Jumat, 17 Agustus 2012

No shortage of money

M2, arguably the best measure of the amount of readily/easily spendable cash in the economy, has now surpassed the $10 trillion mark, a milestone of sorts. M2 has grown about 6% per year on average for a very long time, but over the past year it's grown at a 7.7% annualized rate. That's not exactly what you would expect from what many consider to be the Fed's massive money-printing operations. It's hardly enough to wreak inflationary havoc in the economy. As the second chart suggests, this extra growth probably reflects some capital flight out of the Eurozone.

Savings deposits, by far the largest component of M2, have been the source of most of the extra growth in M2 since 2008. Savings deposits, of course, pay next to nothing, so these days they are simply a repository for money that people want to keep safe. Savings deposits have grown by a staggering $2.4 trillion over the past four years, and that reflects just how concerned people are about the economic situation. The Fed can't force people to put money in savings deposits, so these deposits really represent the demand for safe money. Money demand, in other words, is the thing that has driven the ongoing increase in M2 in recent years. People want to hold on to money, and to hold on to more of it.

For all the talk of capital fleeing the Eurozone, their measure of the M2 money supply has not declined at all; it has grown at a 2.8% annualized pace for the past two years. As the chart above suggests, the extra money accumulated in the Eurozone in the years leading up to 2008—when the Eurozone was considered to be more attractive than the U.S.—has now largely been reversed. In any event, Eurozone M2 has grown by about the same rate as U.S. M2 over the long haul. Perhaps it's not a coincidence that inflation in the Eurozone has been substantially similar to that in the U.S.

One source of the increased amount of M2 money is Commercial & Industrial Loans, which have increased by almost $270 billion in the past two years, and are currently growing at strong, double-digit rates. This is good evidence that banks are relaxing their lending standards and that businesses are more willing to borrow, both signs of increased confidence and thus a portent of stronger growth to come.

On balance, it's hard to find anything scary in these charts. Money is not in scarce supply, and indeed it is probably just sufficient to satisfy the demand for money. If there is something to worry about, it is the mountain of bank reserves that sit idle at the Fed, some $1.5 trillion worth. To judge from the relatively tame inflation rate and the strong demand for money, the world's demand for idle bank reserves is strong, and so the Fed's creation of those reserves was apparently what was needed to restore needed liquidity to the system. We are in a sort of equilibrium for now, but that could change if the demand for safe dollar liquidity should decline. If the savers start spending the cash they have stuffed into bank deposits, and if banks start using their idle reserves to make new loans, then we could see a tsunami of money introduced to the system which would likely boost nominal GDP by a substantial amount. The biggest monetary risk we face is not knowing whether the Fed would be able to reverse its massive creation of bank reserves in a timely fashion should money demand fall, in order to prevent a significant surge in inflation.

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