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Current interestsI don’t expect there are huge swarms of people interested in my random ramblings, but for those who are, I have retired the previous content of this page to an archive and decided to write a load more!.
Inflation or deflation - update November 20135 years ago, I wrote about the potential for economic catastrophe. We have seen a catastrophe with the implosion of AIG, Lehmans and Fannie May and Freddie Mac. This has resulted in a significantly revised federal reserve involvement with the markets.
The frightful monetary baseMany commentators have been rather shocked by the monetary base chart. In 2008, the "high powered" (non-fractional banking derived money) stood at around 800 billion dollars. The chart now stands closer to 3600 billion dollars. For many observers, this has provided an ongoing frightful portent of inflation.
Inflation? What inflation?The rate of inflation reported by US government statistics, and pretty much mimicked by the UK government has been fairly low. peaking briefly at 5% but averaging at about 2% between nov 2008 and nov 2013. Meanwhile, for most ordinary people paying for food, heating bills, car fuel, postage stamps etc, the rate of inflation may appear nearer 9-11%.
Given that the U.S. monetary base has grown so quickly (35% compound growth since 2008), you may wonder why inflation isn't so high, hyperinflation has resulted.
Give out with one hand, take in with the otherThe US Federal reserve has confused the market somewhat, whilst keeping inflation under control, by responding to financial institutions’s preference in these times to hold cash, as opposed to the more risky treasuries. The federal reserve has "Borrowed" money from the financial system then using that cash to buy treasuries, mortgage backed securities and similar financial instruments. This can be seen clearly in the following graph:
KeyAMBNS or AMBSL Many will be familiar with the Federal Reserve monetary base AMBSL. AMNNS is the non-seasonally adjusted monetary base.
EXCSRESNS Excess Reserves not seasonally adjusted. One of these series have been discontinued, but there is a continuing series, just a little harder to find at the St Louis fed.
ExplanationIn september 2008, the US federal reserve started taking Mortgage backed Securities, then longer term treasuries onto it's balance sheet. On it's own, this would imply a significant increase in new money in circulation. At the same time, the federal reserve started offering interest to financial institutions so that they would put money on deposit with the federal reserve. In essence, the money the federal reserve created to buy assets has been taken back out of the economy.
This graph neatly shows a continuation of the new money in circulation by subtracting excess reserves held on deposit from adjusted monetary base. The key to this is the yellow line. This shows a very smooth and deliberate progression of actual new money in circulation, derived from the two wildly changing volatile series of monetary base, and excess reserves.
This series shows an annual average compound growth rate in new money between August 2000 and August 2008 of 4.7%. Using the AMBNS-EXCRESNS figure, we can see a progression between September 2008 and September 2013 a compound average annual growth rate of new money of 8.1%. Everything else being equal, this would suggest a loss of spending power and the inflation of asset bubbles.
What is perhaps more interesting, financial institutions would rather put money on short term deposit with the federal reserve to receive just 0.25% rate of interest, rather than buy 10 year government treasuries with a rate of 2.6%. The fed is simply responding to the desire of financial institutions to get out of treasuries. Financial institutions would rather have the money right there, ready to spend.
This is dangerous. Very dangerous. If the financial institutions were to exercise their presumed right to grab that money to spend it, it would create a tsunami of inflation. Tripling the amount of new, high power money in the economy of USA. If these institutions believe they will be allowed access to these deposits en masse, they are in cloud cuckoo land. This would trigger a force majeure, bank holiday and trigger IMF rules for bail-in of their deposits back to treasuries. All the while, the spending power of these deposits are being eroded with new money entering circulation. It is very difficult these days to maintain purchasing power whilst holding paper assets.
Economic backdropThe above may seem like a big issue, but the factor which drives the economic systems is productivity. The power to provide valuable goods and services. It is hard to argue against the notion that our living standards today are as a result of industrialisation. The industrial revolution started in England, which has spread throughout the world. Providing warmth, transport, plentiful food, healthcare.
This stands against a movement of industrial productivity eastwards, and an increasing western economic reliance on a financial service sector and debt, coupled with de-industrialisation of the west as far as consumer goods are concerned. This also combined with an economic system whose foundations are compound growth in a world that is finite.
I would argue that the financial woes of 2008 and those continuing today are simply a result of a compound growth system hitting limits. The fall in living standards in recent years the lack of material productivity in the economy which is no longer back-stopped by the financial system.
Email nick at nickhill dot co dot uk.
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