Below is an excerpt from a commentary originally posted at www.speculative-investor.com on 21st March, 2010.
The year-over-year growth rates of popular monetary aggregates M2 and MZM are presently around 2%, which is near their lows of the past 15 years. Furthermore, M3, another popular monetary aggregate, has just experienced the fastest decline in its growth rate in at least 40 years and is now down by about 5% on a year-over-year basis. Note that the Fed no longer reports M3, but unofficial M3 calculations and charts are still available on the internet (at http://www.nowandfutures.com/key_stats.html, for example). So, judging by M2, M3 and MZM the US is now in, or bordering on, monetary deflation. However, TMS (True Money Supply) has risen by more than 13% over the past 12 months.
On the surface, then, it looks like reasonable arguments could simultaneously be made for monetary inflation and monetary deflation/stagnation, but digging deeper reveals that M2, M3 and MZM have components that are not money and that changes in these non-monetary components are responsible for the apparent monetary deflation/stagnation. The non-monetary components we are referring to are Retail Money-Market Funds (included in M2, M3 and MZM), Institutional Money-Market Funds (include in M3 and MZM), Small Time Deposits (included in M2 and M3), and Large Time Deposits (included in M3).
The first and second of the following four charts show the large year-over-year declines in these non-monetary components, while the third and fourth charts reveal substantial percentage increases over the past year in things that are actually "money" (demand (checkable) deposits and savings deposits). These charts were taken from the latest monthly Monetary Trends report put out by the Federal Reserve Bank of St. Louis.
To make sure everyone is on the same page, here is why Money-Market Funds (MMFs) and Time Deposits (TDs) should not be counted in the money supply:
MMFs are investments in income-paying securities, meaning that MMF units must be sold in order to obtain money. The best way to explain is via a hypothetical example. Assume that Bill withdraws $10K from his bank account and deposits the money into his MMF account. Bill's MMF then uses this money to purchase Treasury Notes from Bob, who deposits the proceeds into his bank account. As you can see, the net result of this transaction is the transfer of $10K from Bill's bank account to Bob's bank account, with the MMF acting as an intermediary. No new money is created, and yet the transaction will result in a $10K increase in M2, M3 and MZM (because these money-supply measures include MMF accounts in addition to bank accounts). Some time later, Bill withdraws $10K from his MMF account and deposits the money into his bank account. To facilitate the withdrawal, Bill's MMF sells $10K of Treasury Notes to Fred that Fred pays for with money from his bank account. The net result, therefore, is the transfer of $10K from Fred's bank account to Bill's bank account, with the MMF again acting as an intermediary. No money is destroyed, and yet the transaction will result in a $10K reduction in M2, M3 and MZM.
TDs are loans to banks whereby the lender (the bank's customer), in exchange for a higher interest rate, foregoes the right to access his/her money on demand. For example, when Bill lends money to Bob the money is temporarily transferred from Bill's money supply to Bob's money supply. Bill no longer has access to the money. It's a similar story when Bill opens a time deposit, except in this case he lends part of his money supply to a bank.
As evidenced by the charts displayed above, there have been large declines in MMFs and TDs over the past year. The reason, we think, is that with interest rates so low there is almost nothing to be gained by investing in MMFs or giving up immediate access to one's money by placing it in a TD. By the same token, after interest rates begin to trend upward it is likely that MMFs and TDs will become more popular, causing M2, M3 and MZM to increase relative to TMS.
Another point worth mentioning is that there is some disagreement amongst people who actually understand money as to whether savings accounts should be counted as part of the money supply. The argument against including them is that, like time deposits, they are loans to banks.
To explain why we believe that savings accounts should be included we'll first hark back to the following comment from last week's Interim Update: "...commercial banks generally make loans by creating new money out of nothing, not by transferring part of the existing money supply to the borrower." What this means is that a bank does not generate interest income by lending out the money deposited in savings accounts; instead, it creates new money. This is why the money in savings accounts is always (for all intents and purposes) available on demand, and why, when you use an Automatic Teller Machine, you will usually be given the choice of withdrawing money from your checking account or your savings account. In effect, most banks and their customers no longer differentiate between checkable deposits and savings deposits in terms of the ability to access the deposited funds on demand.
Note that a bank could theoretically insist on a waiting period prior to honouring a request to withdraw money from a savings account, but when was the last time you tried to withdraw money from your savings account and were told by the bank "sorry, but your money is not available right now". We suggest that any bank that began insisting on a waiting period prior to releasing funds from savings accounts would quickly be subject to an old-fashioned "run" and would soon find itself in the hands of the Feds.
The final point we'd like to make is that if US central bankers pay attention to M2, M3 and/or MZM then the slow year-over-year growth rates of these aggregates could become part of the justification for even greater efforts to inflate. That is, even though the money supply is growing rapidly, if Bernanke and his cohorts believe that the money supply is growing slowly, or not at all, then they could be encouraged to double their efforts on the inflation front. Under the current monetary system, nothing promotes inflation more effectively than fear of deflation.
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