And so continues the saga of the greatest monetary expansion in the history of modern, industrialized nations. Through massive purchases of all kinds of assets, the Fed has almost doubled the size of the monetary base since early September. Put another way, they have created more high-powered money in the past three months than in the entire history of the Fed.
This hasn't been inflationary yet, because the demand for money has been extraordinarily strong—fueled by outright panic, a flight to safety, deleveraging, commodity price plunges, and the reversal of "carry trades." But surely it's safe to say that there is no shortage of dollars in the world at a time when the world desperately wants them. Indeed, recent weakness in the value of the dollar and strength in gold suggests that the Fed may have finally added enough liquidity to the system to satisfy the market's thirst. That gives us great comfort, since it eliminates entirely one of the major causes of the Great Depression (i.e., a collapse in the money supply and a subsequent deflation).
This expansion of the monetary base has been made possible by the Fed's shift to quantitative easing, something I highlighted about two months ago, but the Fed only admitted to recently. Now that it's official, and the Fed has promised to remain super-accommodative, the next phase of this process will be to see how much and how fast the abundance of base money gets turned into new spendable money. The base has risen by $800 billion since early September, but M2 (the best measure of money in my view) has only risen by $397 billion. Of that, currency accounts for $32 billion, and some portion of the balance can be attributed to a three-fold increase in mortgage refinancing activity. The potential for further money creation is enormous, nevertheless, since each dollar of base money can potentially support ten dollars of new bank deposits.
Further monetary expansion will be up to the public and the banks. Will people be encouraged by historically low mortgage rates to return to the housing market? Will institutional investors decide that taking on leverage—at a time when prices for many physical assets have collapsed and interest rates are relatively low—is not a bad idea at all? Stay tuned, it shouldn't take long before we find out.