Tuesday, June 4, 2013

No Exit

Mark Sadowski has a guest post up at Marcus Nunes' Historinhas: Koo’s wrongheaded views on the Great Depression as an example of a Balance Sheet Recession – A Guest Post by Mark Sadowski. Pretty long, with lots of graphs. I don't have an opinion yet on Sadowski's post. But hey, I still don't have an opinion on Richard Koo's ideas either.

However, I do have a comment on Sadowski's conclusion. He writes:

Moreover there was never any need to exit from the more than six-fold increase in the monetary base that took place in 1932-48. The most that the monetary base decreased was from $48.413 billion in December 1948 to $42.960 billion in April 1950, or by 11.3%...

So given the history of the last time the Federal Reserve spent an extended period of time at the zero lower bound, as well as the availability of newer monetary policy tools (e.g. interest on reserves), I seriously doubt that an exit from QE will be necessary, much less desirable.

See the three massive spikes in the middle of this graph?

Graph #1: Percent Change from Year Ago, Consumer Price Index

Those spikes are the reason that "there was never any need to exit from the more than six-fold increase in the monetary base". Everything inflated up. The relative size of the monetary base was reduced by the round-about process of everything else going up.


Jazzbumpa said...


Interesting that Nunez hosts Sadowski. Evidently, they are in the same tribe.


jim said...

I read the Sadowski article and my conclusion is the guy is irredeemably confused. His biggest mistake is trying to find a relationship between total credit market debt and bank deposits as if all credit market instruments become bank deposits.

But leaving the Great Depression and focusing on the current economy and the current money supply, I've been looking at this chart:


This is 3 different ways of looking at what most people count as money. It is interesting that they do not match up perfectly.

Since about the end of 2007, it appears that M2 consists of mostly just deposits plus currency in circulation. If you go back to 2004 it looks like there was another trillion dollars of "something" that was in M2 that is no longer there. Was that Money Market Funds? or are MMMF counted as deposits now?

Anyway the most interesting thing about this chart is if we take out the money from the central bank. This is what the chart looks like (as if the money supply was composed of only bank loans and currency in circulation).


That second chart illustrates what the effect would be of private deleveraging absent the money from the FRB. And obviously the drop in the money supply would have been much greater had it been allowed to happen because of the negative feedback effects of a shrinking money supply in accelerating the deleveraging.

Here is zerohedge's look at the same data a couple days ago (accompanied by its usual inflammatory commentary).


Mark A. Sadowski said...

@The Arthurian

Keep in mind that from January 1929 to January 1954 CPI inflation averaged a whopping 1.8%.

Also, Koo recently made the following prediction:

“But nightmare scenario awaits when private loan demand recovers. The problem is what happens when private loan demand recovers. Loan books could grow more than tenfold in the US and five fold in Japan and Europe if bank reserves remain at current levels, triggering inflation rates of 500% to over 1,000%.

To avoid this outcome, central banks will have to mop up excessive reserves by raising the statutory reserve ratio, raising the interest rate paid on reserves, and selling government bonds. All of these measures will serve to lift interest rates, sending bond yields sharply higher and triggering a possible crash in the bond markets.

A sharp increase in government bond yields could lead to fiscal collapse in countries with a large national debt. For Japan, where the national debt amounts to 240% of GDP, the results would be catastrophic.

Expanding quantitative easing because it appears to be doing no harm is grievous error. Mr. Abe and his advisors may believe that all they have to do once their anti-deflationary policies succeed and JGB yields start to rise is have the BOJ buy more bonds. However, bank reserves under quantitative easing have risen to a level capable of fueling a 500% inflation rate, in which case the BOJ would have to sell, not buy, JGBs.

Nomura | JPN”


Yes, you read that correctly. Koo is predicting that the current Japanese large scale asset purchases have the potential to create 500% to 1,000% rates of inflation, a crash in the bond market and a complete fiscal collapse. According to Koo's thinking the money multiplier is highly unstable above the zero lower bound.

You wrote:
"I read the Sadowski article and my conclusion is the guy is irredeemably confused. His biggest mistake is trying to find a relationship between total credit market debt and bank deposits as if all credit market instruments become bank deposits."

The mistake is entirely Koo's. He argues that the asset side of bank balance sheets, and hence money supply, is rigidly constrained by the supply of credit market debt. That claim is key to the his argument that monetary policy is impotent in a Balance Sheet Recession. All I do is methodically show that this claim is utterly ridiculous.

jim said...

Banks create deposit money when they make loans and deposit money is destroyed when loans are repaid or cancelled.
From 1929-1933 a third of the bank deposits disappeared because very little new loans were made and existing loans were paid down or defaulted or were called in because banks needed to raise cash to pay depositor demand for withdrawals. Plus there was a 50% drop in GDP from individuals in aggregate spending less than their income due to saving or repaying debt.

Koo's point is that fiscal policy works because it absorbs the unborrowed funds and puts them in the hands of those who will buy goods and services. Monetary policy fails because it just converts one form of savings to another. That doesn't produce any demand for goods and services. It's like exchanging $50 bill for five 10's. There is no resulting increase in GDP.

Jazzbumpa said...

I never read ZH unless directed there by somebody. That post reads pretty well, for a while, when it's in reporting mode. But this reveals the agenda.

It also means that banks, stuck with massive excess deposits on their books (recall "The "Big Three" Banks Are Gambling With $860 Billion In Deposits") have no choice but to use this capital and gamble with risk assets.

There is always a choice.

Then, starting with the Klarman quote, it turns into a catechism lesson. Not my flavor of Kool-Aide.


The Arthurian said...

I had a similar reaction, Jazz. I thought the first few paragraphs were very good. By the end, it was gone.

"...when it's in reporting mode."

I should take another look.

jim said...


Well I did give a bit of a warning about Zerohedge. I suppose I could have linked to just the graph in that story.

The thing is ZH seems to be the only one who understands where the growth of deposits above loans is coming from.

Here's a WSJ story on the same subject:


The WSJ article doesn't explain where the excess deposits are coming from, but hints (see quote below) that it is coming from depositors as if depositing a check in your account changes the total bank deposits in the system.

"Meanwhile, deposits keep flooding into banks from people like Peter Kelly"

Jazzbumpa said...

Jim -

I wasn't complaining. There just isn't much to draw me to ZH.

Loans/deopsits is an area I haven't thought much about, so I'm ignernt.