Fed Repairing Its Balance Sheet: Not Inflationary

A lot of pundits expect inflation due to the Fed's moves to provide liquidity. Since banks aren't lending, this potential high-power money does not come into the money supply. In addition, velocity of money has been slowing. No surprise that we have been in a deflationary environment for a year. 

Yesterday the Fed released data on what reserves they hold. As you can see, the overall level of reserves has been flat for a year. Bernanke applied the Bagehot Remedy a year ago to stem the crisis, and in the process swapped solid reserves (Treasuries mostly) for all sorts of questionable paper held in the Maiden Lane structure. Since QE was announced, the Fed has been swapping out of those poor reserves and back into solid reserves (Treasuries again and govt-backed mortgages and agency paper). This chart shows how substantial the reduction has been in the Maiden Lane stuff. But the Monetary Base has remained flat for a year, and you can check out M1 and other money indexes as well. Not inflationary. 

Rather than being inflationary, this should have the impact of solidifying the quality of the reserves and therefore (eventually) the USD. The DX has bounced for the past two days on increasing volume, which might mark the Dollar Bottom, but it is too soon to confirm that. 

Providing liquidity after the secondary crisis after a credit bubble ("secondary" means not the stock market crash, but the inevitable banking crisis which comes after, which came in 2008 after the 2007 peak, and in 1931 after the late 1929 peak) is not inflationary; it is necessary to ameliorate the damage of the credit collapse.  

Comments

[john walker]

Excellent post; thank you.

[Mamma Boom Boom]

Here's link to add to this discussion: http://www.bloomberg.com/apps/news?pid=20601087&sid=aU4bDP7M0p.M

Also, my idicaors were slightly mixed tody, but pointing in the right direction.

[Brian]

Link?
I couldn't find anything on federalreserve.gov. Maybe I was looking for the wrong stuff.

[Brian]

Not related directly to this topic, but there is a lot of interesting data at:
http://data.newyorkfed.org/creditconditions/

[yelnick]

Brian, I added a couple of links, one to the Philly Fed and another to the Bloomberg summary of their report.

[Bollinger]

I have to disagree with a few things here.
M1 (which is monetary base + demand deposits + a few more things) is increasing with 18% 12 month rate, 12% 6 month rate and 13% 3 month rate. All which are extreme figures. Thus, M1 show an extreme increase. (cf FED H.16).
M2 (which is M1 + savings deposits, money market funds etc (i.e. money not used as quickly)) also increase but not as much. Only exception is the last 3 month which show -2.6%.

The reason that we don't see much inflation despite the strong increase in money supply is due to a reduction in money velocity. Thus, money is not used as quickly.

When the economy turns upp, velocity will increase and USD will have two digit inflation unless money supply is drastically reduced. The latter is sometimes called the FED exit strategy, and is so far undisclosed. Question is will FED have the guts to increase fed funds to 20% when the economy turns up again.

Total debt is increasing rapidly in the US. Dept related to housing is however falling, which is reasonable since house prices is declining. This decline is more than compensated by increase in public debt. Some figures:
* $60000 bil : total debt
* $2460 bil : total consumer credit
* $850 bil : commercial bank consumer credit

Banks do lend, but are not increasing volume since Q4 2008. Note that banks own only one third of consumer credit.

[song]

I really confuse by legend used, is it possible to have an arrow to point out which one is the moneny base. Can someone give me a formula on how money base is related to these items in balance. Can someone show me how much is the public debt of percent of GDP, Corp debt/GDP, personal debt/GDP. Compare these with 1929, 1987. The definition is important, otherwise, you will have people like Ken Fisher talking about we have too little debt.

[Eventhorizon]

Bollinger,

Not sure I follow:

"The reason that we don't see much inflation despite the strong increase in money supply ..." translates as
"The reason that we don't see much increase in the money supply despite the strong increase in money supply ..."
or
"The reason that we don't see much increase in prices despite the strong increase in money supply ..."?

I think you mean the last since inflation is always and everywhere a monetary phenomenon. Price changes are a function of (among other things) inflation, not the other way around.

So, in the end, it comes down to your definition of "money supply". In a fiat economy with fractional reserve lending you have to include credit in the money supply, M1 and M2 are not good measures - look up Hayek's definition, it seems much better to me. Then the issue becomes whether or not the increase in monetized public debt is offset by the decrease in private debt.

I find it hard to believe that a trillion dollars of monetized government debt even comes close to off-setting the collapse of private credit (which is of the order of 10's of trillions). Hence we are experiencing deflation (certainly of the type I have been expecting). Of course, since banks are now free to use fictitious values for the debt they carry, we will never know the true answer to the question.

[Bollinger]

Eventhorizon,
yes, you are right. The second alternative is what I did mean. (Usually people use the word inflation to mean general increase in price level. The Mises adepts, however, mean increase in money supply. I would prefer reduced value of the currency).

The effect of FRB is seen in M1. M1-M0 is credit. What you miss with M1 and M2 is securitization of debt. You could buy a house with borrowed money and it dosn't have to show up in M1 or M2.

I would say that M1 is probably a good enough measure (with M1 based velocity) to use when it comes to discussion about inflation. The reason for this is that M1 is the money that people use for almost all transactions.

Securitized debt is rather slow money. Often bound to 5-10 years. We should probably not use the term money for something that is not availble within a few days. Strictly speaking only M0 is money.

The most resent measure I have seen on total debt did include Q1 2009, and there total debt was rapidly increasing. (That is, the same increase as for the last years).
I don't know where the talk about credit reduction comes from. It has not been possible to find in any statistics.

[marck]

You are right - the dollar has bottomed for now.
Using basic triangle technical analysis rules the dollar was to stop at 76 cents then go up, which it did exactly. I believe we bottomed to form the left shoulder of an inverted head and shoulders. The fascinating thing is how the market value for the dollar and equity markets are closely interwoven. I really believe the rally is fake and brought on by the Federal Reserves virtual firms like Goldman Sachs. Since those that jumped on the train are mostly speculative short term investors plus there are very few short sellers to momentarily take profits on corrections, the markets are going to plunge with significant force when the Fed sells to "save the dollar".