I received the following comments from Lacy regarding How Many Rate Hikes Does the Market Now Expect of the Fed?
Mish,
Excellent analysis.
Here is my analysis of the Fed’s H.8 Report which I am sure you have seen.
Line 36 or ODL (the best measure of money) is a showing a clear cyclical pattern. Decreases stretch back to Q2 and there was a sharp 7.2% rate of decline in January and the drop in the last 12 months is a record. Line 36 is the leading indicator of credit. The contraction in money supply coupled with a rise in interest rates has reduced the desire of banks to lend and the desire of businesses and individual to borrow.
Hope you are well.
Lacy
A Better Definition of Money
Other Deposit Liabilities is Lacy’s preferred measure of money supply.
I discussed ODL in A Better Definition of Money and Lacy Hunt’s Thoughts on When a Recession Will Start
The main difference between ODL and M2 is that ODL does not include currency or retail money market funds.
Currency is accepted at an increasingly fewer number of business establishments and simply cannot be used for very large sized transactions. Retail money market funds never became an important medium of exchange. Both are becoming a far less used medium of exchange.
ODL has the additional advantage that it is the main source of funding for bank loans and investments, making ODL both a monetary and credit aggregate. Friedman would not be surprised that the need to change the best definition of what constitutes money would change over the years.
The Biggest Collapse in M2 Money Supply Since the Great Depression
I previously posted charts of ODL on January 25, in The Biggest Collapse in M2 Money Supply Since the Great Depression.
I repeat my caution to not confuse ODL with the Fed’s H.6 Money Stock Report line Other Liquid Deposits.
If you are looking at data downloads from Fred (the St. Louis Fed depository), it’s easy to pull the wrong numbers.
My previous charts of ODL were based on a definition of ODL = M2 – (Currency + Retail Money Market Funds).
That gives a similar, but not exact match to the H.8 line 36.
ODL Through January 2023
My ODL number above, based off H.8, still does not match the H.8 report that has January at $16,007.8 billion.
This is because Fred uses a Monthly Average calculation whereas the H.8 report is weekly.
H.8 appears to be using an average of January 11, January 18, January 25 whereas Fred appears to include an additional week of January 4, at 16,068.6.
The former averages to 16,008.2 and the latter 16,023.3. Tiny rounding errors account for the difference.
The Fed appears to average complete weeks that fall within the month but Fred (the St. Louis Fed depository download) doesn’t.
I will contact the St. Louis Fed to see if they wish to update their Fred methodology for calculating monthly averages of H.8 data.
If the monthly numbers do not precisely match, neither will the percentages in the next chart.
ODL Percent Changes Through January 2023
Regarding my original calculation: ODL = M2 – (Currency + Retail Money Market Funds) Lacy commented “You are right there are some other small items in the difference with M2 but I ignore them because they are immaterial and I want a variable I can track weekly.“
Meanwhile, ignore any small differences in various calculations as long as you are looking at the right things.
The key point in all of this is not tiny differences in numbers but Lacy’s comment regarding bank lending.
The contraction in money supply coupled with a rise in interest rates has reduced the desire of banks to lend and the desire of businesses and individual to borrow.
I have made similar comments many times.
The key constraint on bank lending is not reserves or deposits but rather capital impairment. If banks are not capital impaired, they will lend if they believe they have good credit risks who want to borrow.
By hiking rates, the Fed has purposely reduced the desire of banks to lend due to recession risk. Rising interest rates also reduce the incentive for businesses and individuals to borrow.
This tightening of money will eventually result in a contraction in hiring and wage growth. And a contraction in hiring is what the Fed wants whether they say so or not.
Recent Data
Recent data has been a mixed bag.
- The Philly Fed Manufacturing Report was a Disaster. Excluding the Covid pandemic, it was worst since the great recession.
- On the housing front, Starts Drop Another 4.5 Percent to a New Post-Covid Low
- And Industrial Production Much Weaker Than Expected, With Negative Revisions Too
- On the strong side, Consumers Go on Huge Retail Sales Shopping Spree in January After Months of Weakness
- Note that the CPI Accelerates 0.5 Percent in January, Up 6.4 Percent From a Year Ago
The CPI will keep the Fed hiking sooner and for longer.
This post originated at MishTalk.Com
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classifications in May 2020 (eliminated the 6 withdrawal restrictions on
savings accounts, which isolated money intended for spending, or
means-of-payment money, from the money held as savings, or the demand for money
(reciprocal of velocity).
Powell:
#1 “there was a time when
monetary policy aggregates were important determinants of inflation and that
has not been the case for a long time”
#2 “Inflation is not a problem
for this time as near as I can figure. Right now, M2 [money supply] does not
really have important implications. It is something we have to unlearn.”
#3 “the correlation between
different aggregates [like] M2 and inflation is just very, very low”.
Powell is the worst FED
Chairman we’ve ever had.
“CHAIRMAN GREENSPAN. I must
say that I have not changed my view that inflation is fundamentally a monetary
phenomenon. But I am becoming far more skeptical that we can define a proxy
that actually captures what money is, either in terms of transaction balances
or those elements in the economic decision-making process which represent
money. We are struggling here. I think we have to be careful not to assume by
definition that M1, M2, or M3 or anything is money. They are all proxies for
the underlying conceptual variable that we all employ in our generic evaluation
of the impact of money on the economy. Now, what this suggests to me is that
money is hiding itself very well.”
The problem is that no money
supply figure standing alone is adequate as a guidepost for monetary policy.
The turnover ratio for DDs as opposed to TDs is 95: 5.
Transaction’s velocity is an
“independent” exogenous force acting on prices. However, income
velocity merely tells us that a given volume of m will have to turnover a
certain number of times to finance a given volume of nominal gDp. Income
velocity does not assist in any way in explaining inflation.
Link: George Garvey:
Deposit Velocity and Its Significance
(stlouisfed.org)
“Obviously, velocity of total deposits, including
time deposits, is considerably lower than that computed for demand deposits
alone. The precise difference between the two sets of ratios would depend on
the relative share of time deposits in the total as well as on the respective
turnover rates of the two types of deposits.”