Monetary forensics

Since RW has been pretty vocal about the price inflation that is about to hit, I decided to do some simple monetary forensics, and found a few interesting things you might want to see. We all know that there are a bunch of different monetary aggregates, that measure different pseudo-real amounts of money in the system. First out we have the required reserves, which is the base upon which banks do their lending. After that, we have M1, that is the sum of all cash and demand deposits. Below graph shows percentage change in required reserves, and the M1 money supply.



Now cash is a bit tricky, because much of it may be hoarded in other places than the US, or may exist as vault cash, which means that the correlation between paper money and prices may be somewhat distorted. Demand deposits, on the other hand are pretty simple. It is money held at your local bank, available for immediate usage. Below shows percentage change in demand deposits and required reserves :

Finally, we have the M2 money supply, which includes things like small time deposits, savings accounts and money market funds. This wouldn't really be that interesting, if it weren't for the fact that you can draw checks and make payments directly from some of these accounts as well these days, and thus they could be considered part of the money supply. Here is M2 and required reserves :

So, what to make out of all of this? Well, clearly something is creating a lot of new money, and at increasing rates. M1 is increasing at a 15% annual rate, demand deposits at nearly 40% (!!!) annual, and the M2 money supply at about 8%. Remember however, that these are comparisons year-over-year, and most of the change is probably in the last few months, meaning the increase and acceleration is EVEN BIGGER.

Most people would say this is all a result of the monetary policy of the Federal Reserve. I would agree on that, but there is one more mechanism that isn't mentioned that often - the shutting down of failing banks by the FDIC. Basically, the FDIC goes in and takes over a failed bank and saves the depositors. However, since the financial crisis started the losses by the FDIC made on these transactions have been in the range of 10-35%, meaning that the banks (due to the change in FASB in early 2009) have been lying about the value of their assets, and as the FDIC goes in and saves them it effectively refills the hole in the banks balance sheet. Where does the FDIC get its money? Well, from the member banks, but in the end everyone knows that the Treasury is backing the whole thing. The important thing to notice is that these broken banks know they are bust, but until they are picked apart and the assets sold off, the capital locked into those banks are not used for additional lending, meaning they do not contribute to increases in the money supply.

I don't know how big an effect this has, but I do know that the more of the bad assets and toxic waste is cleaned out from the banks balance sheets, the higher the risk of massive money creation on a scale most people probably cannot imagine. Or, to put it simply, if the Federal Reserve succeeds in what they have attempted, namely to get "credit flowing" again, there will be an inflationary firestorm of enormous proportions.

Just imagine what those money supply figures would show right now if the US economy was "doing good". *Brrrrr*