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I'd like to think that last week's post got the ball rolling, because the impulse for the 5.6% rally in the S&P 500 over the past three days looks to be declining expectations for Fed tightening. I thought it was inevitable: a super-strong dollar, collapsing housing and commodity prices, and a huge increase in real interest rates were all but shouting at the Fed to back off and give the economy some time to digest things.
The following charts highlight three major news items revealed today:
Chart #1
As I've been noting for well over a year, Chart #1 (growth of the M2 money supply) is the most important financial news that nobody (outside of a handful of economists) has been paying any attention to. As the chart shows, there was explosive growth (completely unprecedented!) in the money supply in 2020, driven almost entirely by the monetization of Covid stimulus payments in 2020-2021. This was the proximate cause of the inflation which has wracked the country for almost two years. Fortunately, with the cessation of Covid payments in mid-2021, M2 growth cooled dramatically: M2 has not increased meaningfully for the past 9 months, and it has in fact declined at a 2.2% annualized rate over the past 6 months, as we learned from this morning's release of the September numbers. This all but guarantees a future decline in measured inflation.
If the Fed had been paying attention to the slowdown in M2, they would have toned down their tightening 4-5 months ago. And of course, if they had been paying attention to M2 18 months ago, they would have begun raising rates long before it became painfully obvious that we had an inflation problem.
Chart #2
Chart #2 compares the value of the dollar (white line) with the level of real interest rates on 5-yr TIPS. Long-time readers will know that 5-yr real yields are the market's expectation for what the real Fed funds rate will average over the next 5 years, and as such they are the best measure to watch for how much the Fed is expected to tighten. These two variables have been joined at the hip for at least the past year: rising real rates have tracked the increase in the dollar's value on the forex markets. Declining real yields this month have closely tracked the decline in the dollar's value. A weaker dollar has nearly everyone breathing a sigh of relief. Maybe the Fed won't have to cause a recession after all ... as I argued in a post last August.
Chart #3
The other big piece of news this morning was the sharp decline in national home prices (Chart #3 shows the 12- and 6-month rates of growth of prices). It's important to note that the August number is actually an average of prices over the 3 months ending in August, which means that prices today are almost certainly much lower than the chart suggests. This decline in prices was virtually assured, given the doubling of 30-yr mortgage rates this year and the huge decline in new mortgage originations that I highlighted last week (Chart #3 of this post). The last thing the Fed needs to do is kill the housing market yet again (remember 2008?).
The next FOMC meeting is scheduled for November 2nd, and it's going to be very important. Not too long ago the market thought a 75 bps hike in the funds rate (to 4.25%) following that meeting was virtually assured. Now it's questionable, while a 50 bps hike is beginning to look like a (remote) possibility.
66 comments:
Home prices cooled at a record pace in August, S&P Case-Shiller says--today's news
Recently, the Reserve Bank of Australia, in roughly the same pickle as the Fed, opted for a 0.25% rate hike. The RBA meets monthly, except Jan.
I see no reason for the Fed to be so aggressive. If the market knows there will steady rate increases, that should be enough. There is difference between going on a diet, and sudden starvation.
I still wonder why the Fed thinks it has to sell its hoard of US Treasuries.
Yes, the new money #'s are contractionary. There's been a marked deceleration in long-term money flows which should show up in lower prices in the next couple of months.
Yeah, I don't know why people aren't watching the #'s more closely.
re: "If the Fed had been paying attention to the slowdown in M2, they would have toned down their tightening 4-5 months ago."
You're modeling is wrong. Short-term money flows have not fallen. R-gDp for the 3rd qtr. is estimated @ 2.9%
Dan Thornton is correct. “Money Supply and Inflation: Where’s the Proof?” WSJ July 21, 2022
Link: George Garvey:
Deposit Velocity and Its Significance (stlouisfed.org)
“Obviously, velocity of total deposits, including time deposits, is considerably
lower than that computed for demand deposits alone. The precise difference
between the two sets of ratios would depend on the relative share of time deposits
in the total as well as on the respective turnover rates of the two types of
deposits.”
The Keynesian economists have achieved their objective, that there is no difference between money and liquid assets, viz., the Gurley-Shaw thesis:
“substitutability between money and wide range of financial assets, also called near- moneys”
“an appropriate definition of money must include the liabilities of non-bank financial institutions.”
R * revolves around the activation of monetary savings. The impoundment of monetary savings lowers R * and vice versa.
To quote economist John Gurley, “Money is a veil, but when the veil flutters, real-output sputters.”
How does the Fed incentivize banks to lend to the open market vs. parking funds overnight at the Fed (and earning enormous risk-free profits by doing so)?
Bulldogs, the welfare of the system of banks is codependent on the welfare of the nonbanks, i.e., putting savings back to work.
The remuneration of IBDDs does the opposite. So, we will see an acceleration in bank failures.
Bulldogs: If the Fed wanted to incentivize banks to increase their lending, they would simply lower the Fed funds rate relative to the risk-adjusted rate they could receive on bank loans. Today they are doing the opposite, in the belief that banks have already lent too much money (bank loans effectively create money, and the economy is awash in money): thus, they are pushing short-term rates higher than the risk-adjusted returns banks can earn on new lending, with the result that banks today are incentivized to hold on to their bank reserves, rather than to use them to collateralize new loans and deposits.
fed funds rate currently 3-3.25%, so a 75bps raise would not take it to 4.25% as you write
"M2 has not increased meaningfully for the past 9 months, and it has in fact declined at a 2.2% annualized rate over the past 6 months, as we learned from this morning's release of the September numbers. This all but guarantees a future decline in measured inflation."
How unbearably naive! After increasing M2 by ~40% during the pandemic, the FRB is being pressed not only to slow interest rate increases but further postpone quantitative tightening (currently set at $95B/month starting in November).
The October rally in the stock market is due to 1) good earnings reports and 2) an extraordinary amount of money sloshing around seeking yield (see M2). For twelve years the FRB was the default purchaser of federal debt instruments, printing money to buy the Treasury's bonds. Given the short-term nature of much of the nation's debt financing, Yellen is confronted with rolling over considerable debt as instruments mature. Treasury needs liquidity to temper the competition for higher interest rates; FOMC needs higher interest rates to temper inflation. And the USA and the world need real reductions in M2 (not a paltry ~2.2% compared to a ~40% increase).
The proposed QT at less than $100B/month against an FRB balance sheet of ~$9T must happen at some point, the sooner the better. And the sooner higher interest rates and less M2 confront all the actors (Treasury, Congress, businesses...) the better for all of us. The problems that face us today are the result of recklessness - overspending, under taxing, over-borrowing, globalization (the eternal search for subsistence wages) - and endless tinkering with matters which left to resolve themselves do so quicker and in better order than any collection of academics, politicians, and bureaucrats will ever do.
re: "they would simply lower the Fed funds rate relative to the risk-adjusted rate they could receive on bank loans"
Do you mean?
https://fred.stlouisfed.org/series/DRISCFLM
Or?
https://fredblog.stlouisfed.org/2016/10/a-marginal-look-at-bank-margins/
Scott,
The decline in inflation from June to September in the CPI was almost exclusively due to the price of oil and in turn gasoline dropping from the $120/barrel area to the $78/barrel area. Today, at the end of October oil is back to $89.50/barrel a 10% increase for October. That implies that October will see gasoline add .5% to the October CPI versus subtracting .5% from the CPI like it did in August and July, a very substantial effect on the next inflation report.
The biggest indicator for the Feds that endogenous inflation is abating, is the correction in home prices, which is possibly caused by the rising interest rates. However, the bulk of housing stock is unaffected. However, it may impact expectations and security, which means that Americans will save more and spend less...maybe.
The other important factor is the USD's strength, which is not apparent to Americans but obvious to the rest of the world. So far the ONLY country unaffected by the strength of the USD is Mexico, which has seen its exchange rate to the dollar essentially unchanged over the past 24 months...if you consider how screwed up Mexico's economy is right now, its surprising. The Fed's potential easing will lead to a fall in the USD and a rise in the cost of imported good (small percentage of the US economy overall).
Still its possible that the Feds are working on the premise that inflation risks at home have reduced. Sounds plausible, but then again they are driving are by looking in the rear-view mirror.
“Buybacks” on the horizon? The FED’s Ph.Ds. don’t know a credit from a debit. Savings flowing through the nonbanks increases the supply of loan funds, but not the supply of money.
Lending by the banks is inflationary (increases the volume and turnover of new money). Lending by the nonbanks is noninflationary (results in the turnover of existing money, a velocity relationship). Where do you think velocity went with the deregulation of interest rates by the ABA.
The correct response to stagflation is the 1966 Interest Rate Adjustment Act. “while the aggregate of time and demand deposits continued to increase after July, the proportion of time to demand deposits diminished. Whereas time deposits were 105 percent of demand deposits in July, by the end of the year, the proportion had fallen to 98 percent. These were all desirable developments.”
M1 peaked @137.2 on 1/1/1966 and didn’t exceed that # until 9/1/1967. Deposit rates of banks decreased from a high range of 5 1/2 to a low range of 4 % (albeit not enough). A .75% interest rate differential was given to the nonbanks.
And during this period, the unemployment rate fell.
While Dr. Philip George doesn't explain it succinctly, he does point out the problem.
"The error we are talking about is the error of regarding money as cash balances, and the demand for money as the demand for cash balances. The idea dates back to the early part of the 20th century in Cambridge, UK, and has appeared so obvious it has held unquestioning sway over all schools of economics."
That's why I like Scott Grannis. Look at the Calafia Beach Pundit: “money demand fell from mid-2017 to mid-2018 as confidence soared and the economy strengthened”
Link: September 25, 2018: “An Emerging and Important Secular Trend”
Link: “Demand for Money; What Went Up Will Soon Come Down”
Link: m2/gdp
https://fred.stlouisfed.org/graph/?g=eTtE
Money has no impact unless it is turning over. “According to Dr. Milton Friedman, the main reason for the non-neutrality of money in the short-run is the variability in the time lag between money and the economy.”
Bankrupt-u-Bernanke "did it again". The FED drained required reserves for 29 contiguous months (i.e., the rate of change was negative, coincident with the top in the Case Shiller Home Price Index). And M1 NSA money stock peaked on 12/2004 @ 1467.7. It didn’t exceed that # until 10/2008 @ 1514.2.
Powell must step on the brakes, drain the money stock, for a considerable length of time.
Hard to believe 1. that these central bankers got this wrong and 2. that they would admit it.
"THE INFLATION CRISIS has come from “pretty much nowhere” according to the European Central Bank president Christine Lagarde"
https://www.thejournal.ie/lagarde-inflation-5905973-Oct2022/
Many economic modelers and their bosses, the bankers, need to be fired.
wkevinw -
Public "experts" across pretty much every domain have exposed the shaky mastery over their area of expertise and the base human flaws of cowardice and reflexive pursuit of self interest. The Fed and European bankers seem little different.
I wish it weren't so. I wish I didn't sound like a crank. The fall from grace is really stunning in the abstract.
Scott - In your opinion, how much of the US market could be regarded as a "command" economy?
^index of command economy:
https://upload.wikimedia.org/wikipedia/commons/4/48/Federal_state_local_percent_of_gdp.webp
pangloss wrong again.
Well, Jerome Powell talked tough. He probably has a bust of Paul Volcker in his office.
But...maybe the tough talk was to allow a slower rate of rate increases going forward. House prices have cracked, Wall Street has cracked, the dollar is king, labor markets are loosening.
Oil is still high, but a strong cartel is operating on that.
Shouldn't there be an oil-buyer's cartel or bloc?
Big housing crisis. A source of income inequality, the GINI index – “the distribution of income between the main factors of production: land, labour and capital”.
If you raise the administered rates, you cut back on residential housing construction. That’s operating in reverse. New construction is part and parcel with R-gDp, not inflation.
To cut inflation, you hold constant the means-of-payment money supply, in this case, for at least 3 years.
The way to immediately drop prices is to raise reserve requirements on reservable liabilities. Or doesn't anyone follow the data?
In 2010, the PBOC’s RRR went to 18.5% – “to sterilize over-liquidity and get the money supply under control in order to prevent inflation or over-heating”
But Powell thinks banks are intermediaries. Not so. There's a difference between the system of banks (macro-economics) and an individual bank (micro-economics).
Never are the commercial banks intermediaries in the savings-investment process. From the standpoint of the entire payment’s system, commercial banks never loan out, and can’t loan out, existing funds in any deposit classification (saved or otherwise), or the owner’s equity, or any liability item. Every time a DFI makes a loan to, or buys securities from, the non-bank public, it creates new money – demand deposits, somewhere in the system. I.e., all deposits are the result of lending and not the other way around.
All monetary savings originate within the payment’s system. The source of interest-bearing deposits is non-interest-bearing deposits, directly or indirectly via the currency route (never more than a short-term seasonal situation), or through the bank’s undivided profits accounts. This is the cause of secular stagnation, the deceleration in velocity.
Hello, can anyone please answer a question:
When a member bank buys treasuries from the Treasury in order to turn around and sell to the Fed, does the bank need to have reserves to conduct this?
i.e. every other asset purchase, or loan, that a bank makes requires, I believe, a certain amount of reserves (or did - before the no reserve requirement). Is this also true in dealings with the Treasury - even when both parties know the securities are going to be immediately sold to the Fed (for example, in the case where the Fed is expanding its balance sheet)?
Thank you, Richard
@Richard
Banks don't buy directly from the Treasury, they buy securities in the secondary market. But let's work with the idea that the end result is the same.
When banks buy a Treasury security, they buy using money on hand, ie it's an asset swap. In the new 'ample reserves' era, banks are drowning in excess money so that's not an issue.
When the Fed buys a Treasury security directly from the bank (please note that the huge majority of Treasury securities bought by the Fed was through private market participants who had accounts in commercial banks), it's also an asset swap ie the Treasury security goes to the Fed and the Fed credits the bank with money. However, this specific transaction has two effects: 1) money appears as an asset for the bank and 2) this money is deposited at the Fed (liability for the Fed) and, simultaneously, new reserves are created.
In theory, the idea was to stimulate private lending and, hopefully, private productive investment. Now, we're learning that the idea resulted essentially in only asset inflation which is speculative in nature (the more risky the asset, the more asset inflation but this has permeated in all asset classes). Is it surprising then that so many people are hoping for a pivot?
https://www.clevelandfed.org/indicators-and-data/inflation-nowcasting
October 2022 8.09% y-o-y CPI
2022:Q4 7.20% CPI
Stagflation, business stagnation accompanied by inflation.
@Salmo Trutta
Here's a link which you may find interesting and which contains many nice formats for data aggregation and presentation about excess savings.
https://www.federalreserve.gov/econres/notes/feds-notes/excess-savings-during-the-covid-19-pandemic-20221021.html
The major issue about the link is the inappropriate application of the money demand concept. They believe aggregate excess savings occurred as a result of lower consumption and simultaneous higher income for the whole population (makes no sense when one really thinks about it) and do not realize that lower consumption at the aggregate level does NOT result in higher savings at the aggregate level. 80 to 85% of excess savings resulted from unprecedented public issuance of debt bought by the Fed and by commercial banks.
The private sector is 'wealthier' to the same extent the public sector is 'poorer'. On a net basis, we are likely to see lower aggregate demand going forward as a result of another round of capital misallocation.
Unless the public sector massively pivots soon to maintain the inflation impetus injected a while back, how could this 'current' inflation be sustainable?
Hello all:
Curious to hear your thoughts about Christine Lagarde's pledge to match rate hikes... has the kicked can finally reached the end of the road?
Question: What sovereign debt nightmares will re-emerge in the EU as terminal rates approach 5% (or more) and stay held there for quarters if not YEARS... what if a FED pivot doesn't come soon and the ECB sustains ultra-tight policy to match?
Thanks!
Thank you Carl! Ok, this member bank purchasing of treasuries is then, after all, the common sense way one would think a bank would buy something: it would have the cash, and it would pay for it.
I was thinking, however, that the mechanics were going to be more like the way banks make loans, i.e. they don't actually have to have the "cash", they just make the loan - but they do need (or did need) a certain amount of reserves to do this.
One thing I did not understand; you said member banks do not buy directly from the Treasury; I thought this was one of the main functions of member banks - to deal directly with the Treasury. I thought it is only the Fed that cannot buy directly from the Treasury.
Thank you again. Richard
^Almost all US government debt is bought by authorized primary dealers who act as intermediaries between the Treasury and private market participants who then buy in the secondary market.
Primary dealers can be subsidiaries of US banks but can also be subs of foreign financial institutions, subs of brokerage houses etc
Primary dealers can hold securities on their balance sheets as inventory but those entities do not make money by holding with market price changes, they make money through making markets (commissions, fees, arbitrage operations etc).
Look here:
https://www.newyorkfed.org/markets/primarydealers
It's really only a portion of the financial plumbing and maybe the flows are the more significant aspects.
Yes, I was referring to primary dealers when I said member banks (sorry, primary dealers is more accurate). Ok then, do the primary dealers have to have cash to buy the treasuries, or do they buy with leverage (I assume, as broker-dealers) with their capital being their "reserves" parked at the Fed (assuming that reserves are still required)
What I am getting at is, where do primary dealers get the margin (reserves) to carry out the Fed's massive purchases of securities? It seems like they really don't have to have anything really at all; it seems, in effect, that the Fed is really buying directly from the Treasury.
^Independence is a relative concept.
The Federal Reserve Act contained provisions to prevent the Fed from buying directly from the Treasury in order to prevent the notion that the US could become a banana republic.
The primary dealers act technically to add distance from the Treasury to the Fed by creating an 'open market' but you are correct in suggesting that the distinction can be moot.
re: "how could this 'current' inflation be sustainable?"
Greenspan eliminated the transactions' velocity of money in Sept. 1996.
Powell eliminated deposit classifications in May 2020.
The FED is operating without a rudder or an anchor.
That said, inflation is decelerating, but not as fast as people hoped. What we are left with is stagflation, business stagnation accompanied by inflation. That doesn't bode well for the economy and therefore stocks.
Thank you Carl.
I take it then that primary dealers do need capital and/or reserves for each and every treasury purchase. Do you know how much/what percentage that is?
Thank you.
I know, on and on it goes, but this should be the final thing I am trying to nail down.
Thanks
"Direct Purchases of U.S. Treasury Securities by Federal Reserve Banks"
https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr684.pdf
Thank you Salmo (can I say "brown" without the fish?)
For some reason I have had a mental block about how the commercial member banks get the money to buy the treasuries to sell to the Fed - under a hypothetical scenario, let's say, where all the member banks were tapped out on their reserves/capital, how would they "get" the money to buy the treauries to facilitate the Fed's purchases.
That is, if banks (as a whole) were similarly tapped out (no excess reserves, no additonal capital) as far as making traditional loans, they could not do so (at least I think this is still a common sense conclusion). I was thinking this would be the same for facilitating the Fed's purchases. But, apparently then it is more like a three way swap?, i.e. the banks buy the treasuries, immediately sell them to the Fed, and the banks, with more reserves now, can fulfill paying for the treasuries they have bought (from the treasury or other sources). Thank you.
Hi Richard,
Your questions would require some additional research, if you're looking for a precise explanation.
I will only say that primary dealers, as entities, are not banks and do not need 'reserves'. They need to meet several requirements including minimum capital (i think 150M) and obviously need more capital in correlation to net exposures to various securities including Treasuries. These entities are typically leveraged (asset to capital of something like 10 to 1) and may need (like in 2008 and in 2020) access to temporary capital (against collateral) from the Fed so they don't exactly go unconstrained.
If really interested, look at the following:
https://www.federalreserve.gov/econres/notes/feds-notes/dealer-inventory-constraints-during-covid-19-pandemic-evidence-from-treasury-market-broader-implications-20200717.html
You may have heard that the Treasury is looking at Treasury buyback operations and maybe you want to look this up (it's related to primary dealers phoning the Fed lately about liquidity conditions in the market) and to share here your impressions, if any, about the fundamental underlying causes leading to the 'conversations'.
-----
@Salmo Trutta
"(#2) Purchases and sales between the Reserve banks and non-bank investors directly affect both bank reserves and the money stock."
You realize that this is a widely misunderstood issue?
The IOR increases the supply of loan funds while decreasing the demand for loan funds (taking debt off the market). It is essentially an asset swap (increasing outside money). But reserve velocity is not tracked. And Greenspan eliminated the transactions velocity of money reporting.
The payment of interest on IBDDs artificially suppresses nominal and real rates of interest, the siphoning of funds dissipated in financial investment (the transfer of title to goods, properties, or claims thereto), as opposed to real investment. I.e., it stokes asset prices.
Thus, the IOR increases income inequality. Paying Interest on Reserve Balances: It's More Significant Than You Think is an ipsedixitism.
FRBSF: “Paying interest on excess balances should help to establish a lower bound on the federal funds rate.” But interest is the price of loan funds, not the price of money. The price of money is the reciprocal of the price level.
It is axiomatic, the money stock can never be properly managed by any attempt to control the cost of credit.
The only tool, credit control device, at the disposal of the monetary authority in a free capitalistic system through which the volume of money can be properly controlled is legal reserves. Powell eliminated legal reserves in March 2020. And Powell also eliminated deposit classifications.
Monetarism has never been tried.
#2
Unlike Treasury issuance, because the belligerent bifurcation (the mis-aligned distribution of sales and purchases of debt by the FRB-NY’s trading desk and its customers/counter-parties is largely unpredictable, so too now is the volume and rate of expansion in the money stock. FOMC policy has now been capriciously undermined - by turning non-earning excess reserve balances (Manna from Heaven) into bank earning assets.
The FED has emasculated its "open market power", the power to create new money and credit.
This is in direct contrast to targeting: *RPDs* (reserves for private deposits) using non-borrowed reserves as its operating method (predating Paul Volcker’s October 6, 1979 pronouncement on the *Saturday before Columbus Day*), as Paul Meek’s (FRB-NY assistant V.P. of OMOs and Treasury issues), described in his 3rd edition of “Open Market Operations” published in 1974.
This adds up to an obdurate apparatus that the Fed cannot monitor, much less control, even on a month-to-month basis. What the net expansion of the money stock will be, as a consequence of any given addition or subtraction in Federal Reserve Bank credit, nobody can forecast until long after the fact. And the whole process is now initiated by the member banks, via proffered bankable opportunities, not by the monetary authorities.
Example. Bernanke contends: “a flawed and over-simplified monetarist doctrine that posits a direct relationship between the money supply and prices”.
See the Nattering Naybobs’ “Elephant Tracks”.
Some people think Feb 27, 2007 started across the ocean. “On Feb. 28, Bernanke told the House Budget Committee he could see no single factor that caused the market’s pullback a day earlier”.
In fact, it was home grown. It was the seventh biggest one-day point drop ever for the Dow. On a percentage basis, the Dow lost about 3.3 percent – its biggest one-day percentage loss since March 2003.
It reflected an historical drop in legal reserves.
ME -flow5 (2/26/07; 14:34:35MT – usagold.com msg#: 152672)
Suckers Rally. If gold doesn’t fall, then there’s a new paradigm
And we know that Bernanke dismissed monetarism’s connection. As Dr. Richard G. Anderson (the world’s leading guru on bank reserves) wrote me:
“Spencer, this is an interesting idea. Since no one in the Fed tracks reserves…”
Bernanke contracted legal reserves for 29 contiguous months which directly caused the GFC.
“NGDP growth continued at an extremely rapid rate in 2022”
AD = M*Vt. According to George Garvey, Deposit Velocity and Its Significance, demand deposit turnover, bank debits to deposit accounts, underweights Vt. Greenspan eliminated the only valid velocity figure for spurious reasons.
Remember that in 1978 (when Vi, income velocity, fell, but Vt, transactions’ velocity, rose) all economist’s forecasts for inflation were drastically wrong.
see:
https://files.stlouisfed.org/files/htdocs/publications/review/87/03/Changes_Mar1987.pdf
https://fred.stlouisfed.org/graph/?g=eTtE
Vt can move in the opposite direction as Vi.
Historically, given a large injection of new money, the transactions’ velocity rises immediately thereafter (after the roc in DDs peaked in Feb 2022). Thus, it is no happenstance that N-gDp and thus inflation has remained higher than expected when relying solely on the roc in our means-of-payment money supply.
Thank you Carl for your help.
Salmo, if I can ask you to flush out a litlle for those of us who are still trying to learn:
- What was it that Greenspan did in Sept. 1996 to eliminate the transactions' velocity of money?
- what were the deposit classifications that Powell eliminated in May 2020?
- what are IBDDs?
- your recent comment about a sucker's rally in gold - is that a reference for today, or back in 2007? And, if the latter, what are you trying to say about a contraction in legal reserves relative to today?
Thank you very much.
Richard
Scott Grannis turned out to be right. CPI declining.
Greenspan eliminated the G.6 Debit and Deposit Turnover Release, which showed that our means-of-payment money supply turned over 95:1 over time deposits. I.e., financial transactions are not random.
It should be obvious that the extent of money’s impact on prices and the economy is measured by money flows not the stock of money. If the transactions velocity of money was a constant it would not matter, but money turnover has varied from an annual rate of 13 in 1945 to over 525 in September 1996 (last figure from the G.6 Debit and Demand Deposit Turnover release, then the Fed’s longest standing reported banking statistic).
The G.6 release fell to President Bill Clinton’s “Paperwork Reduction Act of 1995”: From the Federal Register: “The usefulness of the FR 2573 data in understanding the behavior of the monetary aggregates has diminished in recent years as the distinction between transaction accounts and savings accounts has become increasingly blurred”.
The G.6 was discontinued at the same time it was needed (to reflect asset inflation). Bank debits reflect both new & existing residential & commercial real-estate sales/purchases. As such the housing boom/bust would have stuck out like a sore thumb.
In 1931 a commission was established on Member Bank Reserve Requirements. The commission completed their recommendations after a 7 year inquiry on Feb. 5, 1938. The study was entitled “Member Bank Reserve Requirements — Analysis of Committee Proposal”
its 2nd proposal: “Requirements against debits to deposits”
http://bit.ly/1A9bYH1
After a 45 year hiatus, this research paper was “declassified” on March 23, 1983. By the time this paper was “declassified”, Nobel Laureate Dr. Milton Friedman had declared RRs to be a “tax” [sic].
Link: The G.6 Debit and Demand Deposit Turnover Release
https://fraser.stlouisfed.org/files/docs/releases/g6comm/g6_19961023.pdf
Non-transaction deposits have very little turnover. 95:5 at best.
That leaves DDs and currency:
https://fred.stlouisfed.org/series/DEMDEPNS
Link:
https://marcusnunes.substack.com/p/misleading-monetarist-views
“Clearly, it´s not “all about money”. In fact it is, but not only about money supply. We must take into account money demand (or its inverse, Velocity).”
IBDDs are interbank demand deposits, which are now remunerated.
Powell deemphasized the role of money in the economy. This is also a ruse. To coverup his ruse Powell has destroyed deposit classifications. Powell eliminated the 6 withdrawal restrictions on savings accounts, which isolated money intended for spending, or means-of-payment money, from the money held as savings, reflecting money demand.
This is the rate-of-change in long-term monetary flows, proxy for inflation in American Yale Professor Irving Fisher's truistic "equation of exchange".
Link: George Garvey:
Deposit Velocity and Its Significance (stlouisfed.org)
“Obviously, velocity of total deposits, including time deposits, is considerably
lower than that computed for demand deposits alone. The precise difference
between the two sets of ratios would depend on the relative share of time deposits
in the total as well as on the respective turnover rates of the two types of
deposits.”
AD = M*Vt (where N-gDp is a subset and proxy). According to George Garvey, Deposit Velocity and Its Significance, demand deposit turnover, bank debits to deposit accounts, underweights Vt. Greenspan eliminated the only valid velocity figure for spurious reasons.
Remember that in 1978 (when Vi, income velocity, fell, but Vt, transactions’ velocity rose) all economist’s forecasts for inflation were drastically wrong.
see:
https://files.stlouisfed.org/files/htdocs/publications/review/87/03/Changes_Mar1987.pdf
https://fred.stlouisfed.org/graph/?g=eTtE
Vt can move in the opposite direction as Vi.
Historically, given a large injection of new money, the transactions’ velocity rises immediately thereafter (after the roc in DDs peaked in Feb 2022). Thus, it is no happenstance that N-gDp and thus inflation has remained higher than expected when relying solely on the roc in our means-of-payment money supply.
Vi is a “residual calculation – not a real physical observable and measurable statistic.” Income velocity may be a “fudge factor,” but the transactions velocity of circulation is a tangible figure.
I.e., income velocity, Vi, is endogenously derived and therefore contrived (N-gDp divided by M) whereas Vt, the transactions’ velocity of circulation, is an “independent” exogenous force acting on prices.
Money demand is viewed as a function of its opportunity cost-the foregone interest income of holding lower-yielding money balances (a liquidity preference curve). As this cost of holding money falls, the demand for money rises (and velocity decreases).
As Dr. Philip George says: “The velocity of money is a function of interest rates”
As Dr. Philip George puts it: “Changes in velocity have nothing to do with the speed at which money moves from hand to hand but are entirely the result of movements between demand deposits and other kinds of deposits.”
“The first lesson of economics is scarcity: there is never enough of anything to fully satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.” – Thomas Sowell
"The shelter index accounted for over 40 percent of the total increase in all items less food and energy."
The shelter index is a lagging indicator. So, Scott nailed it.
https://www.clevelandfed.org/indicators-and-data/inflation-nowcasting
Cleveland FED has big drop in 4th qtr:
Inflation nowcasting: 2022:Q4 5.43
CPI, Shelter index- yes, that is the main cause of the sticky inflation at this point.
I thought we would be about 4-6% headline cpi by Oct 22, but it looks like maybe that will be by Jan 23.
The battle then will be about wage-push catching up with inflation from 2021-2022. That may keep the headline cpi between 4-6% for ~ 2 years.
What will that do to the Fed's actions and financial (+ Real Estate) markets?
Salmo, I love it. Keep it coming. It is a joy to see a thoroughly active, intense, if not genius, mind in action unveiling the truths behind such complicated "stuff".
We all benefit from your dedication to understanding a certain corner of the world - a most important corner of the world. It is much easier to be a generalist with interests here and there. But our learning comes from people like you, and Scott, who dedicate themselves to figuring it out!!
Thank you. Richard
De-dollarization is here...
See Dr. Philip George's blog, the economist that wrote "The Riddle of Money Finally Solved".
http://www.philipji.com/item/2022-10-01/the-US-can-weather-another-interest-rate-hike
George just rediscovered Dr. Leland Pritchards, Ph.D., Economics, Chicago 1933, M.S. Statistics, Syracuse, model. They said the same thing about money demand, like Scott Grannis explained.
“Should Commercial Banks Accept Savings Deposits?” Conference on Savings and Residential Financing 1961 Proceedings, United States Savings and loan league, Chicago, 1961, 42, 43.
Note: all monetary savings originate within the payment’s System. And banks do not loan out deposits, they create deposits. Bank-held savings have a zero payment’s velocity. The expansion of interest-bearing saved deposits makes no contribution to gDp.
Want to echo Richard & others who highlight the importance of this blog & the amazing commentary shared within!
So thank you again, Mr. Grannis for the (free) blog venue from which to learn great things!
GOLD! Holy smokes... For giggles ... pull-up Gold futures on a 4H chart and notice the *exact time* at which I bought puts last week ... ugh...
John Cochrane has an excellent graph of money demand (last graph)
see: https://johnhcochrane.blogspot.com/2022/11/the-second-great-experiment-update.html
The crypto collapse is underway. Will it spillover? You had predicted this as a concern and indeed the Fed has risen rates until something finally broke. Will it stand pat?
Asset valuation prices are driven from the appraisal of loan collateral, and loanable funds, which depends upon Gresham’s law: “a statement of the least cost “principle of substitution” as applied to money: that a commodity (or service) will be devoted to those uses which are the most profitable (most widely viewed as promising), that a statement of the principle of substitution:
“the bad money drives out good”.
“I often say that when you can measure what you are speaking about, and express it in numbers, you know something about it.” - William Thomson, Scottish physicist (1824-1907)
• Lecture on "Electrical Units of Measurement" (3 May 1883), published in Popular Lectures Vol. I, p. 73
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Velocity: Money's Second Dimension - By. Bryon Higgins
"Money has a 'second dimension’’, namely, velocity . . .. " Arthur F. Burns in Congressional Testimony.
“The rapid growth in M1 velocity for the past three years is particularly surprising when one considers the accompanying pattern of increases in market interest rates. One of the primary factors contributing to the normal increase in velocity during periods of economic expansion is the rise in market interest rates that typically accompanies rapid economic growth. Businesses and households intensify their efforts to economize on cash balances as the opportunity cost of holding money rises. A substantial portion of the increase in velocity during the current expansion occurred in 1975 and 1976, however, a period in which market rates were generally declining. Thus, the interest sensitivity of the demand for money does not provide a complete explanation of the behavior of velocity in the current recovery.”
www.kansascityfed.org/PUBLICAT/ECONREV/EconRevArchive/1978/2q78higg.pdf
^The Federal Reserve Act contains the following:
"The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates."
Why?
And why the use of the word commensurate?
Carl, the monetary transmission mechanism isn't interest rates, isn't the money stock, it's money flows, the volume and velocity of money. The monetary transmission mechanism was required reserves, the truistic monetary base. And as Dr. Richard G. Anderson said: "reserves are driven by payments".
Contrary to the likes of Alan Blinder, in his new book, A Monetary and Fiscal History of the US 1961-2021, it's not supply shocks, it's monetary shocks.
The FED's Ph.Ds. don't know a debit from a credit, money from mud pie, a money creating institution from a nonbank.
“The problem is that we cannot extract from our statistical database what is true money conceptually, either in the transactions mode or the store-of-value mode. One of the reasons, obviously, is that the proliferation of products has been so extraordinary that the true underlying mix of money in our money and near money data is continuously changing. As a consequence, while of necessity it must be the case at the end of the day that inflation has to be a monetary phenomenon, a decision to base policy on measures of money presupposes that we can locate money. And that has become an increasingly dubious proposition.” -- Alan Greenspan
As I said: GDP predictions within one year are infallible. Roc's in M*Vt = Roc's in P*T.
Irving Fisher: “Each of these five magnitudes is extremely definite, and their relation to the purchasing power of money is definitely expressed by an “equation of exchange.”
“In my opinion, the branch of economics which treats of these five regulators of purchasing power ought to be recognized and ultimately will be recognized as an EXACT SCIENCE, capable of precise formulation, demonstration, and statistical verification.”
We knew this already. In 1931 a commission was established on Member Bank Reserve Requirements. The commission completed their recommendations after a 7 year inquiry on Feb. 5, 1938. The study was entitled "Member Bank Reserve Requirements -- Analysis of Committee Proposal" Its 2nd proposal: "Requirements against debits to deposits"
http://bit.ly/1A9bYH1
After a 45 year hiatus, this research paper was "declassified" on March 23, 1983. By the time this paper was "declassified", Nobel Laureate Dr. Milton Friedman had declared RRs to be a "tax" [sic].
Link: Daniel L. Thornton, Vice President and Economic Adviser: Research Division, Federal Reserve Bank of St. Louis, Working Paper Series “Monetary Policy: Why Money Matters and Interest Rates Don’t”
bit.ly/1OJ9jhU
“Today “monetary policy” should be more aptly named “interest rate policy” because policymakers pay virtually no attention to money.”
As I said: The only tool, credit control device, at the disposal of the monetary authority in a free capitalistic system through which the volume of money can be properly controlled is legal reserves. The FED will obviously, sometime in the future, lose control of the money stock.
May 8, 2020. 10:38 AMLink
Daniel L. Thornton, May 12, 2022 agrees with me:
“However, on March 26, 2020, the Board of Governors reduced the reserve requirement on checkable deposits to zero. This action ended the Fed’s ability to control M1. In February 2021 the Board redefined M1 so that M1 and M2 are very nearly identical. Consequently, it makes little sense to distinguish between them. In any event, the checkable deposit portion of M2 cannot be controlled now because there are no longer reserve requirements on these deposits. Here is the reason the Fed cannot control these deposits.”
https://www.dlthornton.com/images/services/Some%20Thoughts%20About%20Inflation%20and%20the%20Feds%20Ability%20%20to%20Control%20It.pdf
You will note that Scott Grannis is right. The Cleveland CPI inflation nowcast for the 4th qtr. of 2022 is 5.7%.
"Wholesale prices rose 0.2% in October, less than expected, as inflation eases"
There goes DXY.
@salmo trutta... there goes /GC to the moon, therefore? Do you think spike in gold is a flight-to-safety from crypto collapse, or sovereigns (Japan) flooding market of UST & buying gold instead? Thanks!
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