Sunday, November 22, 2009

On Supposed "Covert" Money Creation

I have received a few emails re a guest post at ZeroHedge by "Don" in which he claims that there has been "covert" money creation going on. He writes:


This note contains an update on where Fed printing stands, how much is left, what the pace of purchases is, and when the program will stop. It also updates the Fed's balance sheet, and its inflationary impact. This update houses some very important developments, due to actions at the US Treasury in coordination with the Fed.

Needless to say, Fed monetization programs have been a huge source of liquidity for the marketplace. It remains to be seen what will happen when this program is over, but it seems fair to say that liquidity will dramatically contract.


There are a few main conclusions from this analysis:

  1. Treasury program: The $300B Treasury program is now basically over (source).
  2. Agency/MBS program: The $1.425 Agency/MBS program is about $1.18T finished, while purchases continue at a slightly slackened pace of approximately $90B per month. At this rate, the program will be effectively over and done with by the middle of February 2010. This has clear liquidity implications for the marketplace come that time.
  3. SFP reduction and $268B of net printing the past 2 months: The "SFP", a program through which the US Treasury issued debt for the Fed to spend to blunt the inflationary impact of Fed balance sheet expansion, has led to tremendous money printing the past 2 months. Since 9/23/09, we've seen the SFP reduced by $185B and Fed Assets *increased* by $83B. In effect, then, the past 2 months have witnessed $268B worth of net printing of money by the Federal Reserve, without so much as a peep from the MSM (source).
  4. Real economy printing flat: It is true that the amount of money that has worked its way into the Real Economy (net of excess reserves and SFP) has remained flat (source). However this is due to the fact that banks now have $1,046B of excess reserves deposited back at the Fed, on which they are earning a risk free return of 25 bps. More free money for the banks guys!
There is just nothing in this commentary that should surprise regular EPJ readers. EPJ readers know that Bernanke is, like a mad scientist, using all kinds of new tools. They know that excess reserves are over a trillion dollars, in fact I was one of the first to point this out months ago.

There is nothing "covert" about any of this, and neither is the fact that money supply itself has not been growing. This I have also brought to the attention of EPJ readers, ages ago. Breaking down how exactly Bernanke has been shifting assets around is interesting but the only place you need to keep your eye is on M2. If suddenly banks start lending out the excess reserves, it will show up here. If Bernanke floods the system with so many reserves that banks finally decide to do something with them other than store them with the Fed, this will also show up in M2.

Don't get overly caught up in Bernake's toolbox, watching M2 will provide enough guidance. That said, there is nothing wrong wit being aware of the huge excess reserves or that Bernanke is doing all kinds of unusual asset maneuvers but none of this should be considered "covert" anything, it's all there for everyone to see, and it is certainly not money creating, covert or otherwise, if you consider M2 the money supply. It is extremely dangerous to believe that "covert" money printing is going on, indeed, it might cause you to go in and buy this stock market, which is on the brink of collapse largely because there is no money printing.

"Don" seems to be aware of the lack of money entering the system (in his point 4), so I am completely mystified as to the overall point he is trying to make when he says there is liquidity entering the system from "covert" money. There is simply none.


  1. A question. If both M3 and M2 were available, would you still prefer to use M2? I ask because here in Australia the central bank publishes M1 and M3, but not M2. Though it is not difficult to derive M2 from the tables available.

    BTW, the Reserve Bank of Australia has been paying interest on reserves since 1996. So its nothing new here.

  2. I don't follow Australia money supply close enough to know how to comapre it to that in the states. Further what you are really watching for is trends up or down. And M2 and M3 (in the U.S. generally move in tandem.)

  3. M2 (un-official measure) and M3 move in tandem here also. Nonetheless, if you had both, which one would you prefer?