MZM is the broadest and most reasonable measure of liquidity in the US economic system. Bank Reserves and Cash are its narrowest component.
Bank reserves are becoming decoupled from MZM now since banks are borrowing heavily from the discount window and building reserves in anticipation of future financial shocks and writedowns of assets. We are in a deleveraging panic.
Breaking this impasse between fear of writedowns and moving forward with economic growth is the preoccupation of the Treasury and the Fed. We agree that this is the problem, we may merely differ on the approach to take to solve it.
This 'crunch' in primary liquidity, or bank reserves, in a deleveraging panic for the banks has a dampening effect on the broader components of liquidity in MZM.
One can make the case that the panic is originating with the banks as they reap the results of their misrepresentations of their assets and reckless speculation by deleveraging.
The Fed and Treasury approach seems to be to fill the Banks' reserves until they overflow and being to trickle down to the real economy. They believe that they will receive more benefit by placing their capital here because of the power of the fractional reserve money multiplier.
In the short term this may not be fruitful. The engine is seized. Pouring more gasoline in it may not be productive.
Banks need a kick start by a component of the economy that is still functioning normally, if in an impaired manner. That is in the real economy. Rather than reaching the real economy through the banks, the Fed and Treasury might well be more effective in focusing on stimulating real economic activity by stimulating consumption and production directly. Trickle up if you will.
One has to wonder what Keynes would have said about these different approaches to applying stimulus: provide stimulus to the broader public through increases in wages and economic activity, or to provide stimulus to the banks and hope that they will lend to the broader public at rates low enough to stimulate projects that would not otherwise be feasible.
This is a critical point, and little debated or understood as it is emotionally charged with words like 'socialism.' Most do not understand the fractional reserve banking system, but it seems more official, more palatable, to give them billions, enormous sums, and to give the public as little as possible for fear of debasing the value of work and the currency.
Paulson and Bernanke both view the economy as an adjunct to the financial system so from their perspective the choice is obvious.
The Fed and Treasury may succeed eventually in their approach of filling all banks, solvent and insolvent, stable and unstable, until they burst with liquidity and overflow into the broader economy.
In doing so they risk a significant bout of inflation and financial instability that may surprise them. But based on the experience of the Fed under Volcker they are convinced they can cure any inflation, having done it -- once.
MZM in turn has its correlation with secondary liquidity in the form of less liquid assets such as stocks and bonds, gold, forex and the time encumbered components of M2.
Do not think of this as 'cause and effect' but more in terms of a teeter totter, as individuals make decisions about their desire for immediacy and safety of assets and move capital, selling some assets and holding others.
If seen on the scale of immediacy and safety things will make more sense as they evolve.
There is a relationship between MZM and Gold, which as liquid assets which differ in Immediacy and Safety as an investment choice. In a short term panic immediacy overwhelms safety. As an aside and not illustrated in this chart, 'paper gold' which is less safe is diverging from 'Physicial Gold' in the lens of investor choice. That divergence may become greater in the short term as investor fears shift from the immediacy of capital to its safety.
Here is something to think about in the chart below. It shows the 'forex' component of liquidity falling to the immediacy of the home currency in a deleveraging panic.
More food for thought. The "why" is all important.
