Sean Corrigan of Diapason Commodities — ever cautious on inflation – is unsurprisingly also a bit of a money-supply fiend. The issues of monetary base, M2, M4, and all other definitions thereof, frequently make a prominent appearance in his research notes.
Given that Corrigan is so passionate about the issue, it is not surprising that a general misunderstanding of money supply might grate — especially when the said misunderstanding emanates from the establishment itself.
Note, for example, the Bank of England’s recent decision to use M4 ex-IOFC as its preferred measure of money supply — the switch incrementally justifying a deflationary rather than inflationary fear in the near to medium term.
Yet, as Corrigan explains in his latest research note, this hardly serves anybody if exit strategies are actually being formed around the more traditional measure. Or as the appendix to his most recent report states (our emphasis):
‘Money supply’ whether properly defined or under the current, bastardized usage consists of liabilities of the Banks to the non-banking private sector, though the exclusion of the government from this – in economies where they routinely spend 20-30% of the total disbursed – is not really economically justifiable. Moreover, part of the reason we exclude monetary institutions’ liabilities from their peers is to avoid double-counting – if Bank A places customer funds with Bank B which desposits with Bank C which lends them to a shopkeeper, we only have one monetary liability not three (though potentially a lot of what the Victorians called cheque-kitting).
However, if we stick to a strict description of money as a near-universally accepted means of payment, accessible on demand at full par value, the commercial banks’ new excess reserve balances held at the Fed and its foreign peers might justifiably be counted as ‘money’ and, since they are not elsewhere recorded, they might be added to the total even though they are presently being held for precautionary, not transactional, purposes.
Which brings him to the issue of using repos with money market-mutual funds (MMMF) as a potential exit strategy:
If we grant this latter proposition, then — and only then — will the supply of MONEY be impacted by this whole business of drawing upon MMMF resources (which let us re-emphasize, are NOT themselves, despite the confusing institutional nomenclature, strictly MONEY, either – a negative which will be all the more categorical once the Fed’s emergency, ‘break the buck’, blanket guarantee is allowed to lapse).
This, as far as we understand, means that the Fed’s MMMF-focused exit strategy is all very good, but at the end of the day will mostly impact credit creation rather than existing money supply. What’s more, the strategy will only be seen to be working via traditional money-supply measures, which include those very reserves currently being hoarded by the banks, and which deflationistas are keenly encouraging us to overlook.
But there’s also the issue of elasticities to consider, largely down to the documented lag between credit creation and deposit formation, and other behavioural factors.
As Corrigan points out, it is reckless to presume these will be the same as they were in previous boom cycles. That is to say, it is hard to anticipate just how quickly money will start flowing when it finally does. This is a big unknown.
For example, note the following chart from Corrigan’s report showing year-on-year CPI versus US money velocity as measured by plotting US manufacturing and trade sales numbers against M1:
As Corrigan explains, econometricians have tended to disregard the above mechanisms because of the wild fluctuation of elasticities involved. Nevertheless, there is a reasonable qualitative fit to the broad behaviour you might expect of CPI some while later, according to Corrigan.
Which leads him to conclude:
The MONEY is there: what we have to work out is what consequences – intended or otherwise – its continued liberal provision will have for us and and for our investments.
Related links:
Penny for your thoughts, BofE - FT Alphaville
Money money money, ex-IOFC – FT Alphaville