Tuesday, 5 November 2013

U.S. Money, Credit & Treasuries Review (as of 16 October 2013)

The US monetary base is closing in on USD 4 trillion. As the Fed "decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month" last week (here), the base will exceed USD 4 trillion in about five months time.

The M1 money supply tumbled this week, decreasing USD 91.6 billion, or 3.49%, compared to two weeks ago due to a substantial fall in the amount of Demand Deposits outstanding. The M2 money supply on the other hand increased USD 135 billion, or 1.25%, driven by a significant increase in Total Savings Deposits. It's therefore likely some of the demand deposits were transferred to savings deposits by customers. Compared to the same week last year, the M1 and M2 increased by 8.59% and 6.62%, respectively. Though both growth rates increased for the bi-weekly period ending 16 October, they are lower by some margin compared to the average year on year (YoY) growth rates during the last 52 weeks and the average YoY growth rate last year.

The YoY growth rates for Bank Credit and Loans & Leases in Bank Credit continue appear to be stuck in a falling trend, though both picked up slightly this week. As banks create money out of thin air when granting loans and as they've only created USD 60.6 billion in loans this year, the Fed has this taken on the role all by itself of expanding the money supply through its asset purchase program (monetizing the debt). It is, in my opinion, likely to continue this purchase program for the foreseeable future to drive money supply growth, to keep interest rates down and to sustain artificially elevated asset prices. This results, among other things, in a lower purchasing power of the dollar than it otherwise would have had (see The Madness of Generating Asset- and Price Inflation, and Why It's Rational for Some for more on this).

The Fed believes, or at least says so publicly, that it needs to stimulate growth. This is of course nonsense as real wealth is not created through keeping interest rates artificially low (there is no free lunch in an economy!) and through printing money - newly printed fiat money is not capital. Rather, real wealth and real economic growth is created through production, savings and investments, or as professor Jesús Huerta de Soto puts it when explaining the essential difference between rich and poor countries,
...the essential difference between rich societies and poor societies does not stem from any greater effort the former devote to work, nor even from any greater technological knowledge the former hold. Instead it arises mainly from the fact that rich nations possess a more extensive network of capital goods wisely invested from an entrepreneurial standpoint. These goods consist of machines, tools, computers, buildings, semi-manufactured goods, software, etc., and they exist due to prior savings of the nation’s citizens. In other words, comparatively rich societies possess more wealth because they have more time accumulated in the form of capital goods, which places them closer in time to the achievement of much more valuable goals. 
Money, Bank Credit and Economic Cycles, 3rd ed, p. 279
To keep the house of cards standing in mid air, the Fed continues to "stimulate" the economy through monetizing debt and keeping interest rates low. If it ends these policies, it will become immediately apparent for all that the emperor indeed has no clothes as the full force of the Austrian Business Cycle Theory would reveal it all (here if you're not familiar with it, alternatively do a search on "Austrian Economics" on this website). Even if the Fed continues with the current policies, a mere slowing down of the growth rate in money supply (or some other event such as sovereign debt issues in the US or abroad) could lead to a significant market correction. Also, the US fractional reserve banking system is very fragile with an equity/total asset ratio of only 10.94% as of 23 October. Therefore, the Fed might soon find itself in the position of having to increase its asset purchases to above the current USD 85 billion a month. This way, it could keep the artificially pumped up economy and asset prices elevated for a long time in nominal terms. But it would make the ultimate outcome and adjustment even worse.


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Treasury yields fell during the bi-weekly period ending 1 November with the 10-year yield shedding 11 basis points. Compared to the same period last year, the 1-year yield has decreased 7 basis points while the 10-year yield is up by 81 basis points. As a result, the spread between the two has widened by 88 basis points during the same period.














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