Monday, June 8, 2009

Inflated Expectations: April 2009 Edition

The great inflation/deflation debate rages on. I continue to have things both ways by expecting deflation in the near term and inflation in the long term. However, the exact start and end dates of those time periods continue elude me.

M1 through MZM are up far more than the GDP growth rate - which is not hard when GDP is shrinking. So why aren't we carrying around our lunch money in wheelbarrows? Well, all that new money isn't doing anything. At least that is what the M1 Multiplier is supposed to tell us. Banks are hoarding cash, so much so that they are holding more on reserve at the Fed than people are putting into their checking accounts. And people are putting more in than they have at any time in the past decade.

So you say "whu-huh?!?" Let me explain a bit further. The numerator in this ratio is M1, which is currency plus demand deposits (checking, basically). The denominator is M0, which is currency plus commercial bank reserve deposits at the Fed. Normally, due to the magic of fractional reserve banking, every dollar the Fed pumps out in cash results in another $.60 or more of money appearing in various demand deposit accounts. But now, even though the Fed is still pumping out dollars, the fraidy-cats at the banks are stashing away even more at the Fed. A lot more (see the fifth graph down).

Zooming out a bit shows that, like so many other things happening lately, the change in the M1 Multiplier is unprecedented - at least in the data that Fed provides. I'll have to see if there is a wider set floating in the tubes somewhere. Also, there is a long-term downtrend, which probably reflects changes in how people manage their money.

But, you ask, what happens if the banksters snort a few lines of coke and decide to go on a loaning spree, and need their excess reserves back to fund their fun? I dunno. My guess is not much, because the excess reserves have been used by the Fed to buy stuff - mostly stuff of dubious value. So the process would be reversed - cash back in, stuff back out into the great and glorious markets, deposits redeemed, and voilà! no problem. Maybe. I really dunno. But it's something to ponder.

Update: Regarding inflation, I think the question is: what is the exact nature of the money that banks have deposited, and that the Fed has used to buy stuff? Is it currency, or is it just bank money making another stop on its way through the system. Normally, the required reserves that the banks keep on deposit are in cash. The requirement that they be in cash, and the limited amount of cash issued, act to restrict the amount of money that banks can lend out. Is the same true for the excess reserves?

Update: Scratch the previous update. I confused vault cash with reserves. So I am back to being uncertain about the inflationary effect of the excess reserves.

(PS: This is yet another post that might have to be completely redone if I learn more.)

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