth of the monetary base since 2008, inflation has by the BPP (a much better inflationary measure than CPI) been pretty subdued.

  4. If you happen to drive your vehicle over a 1000′ high precipice, does it matter whether it flips end over end, or spins clockwise/counter-clockwise on decent, or just that upon impact, the vehicle/contents are destroyed?

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  6. Off-topic, but I think perhaps it’s time to do a post on Anders Borg and Sweden’s success with tax cuts and reducing spending. Many lessons for France and Spain and their awful figures today.

    “Since becoming Sweden’s finance minister, Borg’s mission has been to pare back government. His ‘stimulus’ was a permanent tax cut. To critics, this was fiscal lunacy — the so-called ‘punk tax cutting’ agenda. Borg, on the other hand, thought lunacy meant repeating the economics of the 1970s and expecting a different result.

    Three years on, it’s pretty clear who was right. ‘Look at Spain, Portugal or the UK, whose governments were arguing for large temporary stimulus,’ he says. ‘Well, we can see that very little of the stimulus went to the economy. But they are stuck with the debt.’ Tax-cutting Sweden, by contrast, had the fastest growth in Europe last year, when it also celebrated the abolition of its deficit. ”

    http://www.spectator.co.uk/features/7779228/swedens-secret-recipe/

    • Sweden been cycling between 6% and 9% unemployment for last three years:

      Real GDP per capita nothing to write home about, not significantly better than other Western nations:

      What Sweden has succeeded at doing is bringing down its debt load:

      Such a low debt-to-GDP ratio would seem to indicate a lot of fiscal slack.

      But this hasn’t actually led to any more fiscal slack than other Western countries with their own currency (Britain, Japan, USA) at least as measured by interest rates:

      So I’m struggling to see why we should hold Sweden up as a successful model. Certainly they have a superficially good-looking debt-to-GDP ratio, but that hasn’t translated into super growth, low unemployment or reduced borrowing costs.

  7. Aziz – and what is the REAL rate of unemployment in the States? It’s surely not what they say it is.

    John S – “Three years on, it’s pretty clear who was right. ‘Look at Spain, Portugal or the UK, whose governments were arguing for large temporary stimulus,’ he says. ‘Well, we can see that very little of the stimulus went to the economy. But they are stuck with the debt.’

    Great post and, yes, they ARE stuck with the debt.

    • If the unemployment rate is massaged in one Western country, we must assume that it is in all of them, as they all have comparable methodologies. Personally, I prefer the methodology of prime employment-population ratio to metrics like U3 and U6, but this is not entirely relevant. The point is that by comparable methodologies Sweden has crappy unemployment, crappy growth, and comparable lending costs. Sweden is no paradigm for economic health.

      • Seasonally adjusted unemployment in Sweden is under 8%. With declining birthrates for over a decade their population is increasingly made up of emigrants and refugees who are largely unemployed or under-employed and collecting welfare, but counted in their unemployment statistics. Excluding Germany their GDP growth is the highest in europe -even with their ridiculous immigration policies and their socialist/welfare state, so Borg must be doing something right. No?

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  9. With the advances in technology/mechanization and a global labor glut holding down wadges, nearly 50% of US residents subsidized and indexed for inflation, asset bubbles are the only stimulus available… This is a symptom of globalization/centralization. Workers need a raise… if private sector ignores this it begs for more world government wealth redistribution and and will dampen confidence in free enterprise even more. This is the new economics of diluting poverty in response to the crony capitalists concentrated wealth. Western Democracies and all who value personal and economic freedom will see this as the trend continues until all the worlds population is economically indexed…… Sweden just happens to be insulated enough to appear like a winner at this moment in time.

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  15. Thank you for the good writeup. It in fact was a amusement
    account it. Look advanced to more added agreeable from you!

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  18. Excellent observation. “Print money” began as a *figurative* expression to describe QE. But it seems lots of people believe it to be a literal expression, that the Fed (literally) hits a button and accelerates the printing presses. That’s the root of the confusion among both the punters and pundits, it seems to me.

  19. Jobs, without jobs people cannot borrow and invest the banks money. The stimulus package was supposed to be pure Keynesian economics, with large unemployment, the government borrows and puts the unemployed to work, upgrading the public infrastructure. While some politicians claim they know economics and use the name of a scientist like economist John Maynard Keynes, their execution is abysmal, i.e. 800 billion stimulus investment wasted.

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