Sunday, February 15, 2009

Monetary Base update

The Fed has pulled about $200 billion out of the system in the past four weeks, but the expansion of the monetary base remains epic in size. We've got to watch this very carefully. So far I would say that most of the expansion of the base (bank reserves and currency) has been in the form of bank reserves and has in turn been in response to a world that is desperately desiring extra safe money of the kind that only the US government can provide. That's not necessarily inflationary. But the recent rise in gold suggests that the Fed's willingness to supply money may be exceeding the market's demand for it. If they don't pull this balancing act off perfectly there could be huge consequences. Stay tuned.

8 comments:

reasonableminds said...

Thanks for the chart, Scott. I've been posting this on the refrigerator door in our office since last October. But what explains the reversal? Paul Volcker making his influence known? Has the administration perhaps decided that the economy is bound to be slow no matter what, but there's no point is letting the currency collapse on top of all that? Or did they finally notice all those people buying gold and figure out that they were essentially shorting the dollar?

brodero said...

Is gold an inflation hedge or a crisis hedge?

Scott Grannis said...

I'm not sure exactly on the source or cause of the reversal, but my guess is that the private sector's demand for the securities the Fed had purchased has improved. If so, that would be a good sign, as is the case with the Baltic and strengthening commodity prices for example.

Gold is always tricky, since it can respond to monetary policy excesses and to crises. And how to sort those two factors out is an art, not a science. But it isn't hard these days to assert that the money factor is significant, so gold is performing its classic role as an inflation hedge (which is no longer cheap).

The Lab-Rat said...

Gold is this years oil, the bubble of 2009. Since the markets been obsessing with deflation of late, I think crisis hedge is a better explanation for the recent run up in prices. But like all manias, it will overshoot massively, if it hasnt already. When Joe Public is piling in, then its time to get out....See Jan sales of American Eagle gold coins?

Scott Grannis said...

Gold is most likely in the process of forming a bubble, but it's not necessarily on the verge of popping. With the Fed pouring tons of money into the system, and with interest rates extremely low, gold is hard for many people to resist. I woundn't recommend buying it, but I do think there is a good reason to own an inflation hedge such as TIPS.

Mark A. Sadowski said...

Note that the explosive growth in the monetary base has come to an end.

Jeff said...

Scott:

Question.....do you believe the major banks in this country are truly insolvent? The more I read and understand the CDO's that they bought/sold, etc. and have on their books...the more I believe they are insolvent and should be taken over and sold back to private investors (similar to what was done with the S&L crisis). Your thoughts/opinions would be appreciated. It seems that until this is done and a new "good" bank is established that folks can trust....we won't get through this recession.

Scott Grannis said...

I'm not a banking expert, but I suspect that banks are fairly precarious. With the salary caps now in place, the banks are going to lose good people and the government could be left holding the bag (even more than currently). But meanwhile I hear lots of talk about new broker dealers starting up, and I imagine that a lot of small banks will grow by leaps and bounds as the big guys wither. Lots of creative destruction will be going on.