Wednesday, January 6, 2010

Goodbye Monetary Base Growth

The FOMC meeting minutes for the December 15-16, 2009 period are out.

In the longest worded minutes that I can recall, the Fed goes into extensive detail on various sectors of the economy. They clearly see upticks across the board. Since the board appears to be nothing more than mere trend followers, a double-dip will clearly catch them by surprise. For them it's, "Hey, the economy was up last month, maybe it will be up next month also."

I note that some are claiming that these minutes are all about a concern over inflation. Zerohedge writes, for example, "FOMC Minutes: Inflation Considerations Prevail." When the Fed actually wrote:
Most participants anticipated that substantial slack in labor and product markets, along with well-anchored inflation expectations, would keep inflation subdued in the near term, although they had differing views as to the relative importance of those two factors. The decelerations in wages and unit labor costs this year, and the accompanying deceleration in marginal costs, were cited as factors putting downward pressure on inflation. Moreover, anecdotal evidence suggested that most firms had little ability to raise their prices in the current economic environment. Some participants noted, however, that rising prices of oil and other commodities, along with increases in import prices, could boost inflation pressures going forward. Overall, many participants viewed the risks to their inflation outlooks as being roughly balanced. Some saw inflation risks as tilted to the downside, reflecting the quite elevated level of economic slack and the possibility that inflation expectations could begin to decline in response to the low level of actual inflation. But others felt that inflation risks were tilted to the upside, particularly in the medium term, because of the possibility that inflation expectations could rise as a result of the public's concerns about extraordinary monetary policy stimulus and large federal budget deficits.
I don't know how you get inflation considerations prevailed, especially given the discussion on other topics and economic sectors.

Most significant was this comment in the lead paragraph of the minutes (My emphasis.):
Since the Committee met in November, the Federal Reserve's total assets were about unchanged, at nearly $2.2 trillion, as the increase in the System's holdings of securities roughly matched a further decline in usage of the System's credit and liquidity facilities. The Manager noted that the System's holdings of securities will tend to decline gradually after the completion of the asset purchase programs, reflecting maturing issues and prepayments on holdings of MBS. The Manager noted that the Committee would likely wish to discuss in detail its policy for reinvesting the proceeds of maturing issues and prepayments; he proposed, as an interim approach, continuing the practice of not reinvesting the proceeds of maturing agency securities or MBS prepayments. Meeting participants supported that interim approach pending further discussion at future meetings.
Bottom line: The unwinding of the "rescue" is about to be seen in full view of all monetary base fear mongers. The Fed is simply going to allow agency paper and MBS loans to mature and they ARE NOT GOING TO REINVEST THE MONEY. The monetary base is about to shrink like you know what in cold water.

Are these monetary base watchers then going to be consistent and turn deflationary when the base shrinks?

Of course, if they do, they may be doing so just as what they should be watching, M2, begins to show the inklings of new life--which would be a real inflationary signal.


  1. I thought that your feeling was that because the Fed wasn't still printing money (besides the 942B) increase in M2 in 2009 that the monetary base watchers were going to be hurt when they realized that Ben will drain off the excess reserves, possibly causing an equity selloff. How does this start M2 rising?

  2. @ Matt M.

    You are correct. The drain won't have anything to do with M2.

    It just so happens that in the last couple of weeks there has been a small uptick in M2. It's too early to call it an uptrend, but if it continues that would be the case. So you would have a declining monetary base, and the real inflation concern, growing M2.

    I was getting a little ahead of myself with the inflationary remark, just to give the monetary base watchers even a little more indigestion.

  3. RW,

    I cannot speak for all base watchers, but just to be clear, I never doubted that milk prices would only go up once M1, M2, etc. started shooting up. But the reason I am alarmed by the huge monetary base is that I think it provides the necessity of a skyrocketing M1 and M2, given everything else about the system.

    My view has been that the Fed will probably try to meet somewhere in the middle, i.e. start sucking down the base once it has no choice because Treasury and corporate yields are going sky high and the excess reserves are being used to earn higher returns elsewhere. In that scenario then, you'd see the monetary base shrink while M2 etc. start rising, and gas and milk prices start rising.

    So please don't think that if that happens, I was misguided in my worries about the monetary base. (Again, I agree that some people don't understand these mechanics, and are worrying about the monetary base without knowing exactly why they should be.)

  4. Bob - Be careful which commodity you pick as a measure of common consumer goods. :) Class III Milk is up to 14 cents, off of lows of 9 cents this time last year, retracing from 20 at the peak of 08.

    Robert - Any reason why M2 is ticking higher?