Saturday, 21 December 2013

U.S. Money, Credit & Treasuries Review (as of 11 December 2013)

After almost seven months of speculation on when and if the Federal Reserve would reduce its asset purchase program, Bernanke finally did decide to taper on Wednesday. The press release reads (my bold),
Taking into account the extent of federal fiscal retrenchment since the inception of its current asset purchase program, the Committee sees the improvement in economic activity and labor market conditions over that period as consistent with growing underlying strength in the broader economy. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the Committee decided to modestly reduce the pace of its asset purchases. Beginning in January, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $35 billion per month rather than $40 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $40 billion per month rather than $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee's sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee's dual mandate. 
The Fed is hence reducing its monthly asset purchases from USD 85 billion to USD 75 billion, commencing next month. This represents a reduction, or taper, of 11.8%. At an annual pace of USD 480 billion (12 x USD 40 billion in treasury securities), the new asset purchase program will still be able to monetize a big chunk of the ever increasing federal debt over the next year. As I wrote yesterday,
For the 12 month period ending June, federal government debt increased by USD 56 billion every month. At this rate, the new Fed asset purchase program of buying USD 40 billion a month in longer term treasury securities would be able to monetize about 71.4% of newly issued government bonds going forward (as opposed to 80.4% under the old USD 45 billion a month).

The U.S. monetary base increased USD 45 billion for the bi-weekly period ending 11 December 2013. At USD 3.7566 trillion, the base has increased USD 1.0656 trillion this year alone (39.60%). On a year on year percentage change basis, the base expanded 39.29%, the highest growth rate since week ending 2 December 2009.

The M1 money supply expanded 8.60% compared to the same period last year. Though this was a significant increase, it was 2.03 percentage points lower than the average during the last 52 weeks and a full 6.54 percentage points lower than the 15.14% average in 2012.

The M2 money supply grew 5.86% on the same period last year to record the lowest year on year (YoY) growth rate since week ending 15 June 2011. The YoY growth in the M2 thus continues to slide as it has done all year.
The growth rate in Bank Credit continued to slide alongside M2. At 1.28%, it was the lowest YoY growth rate since week ending 19 Oct 2011. As money is created (out of nothing) when banks create credit, this slow growth, 5.19 percentage points lower than the average since 1985, helps explain the decrease in the M2 growth rate.

Loans and Leases, which makes up about 73% of Bank Credit, also continued to grow at a decelerating pace. The 2.13% YoY growth rate for the week was the lowest since week ending 14 December 2011 and 4.24 percentage points lower than the average since 1985.

These extremely low growth rates in Bank Credit and Loans and Leases demonstrates that a not insignificant part of the money supply growth this year has been generated through increases in federal debt monetized by the Fed. If this money creation process slows down, without Bank Credit growth offsetting it, the money supply will collapse. If that were to happen, the economy will collapse with it. This helps explain why the taper was modest - the Fed simply cannot (and obviously does not) rely on U.S. banks to create credit and hence money in sufficient quantity to avoid the house of cards collapsing.
Compared to two weeks ago, the 1-year treasury yield was unchanged at 0.13% while the 10-year yield increased five basis points (1.76%) to 2.89%. This perhaps indicates Bernanke's tapering announcement was discounted, at least to some extent, by the bond market.