Author Topic: M2 Money supply growing at 28.4%  (Read 9818 times)

LearningMachine

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Re: M2 Money supply growing at 28.4%
« Reply #20 on: January 05, 2021, 10:51:46 PM »
^wabuffo's answer is excellent. There's a visual complement:
https://www.youtube.com/watch?v=lK_rYS8L3kI
In my limited understanding, velocity has been going down for a while and M1 (and M2) don't include reserves (required and excess).

Thanks Cigarbutt for the visual complement :-).

Federal Reserve Bank of New York agrees with you at https://www.newyorkfed.org/aboutthefed/fedpoint/fed49.html:
Quote
The narrowest measure, M1, is restricted to the most liquid forms of money; it consists of currency in the hands of the public; travelers checks; demand deposits, and other deposits against which checks can be written. M2 includes M1, plus savings accounts, time deposits of under $100,000, and balances in retail money market mutual funds.

I think what wabuffo seems to be saying is that part of the deposit accounts at banks are somehow required to be held at the Federal Reserves such that customers can't access their deposits??  Trying to understand wabuffo's point deeper and get authoritative sources with questions in post above.
« Last Edit: January 05, 2021, 11:03:43 PM by LearningMachine »


bizaro86

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Re: M2 Money supply growing at 28.4%
« Reply #21 on: January 06, 2021, 12:03:23 AM »
I think the consensus appears to be that the Fed expanding its balance sheet (aka printing money) doesn't cause inflation. That doesn't seem intuitive to me, but Wabuffo's points seem logical and well thought out. It also matches with recent history from an empirical stand point. As there has been significant QE but no significant inflation.

I'd like to invert this with a question (selfishly to aid my own understanding). What would cause inflation? We know inflation is possible because it has happened in the past.

Would it require the velocity of money to go up? What if the fed stopped balancing its assets and liabilities and just started writing cheques to the treasury with no offset. I believe that would effectively expand the money supply?

Sunrider

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Re: M2 Money supply growing at 28.4%
« Reply #22 on: January 06, 2021, 02:15:29 AM »
Think of it like this

You magically get the Fedís money printing press (well computer these days) and print yourself 10tn real dollars, i.e. there is no dispute that they are real valid can be spent etc.

Does that cause inflation? No, not as usually defined. It will only drive up the price level if
A - you start spending them on stuff (and ideally faster than stuff can be supplied) or
B - People think you are going to spend them and start raising / paying higher prices in anticipation.

Same thing here, just putting newly created money into fed reserves for the banks doesnít create inflation as long as people donít adjust their expectations or the money actually does go start cycling in the economy. What does that mean? The banks would have to convert those reserves into loans to customers, who then spend the money. So far it seems they only have loaned to financial investors and thus financial assets have inflated... and the public has not (yet?) begun to believe that prices might rise.

(Thereís a technical point in the above in that you can argue that the creation of these new dollars alone makes all existing dollars worth less in terms of real goods ... a bit like it used to be when the dollar was pegged to gold - then it was more obvious as the quantity of money was (nearly) fixed. ... it just seems that people generally donít think about it as an exchange of two things anymore and so have not adjusted their price expectations).

What Wabuffo and Hunt are also saying, I think, is that if the fed liabilities become legal tender, the. All bets are off, because at the moment the money being printed basically just turns extant debt from one form (government treasuries) into another (fed deposits). That shortens the maturity and should push banks to seek higher yields on these assets.

JRM

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Re: M2 Money supply growing at 28.4%
« Reply #23 on: January 06, 2021, 03:54:30 AM »
What Wabuffo and Hunt are also saying, I think, is that if the fed liabilities become legal tender, the. All bets are off, because at the moment the money being printed basically just turns extant debt from one form (government treasuries) into another (fed deposits). That shortens the maturity and should push banks to seek higher yields on these assets.

That's the key.  Up to this point quantitative easing has been bolstering bank reserves.  The banks are still the gate keeper for lending the money out.  When money is lent out it increases the M1 money supply, but is also deflationary in the sense that it must be paid back.  Helicopter money, like PPP loans that don't need to be repaid and stimulus checks, should kickstart CPI inflation. 
« Last Edit: January 06, 2021, 04:10:06 AM by JRM »

mattee2264

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Re: M2 Money supply growing at 28.4%
« Reply #24 on: January 06, 2021, 04:43:06 AM »

 Yeah I think large budget deficits accompanied by a recovery of private sector spending could do the trick with higher commodity prices and supply constraints adding some fuel to the fire.

bizaro86

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Re: M2 Money supply growing at 28.4%
« Reply #25 on: January 06, 2021, 07:48:37 AM »
Think of it like this

You magically get the Fedís money printing press (well computer these days) and print yourself 10tn real dollars, i.e. there is no dispute that they are real valid can be spent etc.

Does that cause inflation? No, not as usually defined. It will only drive up the price level if
A - you start spending them on stuff (and ideally faster than stuff can be supplied) or
B - People think you are going to spend them and start raising / paying higher prices in anticipation.

Same thing here, just putting newly created money into fed reserves for the banks doesnít create inflation as long as people donít adjust their expectations or the money actually does go start cycling in the economy. What does that mean? The banks would have to convert those reserves into loans to customers, who then spend the money. So far it seems they only have loaned to financial investors and thus financial assets have inflated... and the public has not (yet?) begun to believe that prices might rise.

(Thereís a technical point in the above in that you can argue that the creation of these new dollars alone makes all existing dollars worth less in terms of real goods ... a bit like it used to be when the dollar was pegged to gold - then it was more obvious as the quantity of money was (nearly) fixed. ... it just seems that people generally donít think about it as an exchange of two things anymore and so have not adjusted their price expectations).

What Wabuffo and Hunt are also saying, I think, is that if the fed liabilities become legal tender, the. All bets are off, because at the moment the money being printed basically just turns extant debt from one form (government treasuries) into another (fed deposits). That shortens the maturity and should push banks to seek higher yields on these assets.

That makes sense - thanks!

Does increasing bank reserves increase the banks capacity to lend? I suppose they would be limited by the amount of risk weighted assets their equity can support. In that case the Fed taking treasuries in exchange for fed deposits probably isn't inflationary, but the Fed taking junk bonds might be, as more equity would be required to support $1 in junk than $1 in fed deposits, meaning excess equity is available to support new loans.

If that's true, then is the limit on money supply in the real economy bank equity?

DooDiligence

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Re: M2 Money supply growing at 28.4%
« Reply #26 on: January 06, 2021, 07:52:35 AM »
Seems to me that money supply would be a reaction to inflation.

Tight labor, plus supplies of desirable products not meeting demand = higher prices.
More money is needed to support the increased value cost of everything.

There's no problem with supplies of most commoditized inputs,
and no shortage of labor and the ability to shop for both, worldwide.

ATM, there does seem to be a shortage of finished goods in many categories (example: WalMart shelves), but that's more a result of business shut downs or limits in their operations due to the pandemic.

I'm not very well versed on Fed / Treasury operations & it all seems a bit odd but I get that its purpose is to ensure clearance of payments in our system. So as long as there are no liquidity problems?
« Last Edit: January 06, 2021, 10:20:48 AM by DooDiligence »
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wabuffo

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Re: M2 Money supply growing at 28.4%
« Reply #27 on: January 06, 2021, 08:01:42 AM »
<bizaro86>
I'd like to invert this with a question (selfishly to aid my own understanding). What would cause inflation? We know inflation is possible because it has happened in the past.
 
<mattee2264>
Yeah I think large budget deficits accompanied by a recovery of private sector spending could do the trick with higher commodity prices and supply constraints adding some fuel to the fire.


I'm glad these accounting ledger views are helping folks visualize what's really happening with these different government payment flows.  So with that I want to show the three basic payment flows that we've been talking about:
1) The Federal Reserve buying a US Treasury bond in its open market purchases.  (it is not technically allowed to buy it directly from the US Treasury)
2) The US Treasury spends.  (because the US Treasury runs a perpetual deficit - it must spend more than it takes in via taxes.  But I could also focus on a tax payment too - flows would just reverse)
3) The US Treasury issuing a bond to the private sector.

Here's the key takeaway:  Only deficit spending (scenario #2) from the US Treasury actually creates new money (i.e., new net financial assets) for the private sector.  The other two flows leave the private sector with exactly the same net financial assets as it had before, it just changes the form of that financial asset composition.   

Ok - so if you've read this far.  Let's go through all the payment flows.  I'm going to expand the accounting ledger beyond the Fed and a bank (JP Morgan Chase) to add the US Treasury and an Individual/Business Account (which is a proxy for the private sector).  I'm consolidating the govt sector by combining the US Treasury and the Fed on one side (in blue) and the private sector (bank + individual/business) on the other side in green.  The key to focus on is the effect on the net financial assets of the Individual/Business sector.  Focus on which of these three flows increases the net financial assets - highlighted in yellow.

First up - the one payment flow we've already covered.  The Fed buys a Treasury Bond.  In this case, I've made a change.  I've had the US Treasury Bond originate from an Individual/Business through a Bank to the Fed.  Before we just had the Bank dealing with the Fed directly.  [click on drawing for full screen viewing]

I'm not going to go over this one because we've been over it.  Notice though that this payment flow does not increase individual/business net assets.

Next up - the US Treasury deficit spends.  Here the US Treasury issues $10m in CARES Act checks (for example).  The Treasury tells the Fed to issue a payment order and the Fed moves electronic deposits from the Treasury's reserve account to JPM's reserve account.  This creates both a reserve asset and a bank deposit liability for JPM.  But for the private sector - this is a new net financial asset.  Therefore US Treasury deficit spending creates "new money" for the private sector and increases the private sector's net asset values (in terms of the "government's money".


Finally - the US Treasury issues a bond.   Here the private sector buys a bond from the US Treasury. Notice again - that this is an asset swap.  The private sector does not see an increase in its net financial assets.  It's balance sheet stays the same as before buying the bond - it just changes the asset mix.


A long-winded way to answer the question is that the only thing that increases money, banking deposits, net financial assets in the hands of the private sector is US Treasury deficit spending.  Everyone worries about the Fed, the banks, lending - but all of the real action is here.  This is what one needs to pay attention to.  The Fed and the banks are just intermediaries that manage the payment flows through the payment systems.

I'll just add another comment.  File this under = advanced topics.  Compare Payment Flows 2 and 3.  Notice how the act of US Treasury Spending creates an equal in size reserve balance for JP Morgan?  Notice how after issuing a Treasury bond, the bond relieves JP Morgan of that large reserve balance even as it maintains the increase in net financial assets for the private sector? (ie, the bank deposit asset is changed into a Treasury bond asset for the Individual/Business sector).  This is why we say that Federal Government Debt issuance isn't really borrowing - its a reserve maintenance function.  This means that if not for the borrowing, US Treasury spending would create unwanted and large reserve balances in the US commercial banking sector.   This is why one can't think of a sovereign borrowing in its own currency as simply borrowing the way we think of it for individuals, businesses, local and state governments that don't create fiat currency.  Federal borrowing serves a different function than funding the government. 

I know this last point can be confusing.  It is made confusing by the rules that the Congress puts in place to make it look like the government must tax or borrow to fund spending:
- the US Treasury cannot run an overdraft at its general account at the Federal Reserve (i.e., no negative balance),
- the US Treasury cannot borrow beyond an absolute level (ie "the debt ceiling")
- the US Treasury must issue its bonds to the public (and not the Fed).
- the Fed must buy its Treasury bonds in the open market.
Its important to note that these are all political constraints, and not economic ones.  The only economic constraint is that the private sector must want and need the Federal government's money.  This need is not created by legal tender laws or contracts.  It is created by the tax obligations that the Federal government imposes on the private sector and then mandating that these tax obligations can only be extinguished by using the Federal government's money.

Hope this helps and I just haven't confused everyone with my ramblings.  I'm still learning this stuff myself.

wabuffo
« Last Edit: January 06, 2021, 08:41:20 AM by wabuffo »

LearningMachine

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Re: M2 Money supply growing at 28.4%
« Reply #28 on: January 06, 2021, 09:36:57 AM »
Thanks wabuffo for sharing your thoughts and the diagrams.

Are you saying that each bank has two types of accounts with the Federal Reserve: (1) that they cannot withdraw from because it is funded by asset sales to the Fed, and (2) that they can withdraw because they funded it voluntarily with customers' cash?

Here is an excerpt from a Bank of America earnings call, where they are saying that they have a choice on what to do with incoming cash from customer deposits to either (a) park incoming cash from customer deposits at 10 bps with the Fed Reserve or (b) buy securities.  Are you saying that if they pick (a), they cannot take that cash out to start funding riskier loans later?

Quote
We've added $284 billion in deposits since year-end. All of that has gone into cash earning 10 basis points. So as we assess the future of this pandemic, as we kind of assess how much of that is going to stick around and we get a little bit more confident on the -- on those two elements that can be deployed into securities or a portion of it, let's say, can be deployed into securities.

And that's -- there's a big difference even in these rates between what you can earn on a mortgage-backed security or a treasury bond and 10 basis points. So there's some opportunity there but it has to -- I think we're going to be thoughtful about it and it's one of those things I think you know when you see it. Source: https://seekingalpha.com/article/4358922-bank-of-america-corporation-bac-ceo-brian-moynihan-on-q2-2020-results-earnings-call?part=single

Federal reserve interest rate of 10 bps to banks on required and excess reserves: https://www.federalreserve.gov/monetarypolicy/reqresbalances.htm
« Last Edit: January 06, 2021, 09:42:21 AM by LearningMachine »

wabuffo

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Re: M2 Money supply growing at 28.4%
« Reply #29 on: January 06, 2021, 10:08:22 AM »
Are you saying that each bank has two types of accounts with the Federal Reserve: (1) that they cannot withdraw from because it is funded by asset sales to the Fed, and (2) that they can withdraw because they funded it voluntarily with customers' cash?

No there is only one account at the Fed - a reserve account.  Banks also hold a tiny amount of cash outside the Federal Reserve.  They also have vault cash (actual hard currency).

Let's look at the data as at Weds Dec. 23, 2020 as an example.   We'll look at this from both sides of the mirror:
- first from the Federal Reserve's balance sheet (Federal Reserve H.4.1 report), and then
- from the collective balance sheet of all US commercial banks (Federal Reserve H.8 report)  [as always - click on the image to expand it for full-screen viewing]

First - let's go to the Federal Reserve's balance sheet (the liability side):


Bank reserves are a liability of the Fed.  From this snapshot taken on Weds. Dec. 23, 2020 - total bank reserves for the entire US commercial banking sector on deposit at the Fed were $3.177 trillion.

Now let's go to the mirror image of this liability and look at the collective balance sheet of the US commercial banking sector's asset side that matches this Fed liability.  We can find this in the Federal Reserve's H.8 report

We can see here that total cash assets across the entire banking sector were $3.240 trillion.  Why the difference?  Because on the bank balance sheet all cash is consolidated from an accounting perspective and doesn't distinguish between what is at the Fed and what is held by banks themselves or in their vaults.

Thus $3.240 - $3.177 trillion = $63 billion held by banks outside of the Fed reserve accounts.  As expected banks on their own want to hold very little cash.  Thus 98% of what banks classify as cash on their GAAP balance sheets actually is frozen at the Fed.  The $3.177 trillion is there simply because of actions by the Fed (and US Treasury).

Here is an excerpt from a Bank of America earnings call, where they are saying that they have a choice on what to do with incoming cash from customer deposits to either (a) park incoming cash from customer deposits at 10 bps with the Fed Reserve or (b) buy securities.  Are you saying that if they pick (a), they cannot take that cash out to start funding riskier loans later?

Ok - I can see where this gets confusing and BofA is not helping with their description of what's happening here.  First of all customer deposits are not an asset of BofA - they are a liability (unlike reserve balances which are an asset for BofA).  So you can't mix the two, right?

Second - ask yourself where does the growth in total US commercial banking deposits come from?  You might say "saving" or people or businesses "depositing their money" - but actually these transactions move deposits around from bank to bank but don't actually increase total deposits for the entire banking sector. If you get paid by your employer - your deposits at the bank go up but deposits at your employer go down by an equal amount (and total deposits for the entire banking sector don't change).  Its only when you pay taxes to the IRS or get a stimulus check from the US Treasury do total deposit balances for the entire banking sector change.

Go back to this payment flow (US Treasury deficit spending) and think about what was happening in 2020.


The lion share of net, new bank deposits are created out of the blue from US Treasury spending.  And as we can see from the flowchart (substitute BofA for JPM visually here), this spending creates BOTH A RESERVE ASSET for BofA and a BANK DEPOSIT.   So when BofA is saying they've added billions in new deposits since year-end, most of those are via US Treasury spending (though some could be a net increase from transfers of deposits from other banks).   But most of that deposit increase was accompanied by a reserve account increase too.  BofA didn't "deposit cash at the Fed, the US Treasury did" and it stays locked there.  In addition, to the extent that BofA saw a net increase in transfers of deposits from other banks, those deposits, too, were accompanied on the asset side of BofA's balance sheet with a reserve transfer from those other banks. Again those reserves can't leave the Fed's payment and reserve account systems, they can only circulate between reserve accounts as payments/transfers get cleared.

If you are interested you can pull BofA's regulatory Call reports at the FFIEC and there you will see a breakdown of BofA's cash assets between what's actually held at the Fed in reserve accounts.

Hope this helps.

wabuffo
« Last Edit: January 06, 2021, 10:17:35 AM by wabuffo »