Friday, 12 September 2014

The Short Version of the "Austrian" True Money Supply (TMS), as of 1 September 2014

The short version of the Austrian True Money Supply for the U.S., a measure of the money supply applied in this weekly report, increased 0.63% on last week for the week ending 1 September 2014. At $10.2470 trillion, the money supply is now up 3.73% year to date, but is 0.19% lower than the all-time high from four weeks ago.


The 1-year growth rate dropped further this week ending the week on 7.63%, the lowest since week ending 31 March earlier this year.


The change in the 1-year growth rate, measured as the current growth rate minus the growth rate from one year ago (percentage point change), declined for the 114th week in a row. The current difference of 66 basis points is however substantially smaller than it was at the end of last year when the difference was about 500 basis points. 


The 5-year annualised growth rate of the money supply shred 14 basis points from last week to end on 10.40%. This was the lowest growth rate recorded since week ending 28 May 2012 when it was 10.31%. The rate of change in the 5-year growth rate fell for the 40th week in a row as the current growth rate was 155 basis points lower than it was at the same stage last year. This was the sharpest contraction in the 5-year growth rate of the money supply since week ending 13 October 2008 when it contracted 156 basis points. Add that to your list of risks (or opportunities). 



In last weeks report, we had a closer look at this percentage point change in the 5-year growth and compared the 2001 to 2006 period with the period starting in August 2011. The updated chart looks as follows: 


The starting points for both series are the dates when the percentage point change in the growth rate peaked (see the green arrows circled in the chart above). Last week I wrote:
The chart not only demonstrates the resemblance between the percentage point change during the two periods, it also shows that this time around the growth rate is declining faster than it did during the 2001 to 2006 period. Even if the rate of growth continues to decline, the U.S. economy might still avoid some kind of a crisis for many more months if the 2001-2006 period is any guide to the future. 
Without getting too technical, another interesting observation is that the percentage point change in the 5-year growth is currently at the same stage it was for the week ending 29 May 2006 (a 155 basis points year on year contraction in the growth rate). If the growth rate continues to fall from here, and if the 2001 to 2006 "is any guide to the future", this observation could indicate that we are closer to an inflection point (i.e. another crisis of some sort) than if we simply look at the number of weeks the rate of change has declined for the two series (we are currently in week 162). 

It is of course impossible to make an accurate prediction concerning inflection points, but the decline in the growth rate should be viewed as a risk factor to many asset prices, especially U.S. stocks. This is very relevant now as the Fed appears to be close to ending QE (for now that is) which by itself will have a negative effect on the growth rate in the money supply and push interest rates up (or less down) as a result.

Also, I speculate that there is at least some, though likely small, probability that full-reserve banking (or something closer to it) could be implemented the U.S. soon or sometime in the future, ending fractional reserve banking as we know it. Read the full report here. If implemented and not compensated by the Fed or the U.S. government creating new money instead (in "normal" circumstance, banks create the bulk of the new money through making loans), large deflationary pressures could hit the U.S. economy until a new money relation is established. All else remaining the same, bank shareholders would lose, bank bondholders would gain and the stock market would decline if something closer to a full-reserve banking system was implemented. The U.S. dollar would strengthen (over the longer term) and at least partly offset any U.S. stock market losses (and other nominal asset price losses) for foreign investors. Over the longer term and in real terms, implementing a full-reserve banking system would be a positive for the U.S. economy as it would greatly reduce, if not eliminate, the cycles of artificial booms and very real busts the many have become only too familiar with.



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Wednesday, 10 September 2014

Is Full-Reserve Banking The Next Step for U.S. Banks?

In my latest article published on Seeking Alpha, I discuss the possibility that the next step for U.S. banks is to implement a full-reserve banking system.

Your can read the full article here

Monday, 8 September 2014

Bubble Chart of The Day: The U.S. Stock Market to GDP and GNP Ratio

If it looks like a duck, swims like a duck, and quacks like a duck...


...then it probably is a duck.



Saturday, 6 September 2014

Breaking News: U.S. Banks are Now Operating with 100% Reserves

According to bank reserve figures for August released today by the Federal Reserve, something unprecedented in the history of U.S. fractional reserve banking just took place: bank reserves in percent of M1 Money Supply hit 100%!

Though not a current requirement, that reserves now cover 100% of the M1 money supply effectively means U.S. banks (or depository institutions to be exact) are currently operating according to 100% reserve, or "full-reserve banking", requirements in line with those discussed by Ludwig von Mises and Friedrich Hayek.*


Full-reserve banking is a banking practice whereby banks are required to hold 100% reserves against deposits which depositors have a legal right to immediately withdraw. The deposits in questions here include Demand Deposits and Other Checkable Deposits, but does not include savings or time deposits. In addition, both Mises and Hayek stated banks should also hold 100% reserves against notes and coins in circulation.* As the M1 money supply measure includes all these items, the current reserves of U.S. banks now cover both deposits and currency in full.

Under a 100% reserve requirement, banks would not be able to create new money out of thin air (without assistance from the Fed) and would hence only be able to lend what other people and institutions have saved. This would largely eliminate the risks of bank runs driving banks into insolvency. Central banks could still lend money to or purchase securities from banks, thereby increasing bank reserves and hence banks' ability to create new deposits (money) through granting loans. Nonetheless, a 100% reserve requirement would, ceteris paribus, reduce banks ability to lend what has not previously been saved by customers and hence reduce money supply growth which again would have a dampening effect on the business cycle.

The way the Fed helped banks get to this stage is beyond criticism and will not be debated further in this article. But here is a bit of speculation: was it the Fed's plan all along to help banks into a 100% reserve requirement position and then in due course end fractional reserve banking altogether? And replace it with full reserve banking?

Surely, the Fed must by now be aware of the effect creating money out of thin air has on the business cycle? And just as surely, the Fed must know that ending its asset purchase program will negatively affect the money supply growth rate and could provoke a market correction? Taking this into consideration, could it not be that the Fed now believes it has done its job having helped banks get into this 100% reserve position? Could this be the real reason it has been tapering and could it not explain why it implemented QE3 in the first place (at a time when the Fed was able to look to the future having completed the "emergency rescue" of the banking system)?

In other words, it should perhaps not be a surprise if the Fed actually did announce, in due course, the end of fractional reserve banking as we know it. Banks do after all now actually hold 100% reserves against deposits and currency. 

Something is going on here, and that something is not being communicated by the Fed. Or maybe I'm just having a few bad moments at the computer (I'm this night's watchman at the local marina and it's getting late). Time will show.


* See Money, Bank Credit, and Economy Cycles, 3rd ed. by Jesús Huerta de Soto, p. 716-735. Also, both Mises and Hayek argued in favour of a gold standard.

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Liability Type Requirement
% of liabilities Effective date
Net transaction accounts 1
$0 to $13.3 million2 0 1-23-14
More than $13.3 million to $89.0 million3 3 1-23-14
More than $89.0 million 10 1-23-14
Nonpersonal time deposits 0 12-27-90
Eurocurrency liabilities 0 12-27-90


Note. Required reserves must be held in the form of vault cash and, if vault cash is insufficient, also in the form of a deposit maintained with a Federal Reserve Bank. An institution that is a member of the Federal Reserve System must hold that deposit directly with a Reserve Bank; an institution that is not a member of the System can maintain that deposit directly with a Reserve Bank or with another institution in a pass-through relationship. Reserve requirements are imposed on commercial banks, savings banks, savings and loan associations, credit unions, U.S. branches and agencies of foreign banks, Edge corporations, and agreement corporations.

1. Total transaction accounts consists of demand deposits, automatic transfer service (ATS) accounts, NOW accounts, share draft accounts, telephone or preauthorized transfer accounts, ineligible bankers acceptances, and obligations issued by affiliates maturing in seven days or less. Net transaction accounts are total transaction accounts less amounts due from other depository institutions and less cash items in the process of collection. For a more detailed description of these deposit types, see Form FR 2900 at http://www.federalreserve.gov/apps/reportforms/default.aspx

2. The amount of net transaction accounts subject to a reserve requirement ratio of zero percent (the "exemption amount") is adjusted each year by statute. The exemption amount is adjusted upward by 80 percent of the previous year's (June 30 to June 30) rate of increase in total reservable liabilities at all depository institutions. No adjustment is made in the event of a decrease in such liabilities.

3. The amount of net transaction accounts subject to a reserve requirement ratio of 3 percent is the "low-reserve tranche." By statute, the upper limit of the low-reserve tranche is adjusted each year by 80 percent of the previous year's (June 30 to June 30) rate of increase or decrease in net transaction accounts held by all depository institutions.


Friday, 5 September 2014

The Short Version of the "Austrian" True Money Supply (TMS), as of 25 August 2014

The short version of the Austrian True Money Supply for the U.S., a measure of the money supply applied in this weekly report, decreased 0.55% on last week for the week ending 25 August 2014. At $10.1824 trillion, the money supply is now up 3.07% year to date.

The 1-year growth rate dropped to 7.85%, down from 8.06% reported last week. It remains lower than the 8.30% long term average since 1980.


The 5-year annualised growth rate continues to fall. The current growth rate of 10.54% remains well above the long term average of 7.54%, but is much lower than the 12.40% recorded in October last year. The current growth rate is also 1.34 percentage point lower than it was during the same week last year and this week was the 39th week in a row with a declining growth rate on this basis (see the dotted line in the chart below). 


As I've mentioned on quite a few occasions before, the drop in the 5-year growth rate (both the year on year growth rate and the percentage point change in the growth rate) has for some time resembled the decline leading up to the 2008 banking crisis (as indicated by the circles in the chart above). To highlight this resemblance, the chart below depicts the percentage point change in the growth rate compared to last year for the periods 24 December 2001 to 11 September 2006 and 1 August onward. 


The chart not only demonstrates the resemblance between the percentage point change during the two periods, it also shows that this time around the growth rate is declining faster than it did during the 2001 to 2006 period. Even if the rate of growth continues to decline, the U.S. economy might still avoid some kind of a crisis for many more months if the 2001-2006 period is any guide to the future. 

Now, nobody should expect the economy to react to this decline in the growth rate of the money supply in exactly the same way as it did last time around when it culminated in a full-fledged banking crisis. But regular readers of this blog will be familiar with the notion that the money supply does not have to fall in absolute terms to trigger an economic reaction (i.e. a recession or depression). Rather, all that is needed to provoke a reaction is a decline in the rate of growth. As Hayek pointed out in his book Prices and Production:
If the results of our theoretical analysis were to be subjected to statistical investigation, it is not the connection between changes in the volume of bank credit and movements in the price level which would have to be explored. Investigation would have to start on the one hand from alterations in the rate of increase and decrease in the volume and turnover of bank deposits and, on the other, from the extent of production in those industries which as a rule expand excessively as a result of credit injection. Every increase in the circulating media [money supply] brings about the same effect, so long as each stands in the same proportion to the existing volume; and only an increase in this proportion makes possible a further increase in investment activity. On the other hand, every diminution of the rate of increase in itself causes some portion of existing investment, made possible through credit creation, to become unprofitable.
It follows that a curve exhibiting the monetary influences on the course of the cycle ought to show, not the movements in the total volume of circulating media, but the alteration in the rate of change of this volume. 
Hayek's theories and those of the Austrian Business Cycle Theory (ABCT) in general are the reasons why this weekly report looks at the growth rate of the money supply on a weekly basis, including the rate of change. 

Keen readers and students of the ABCT should however be aware that things are somewhat different this time around: rapid bank credit expansion for a long period of time is what fueled the money supply growth leading up to the 2008 banking crisis. Since then however, money supply growth has been driven by the Fed monetizing government debt. The difference hence lies in how the new money has entered the economy and who as a result has become dependent on ever new injections of money. This is key in identifying bubbles. For example, as the U.S. government has expanded rapidly over the last six years (yes, it expanded before this as well), the period since 2008 might be identified much more as a period of over-consumption rather than businesses malinvesting funds (as was a dominant feature of the last bust, e.g. housing). What we do know however is that independent on how the new money enters the economy, the new money is quickly dispersed in the economy and does alter economic structures and prices, including asset prices, in a way that would not happen if money was not created out of thin air. The stock market is an obvious example (e.g. here), or as Fritz Machlup explained in 1931 (The Stock Market, Credit, and Capital Formation),

“A continual [nominal] rise of stock prices cannot be explained by improved conditions of production or by increased voluntary savings, but only by an inflationary credit [money] supply”




However, bank lending this year has shot upwards once again and, as I've written earlier, the U.S. economy is once again entering the situation the ABCT attempts to explain; an increase in credit unbacked by a commensurate amount of prior savings granted to businesses (e.g. here).