Since the beginning of the year, the US monetary base (MB) has increased $912 billion or just over 34%. The monetary base is the basest form of money. MB includes currency that is circulating in a country plus commercial bank reserves (required and excess) that are maintained in the central bank. The difference between the monetary base and M1 money supply is that M1 does not include bank reserves. M1 besides including notes and coins in circulation also includes travelers cheques, demand deposits (chequing accounts) and other demand type deposits. M1 has grown by 8.7% since the end of 2012. But that growth is slightly misleading as M1 peaked with the report of July 29, 2013. Since then M1 has actually declined by about 1%. The decline has been primarily in demand deposits.
The same is being seen with M2. M2 is M1 plus savings accounts, time deposits under $100,000 and money market accounts. M2 has grown only 2.9% in 2013 a rather slow rate of growth. During the 1990’s boom M2 typically grew from 5% to 7% annually. When one looks at money velocity a measure of how rapidly money is turning over in the economy one can’t help but note that money velocity for both M1 and M2 is falling. M1 money velocity is at levels seen back at the depths of the early 1990’s recession. M2 money velocity is at record lows since they started calculating it in the late 1950’s.
Since February 2006, the Fed no longer reports M3. Data today comes courtesy of groups like Shadow Government Stats who continue to track it from various sources. M3 is M2 plus large term deposits of institutions, institutional money market funds and repurchase agreements. M3 has grown roughly 3% in 2013. During the 1990’s M3 was typically growing by 10% or more annually.
The slow growth of money supply (M1, M2 and M3) is more indicative of a slowing or slow growing economy not a booming economy. Money supply growth has not yet turned negative.
I don’t know whether the Fed considers monetary growth when it makes its decisions as to whether to “taper” or not to “taper”.But low monetary growth is not particularly positive for the economy. Since the financial crisis of 2008, the Fed has pumped its balance sheet by almost $3 trillion. The Fed’s balance sheet holds $1.3 trillion of mortgage-backed securities (MBS) of questionable worth. Most of the rest of the portfolio is US Treasuries. It has been rumoured that the Fed has been purchasing roughly 70% of the US Treasury debt issues. Despite QE and the Fed’s hand in monthly bond auctions long term interest rates have been rising. That is not what one would expect given the level of Fed support to the US Treasury market.
Despite all of this purchasing of US Treasuries ten year Treasury notes recently hit just shy of 3% up about 140 basis points since the lows of 2012. And this is currently with the Fed purchasing $40 billion a month of US Treasuries through QE. If they actually did “taper” what would interest rates do? The conventional wisdom is that they would most likely rise further. Foreign buyers have slowed their purchase of US Treasuries and domestic buyers are unable to absorb much more than they are already purchasing.
An additional 1% in interest rates costs the US Treasury an extra $200 billion a year. The reality appears to be that the Fed cannot afford to “taper” because of the potential cost to the US Treasury and what it would do to the US deficits. Given the US is in the midst of the debt ceiling debate and it is believed that D-day is October 17 imagine if the US were not able to come to an agreement over the debt ceiling and were forced to default. Interest rates could rise even more.
The September FOMC was barely over and once again the market was speculating as to whether the Fed would “taper” at the October meeting. The markets initially reacted positively to the FOMC announcement of no “taper” then immediately pulled back again on speculation that instead it will happen at the October FOMC. But if one thinks about it considering all the build-up to the September FOMC the announcement of no “taper” was in effect an admission that things are not going as well as the Fed would like. Given the monetary numbers the odds of the Fed “tapering” at the October FOMC or for that matter the November or December FOMC is low to nil. Some even speculate that instead if the deficit and debt ceiling debate goes wrong they might even have to increase QE.
The Fed’s announcement of no “taper” at the September FOMC saw the US$ fall. The US$ may be the sacrificial lamb. As well it could be an attempt by the Fed to lower the cost of US debt in real terms. However, given the US’s dependency on imports the cost to the US could rise as imports become more expensive. Rising long-term interest rates coupled with a falling US$ is negative for foreign holders of US Treasuries. And it is negative for the US economy.
The Fed is effectively caught in a trap of its own making. Continuing QE is negative for the US$ and potentially inflationary in the long run even if in the short run it continues to help push the US stock market higher. Pulling back on QE or “tapering” could result in a falling stock market and rising interest rates. As well given the slow growth of the US economy “tapering” or ending QE could push them back into recession. The path of least resistance is to continue QE. Bernanke’s term is up in January and he may well wish to leave the problem of what to do about QE to his successor. QE has it would appear only allowed the US economy to muddle along. One can see that in the slow growth of the money supply. Without QE the economy would most likely soften and money growth would most likely soften even further.
The Fed is “damned” if they do and “damned” if they don’t. And in the end, it most likely is going to end badly.
Copyright 2013 All Rights Reserved David Chapman
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