22 March 2013

The Fed Is Printing Money, But Where Is It Going? They Know But Will Not Say

[Robert McTeer] worked for the Federal Reserve for 36 years, including as president of the Federal Reserve Bank of Dallas from 1991–2005, where he was known for his plain, jargon-free public speaking and telling stories about growing up in rural Georgia. He has stated that one of his goals was "to translate economic sense into common sense".

As a member of the Federal Open Market Committee on the Federal Reserve, he was considered "dovish" on inflation and was one of the most consistent opponents of raising the federal funds rate in the late 1990s. He has stated that he does not believe in the NAIRU and Phillips curve.
Bob McTeer says with the provocative headline that The Fed Has Not Been Printing Boatloads of Money.  As you may recall, Mr. McTeer was a member of the Federal Reserve for 36 years
"What they fail to grasp is that their initial assumption that the Fed is printing boatloads of money simply isn’t true."
And yet one can look at the Fed's Adjusted Monetary Base, one of the few measures of money over which the Fed has a more direct measure of control, and we see this:

Although those who follow money already know it, the Fed is printing money but that money is going directly to the banks through their methods of purchasing assets from them, both Treasuries and Mortgage debt (which may be of dodgy pedigree).

We see that here in the expansion of Excess Reserves of the Banks.

But Bob McTeer knows Banking, and he knows where most of that QE money has been going.
"Asset purchases by the Fed normally lead to a multiple expansion of money since, at the margin, reserve requirements are only about 10 percent of deposits. The roughly $2 trillion of asset growth from before the financial crisis through QE2 was largely offset, however, by an expansion in excess bank reserves of $1.6 trillion. In other words, the banking system has been sterilizing or neutralizing the impact of the asset purchases on the money supply."
And he knows that this is a form of 'trickle down' approach, and is not stimulating the commercial economy. But it is helping to prop up a banking sector that has never really taken its losses by writing down bad debts, cutting salaries and jobs, and downsizing to a more historical size relative to the real economy.
"The good news is this is why we haven’t had an expansion of inflation or a collapse of the dollar. The bad news is that is also why the purchases have not stimulated economic activity more than they have. The effect seems to be limited to the downward pressure placed on interest rates.

The Fed’s asset purchases have been increasing bank reserves. The Fed adds Treasuries and Agency MBS’s to its assets and pays, in effect, by crediting the reserve accounts of the banking system. But that’s where it has been stopping."
The downward pressure on interest rates isn't doing much. And that is because the US is caught in a modern variation of a liquidity trap, where aggregate demand and organic economic activity has been laid so low by the shock of a massive financial collapse caused by a credit bubble that it cannot rise of its own accord, even with interest rates near zero.
It is true that the Monetary Base, which used to be considered high-powered money because it consists of currency outstanding plus the reserves of the banking system, expands with the expansion of bank reserves. But, with banks hoarding excess reserves as they have been, the Monetary Base has not had its historical impact on the public’s money supply. If one insists on calling the Monetary Base ‘money,’ then it is money that has gone only to the Treasury and the sellers of MBS’s. This has made the financing of our outsized deficit easier and cheaper.
So the good news is that the government is doing all right, and the banking system is in the pink, and even corporate profits are healthy, thanks to tax credits and accounting gimmicks.

The Monetary Base is still high powered money.  That has not changed.  What has changed is that the Fed is paying interest on those idle reserves.  And  the TBTF Banks are still operating like bucket shops using excess reserves and guaranteed deposits.  When they win they keep the winnings, and when they lose, the Fed absorbs their losses.

It is being directed to a powerful and largely unreformed Banking sector.  And that money is being used to fund Wall Street bonuses, speculation in paper assets to create new all time highs in the equity markets, a bond bubble,  the purchase of distressed assets like homes and farmland in huge rent-seeking blocks,  tax subsidies for private hedge funds,

But the real economy languishes.   And this trickle down approach and lack of reform is what is going to cause a serious bout of stagflation, which is a policy error of the first order.  Prices of key goods like healthcare, education, and food are rising with most of the profits flowing to the top one percent, and while wages remain relatively stagnant and jobs growth is aenemic.

But is Bob's major thesis, that there is no inflation problem because M2 growth is lagging so badly because its velocity has been declining?
"What they fail to grasp is that their initial assumption that the Fed is printing boatloads of money simply isn’t true. If it were true, I would join them in their dire predictions. But it simply isn’t true and hasn’t been true throughout this period.

The latest estimates from the Fed’s H.6 Money Stock Measures show M2 growth actually declining since the Fed resumed significant asset purchases last fall. M2 growth in the three months ending in February was 4.6 percent; it was 6.5 percent in the previous six months and 6.8 percent over the previous 12 months. Even this moderate growth is muted by the average decline in M2 velocity of around 3 ½ percent in recent years, yielding a growth rate of nominal GDP of roughly 4 percent per year."

Given the slack state of the economy since the onset of the financial crisis, MZM and M2 growth has still been fairly substantial. So it is a bit disingenuous for Bob to zoom in on a relatively short time frame, from last fall.

Let's indulge him and take a look a variation of this graph using the measure of change Year Over Year in Billions.  This should make the changes easier to discern.

Yes, M2 and MZM are lagging in their rate of increase. But as every economist knows, there is a lag in the transmission of an expansion of the monetary base and the time in which that appears in the broader measures.  The Fed has written many papers on this lag.  And it is true, especially where the Velocity of Money is sluggish and declining, as has been the case of the US, where Velocity has been declining for many years, as hot money sought the high returns of paper asset speculation and gravitates towards certain sectors like tech start ups and housing that can be exploited.

And Bob knows this, and so does Bernanke. Why don't they do something about it?   Bernanke is under some constraints in speaking as the sitting FOMC Chairman, but his actions speak loudly.

Is Bob playing dumb from an ideological impairment like Greenspan, or merely being Socratic in his homespun Georgian manner? 

Why don't more economists push for a reform of the financial system, a return to a commercial, utilitarian banking sector, and an end to subsidies for Wall Street Banks?  Why do they bury their heads in the sand of singular causes like unlimited stimulus, obsessive austerity, mindless privitization and financializaitn, or the arcane details of broken models? 

Why was Volker left to stand alone, while an army of lobbyists undermines even the most modest attempts at reform?

It is all in the credibility trap.   Careerism.  And a lack of genuine leadership politically.

Who is willing to stand up and tell the Emperors of Wall Street and Washington that they are obscenely, bloatedly naked, and draining the life from the people? No one will say, J'accuse. 

And that is why Bernanke is going to probably leave after this term as Fed Chairman, as did Greenspan, before the next bubble bursts in stocks and bonds, and before the next economic downtur and deluge. 

So he can say that while he was in office, technically everything was fine and great progress had been made. And there will be consultancies, and speeches, and honorariums.

Who wants to be a whistle blower these days? Silence pays.

Die DreiGroschen Oper is a 1931 German musical film directed by G. W. Pabst. It was produced by Nero Film, Berlin.