After finishing yesterday's post, I looked again at the Base Money graph, wondering how reserves fit to it. FRED showed me this:
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| Graph #1: Base Money and Total Reserves |
Just to refresh my memory, here's a piece of Wikipedia's Money Supply table:
| Type of money | M0 | MB |
|---|---|---|
| Notes and coins in circulation (outside Federal Reserve Banks and the vaults of depository institutions) (currency) | ✓ | ✓ |
| Notes and coins in bank vaults (Vault Cash) | ✓ | |
| Federal Reserve Bank credit (required reserves and excess reserves not physically present in banks) | ✓ | |
| Traveler's checks of non-bank issuers | ||
| Demand deposits | ||
| Other checkable deposits (OCDs), which consist primarily of Negotiable Order of Withdrawal (NOW) accounts at depository institutions and credit union share draft accounts. | ||
| Savings deposits | ||
| Time deposits less than $100,000 and money-market deposit accounts for individuals | ||
| Large time deposits, institutional money market funds, short-term repurchase and other larger liquid assets | ||
| All money market funds |
As the MB column indicates, base money is made up of three parts: Notes and coins in circulation, Vault Cash, and Reserves not physically present in banks.
If you walk into the bank with a dollar in your pocket, that dollar counts as "Notes and coins in circulation". If you deposit the dollar, it changes to "Vault Cash". It is still part of base money, but now it counts as Reserves, as this investorwords clip shows:
If that dollar then for some reason gets sent to the Fed it is still base money and it is still reserves, but now it is "not physically present in banks".
That's the relation between the three components of base money.
If that is correct, then we can manipulate the components a bit, and look at it this way:
- The two components of base money are the "coins and currency" that people have, and "reserves"...
- And the two components of reserves are the coins and currency that banks have, and the coins and currency that the Federal Reserve has.
Whoa, Nelly! Maybe you object to the notion that reserves are coins and currency that the Federal Reserve has. Reserves are imagined to be electronic blips or something. But even if true, that is a technical detail completely without relevance. How the Fed stores reserves internally is utterly irrelevant.
So when Steve Roth writes
I’m going to go even farther than Dow and say: the Fed is not printing money. (It can do that, but the result is stuff you can hold in your hand.) That’s a confusing and actually incoherent misconception. The Fed is issuing new reserves and exchanging them for bonds.
I have to disagree. If the Fed is "issuing new reserves" then the Fed is "printing money". The phrase "printing money" is used to mean "increasing the quantity of money". Roth's "stuff you can hold in your hand" objection is ridiculous. Roth's misinterpretation of the common phrase is ridiculous.
The Fed doesn't have to "print" money to print money. It only has to issue the stuff. It can buy something and add electronic-blip funds to the seller's account. Whatever. It is still increasing the quantity of money. It is still "printing money".
Roth writes:
Reserves only exist (can only exist) in banks’ accounts at the Federal Reserve Banks (and only members — banks plus GSEs and other large institutions like the IMF — can have accounts there). The banking system can’t remove reserves from the system by transferring them to the nonbank sector in exchange for [stuff]
But it is not true that "Reserves only exist in accounts at the Federal Reserve." Roth is wrong about that. For as we have seen, vault cash is counted as part of reserves. Vault cash is cash in the banks or in their ATMs. It is not in accounts at the Federal Reserve.
And it is not true that "The banking system can’t remove reserves from the system by transferring them to the nonbank sector". Roth is probably right that banks don't use their reserve funds to buy drill presses and stuff. But banks "remove reserves from the system" all the time. It happens all the time.
Every week the wife deposits my paycheck in the bank and withdraws some cash to get me through the week. That cash is base money. Monday morning at the coffee shop it is "notes and coins in circulation". Before withdrawal it was "vault cash".
Before withdrawal, it was reserves.
If you have ever withdrawn money from a bank as cash, you have forced a bank to remove reserves from the system and transfer them to the nonbank sector. Once the "nonbank sector" has that money, it is no longer considered reserves. Therefore, the total amount of reserves has been reduced.
Reserves are reduced by the simple act of making a cash withdrawal.
What Steve Roth fails to understand is that base money is always money, whatever form it takes -- pocket money, vault cash, or electronic blips at the Federal Reserve.
In days of old when cash was gold,
fiat not yet invented,
gold was the base in every place.
Confusion was prevented.
So anyhow. Base Money is sometimes called the Monetary Base. The Wikipedia table uses the letters MB to represent base money, I suppose because the sequence BM is already taken.
Base money (MB) = Circulating Cash (CC) + Vault Cash (VC) + Reserves at the Fed (RF):
But "Vault Cash" and "Reserves at the Fed" together count as Reserves (R):
Now I can do the simple manipulation I started out to do. Subtract R from both sides:
Graph #1 showed MB and R. Graph #2 shows MB - R (Base Money less Reserves):
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| Graph #2: Base Money less Reserves |
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| Graph #3: Base Money less Reserves (blue) and Currency in Circulation (red) You can click on the graph for a better view at the FRED source page. |
13 comments:
Seems to me you're both right, for the scope you chose but I like Roth's better for this discussion.
"If the Fed is "issuing new reserves" then the Fed is "printing money". The phrase "printing money" is used to mean "increasing the quantity of money"."
So then everything depends on how you define the money supply. Use a narrow view like M0 or MB and you see huge money printing. With a broad view like M2 or MZM and you see proportionately much less money printing. Broaden the basket to include bonds and you see zero money printing.
Which is the correct framing? That would really depend on the story you're trying to tell. Too narrow and all the economically interesting stuff is happening off-camera. Too broad and the things you want to talk about are aggregated into obscurity.
I think Roth picks the right basket. A narrow money supply view tends to lead logically to inflationary fears. The no-money-printing narrative of portfolio effects within a very broad money supply that includes bonds seems a better match to real world outcomes and operations
If the fed is printing money that nobody can spend..........? Thats part of the point.
Ive thought a lot about what that graph can mean that shows that huge spike in 2008. This graph has been used to prove we will have hyperinflation, or at least really nasty inflation, by many many people. Of course this is using the simple QTM which I think is almost complete bunk (mainly because its sooo simple). I think Ive come up with an analogy that might help alleviate the fears of this spike;
Imagine a banquet hall that can be filled with as much food as the owner wishes (like the fed issuing reserves) and people wishing to eat there. Normally the hall is filled with about the amount of food(reserves) that the people who usually come in are going to eat (member banks making payments), but the owner gets word that something bad happened to the rest of the food supply (financial crisis involving shadow banks) and that likely more people will be seeking food, but he doesnt know exactly how much or when. So he fills the banquet hall with enough to feed everybody (reserve spike in 2008) and as the usual amount of people trickle in he simply says "we are expecting a very large crowd today and the rest of the year, please eat what you wish but remember there will be others. As long as there are no food shortages in the banquet hall the line wont get too long (inflation) and no one will starve (payment doesnt clear)
So the only reason for the spike in reserves is to make sure banks have all the reserves they might need in case the tens (maybe hundreds) of trillions of dollars of CDS contracts etc etc sitting out there start rolling in expecting to be paid off. Will they all come in at once? Only in a panic and then they will all be worthless. But no one knows exactly when and where these payments will be expected, so the reserves must be available to clear payments without freezing the system and destroying general commerce.
This is how I conceptualize this
"inflationary fears" ... "alleviate the fears"...
Whether or not reserves are money has nothing to do with inflation.
The point was not to suggest that reserves aren't money, it's to suggest that treasury securities are money. When the Fed issues new reserves to buy them, it's not "printing money" in the sense the phrase suggest because it's a money for money swap.
From that follows the point about inflation.
Geerussell: "Which is the correct framing? That would really depend on the story you're trying to tell."
Keynes agrees.
But expanding the definition of money to include more credit -- to include in this case bonds -- is just one more step in the continuing saga of monetary imbalance and excessive reliance on credit. In that saga, diminishing returns became obvious by 1974.
Changing a few definitions so we may more easily describe how things are since 2008 does not provide a useful solution.
Hi Art,
This discussion about categories of money was initially triggered by Richard Koo's observation that the result of QE is an increase in bank liabilities (non-bank assets) being held as a "store of value". Koo posited that since QE is just an exchange of one store of value for another store of value that exchange has no impact on GDP. That also creates no near term inflation. That's Koo's main point.
Koo makes a second minor point that because such a large quantity is being held as a store of value in such a liquid form there is the potential in the long term to create inflation if the bank liabilities no longer are treated as a store of value and start being used as a medium of exchange.
-jim
But expanding the definition of money to include more credit -- to include in this case bonds -- is just one more step in the continuing saga of monetary imbalance and excessive reliance on credit. In that saga, diminishing returns became obvious by 1974. ... Changing a few definitions so we may more easily describe how things are since 2008 does not provide a useful solution.
It's not quite as arbitrary as that characterization suggests. Not all credit and not just since 2008. The specific instrument of the treasury security, because it is guaranteed money-good and liquid by the issuer of the dollar really belongs in the MB category along with notes, coins and reserve account balances. A discounted dollar from the issuer is still a dollar.
This draws a sharp distinction between the excessive reliance on private credit (a point on which I share your position) and federal "debt".
Geerussell: "The specific instrument of the treasury security, because it is guaranteed money-good and liquid by the issuer of the dollar really belongs in the MB category along with notes, coins and reserve account balances."
Oh, let's talk about that. The argument is that treasury securities are guaranteed. They're as good as base money, so they should be counted as base money.
First of all, if it's as good as a dollar, then it AIN'T a dollar.
Second, if it is is guaranteed to be exchanged for a dollar, well, that's just a promise to pay. As opposed to a dollar bill, which is payment received. Base money is today what gold used to be: it is what we expect to receive when payment is made. Not a promise to pay it later, but *it*, now.
Third, treasury securities are not issued by the entity that issues base money.
You know, if you think treasury securities are as good as base money, and you say they *should* be considered base money, then you are doing the normative thing, saying what should be. There is a place for that, certainly. But who can say what should be, who does not first understand what is?
"Second, if it is is guaranteed to be exchanged for a dollar, well, that's just a promise to pay. As opposed to a dollar bill, which is payment received. Base money is today what gold used to be: it is what we expect to receive when payment is made. Not a promise to pay it later, but *it*, now."
Back in the day you could expand the money supply by digging up a lump of gold from the ground. Of course you didn't actually have dollars until you took it to the dollar issuer's gold window and traded it for dollars. Guaranteed exchange of dollars for gold by the issuer of the dollar is what made gold the equivalent of base money. Well, that's just a promise to pay. As opposed to a dollar bill, which is payment received.
Today, treasuries are gold. Gold that can only be mined by Congress when it deficit spends.
I'd say the money supply wasn't expanded until the gold was minted. And then, the dollars were gold.
Or, until the gold was deposited with a proto-Fed that could issue paper money against it. But again, the paper was the promise, and the gold was the money.
The guarantee was to give gold in exchange for paper. The paper was a promise of gold. Gold was not a promise of anything. Gold was the money.
"Today, treasuries are gold. Gold that can only be mined by Congress when it deficit spends."
...gold that costs interest, a strange gold indeed.
(reposted to fix a link)
"But again, the paper was the promise, and the gold was the money."
The promise is what makes it an IOU and the IOU is the money. It doesn't matter if the promise is printed on paper, stamped on a coin, an entry written in a ledger or bits in the Fed's reserve accounts. If the issuing authority recognizes the promise, it's dollars.
Without a promise, a lump of gold is just another object you can barter for other objects or trade to get money. The same way that fancy cotton paper is just paper until a promise is printed on it, then it's money.
Gold was the voluntarily adopted constraint on money issuance. The dollar was the money and the sovereign issued the dollar. A voluntary constraint that was often broken and eventually discarded.
"...gold that costs interest, a strange gold indeed."
Is it really that strange to contemplate a form of base money that pays interest?
A privilege of being the issuer is control over the thing issued. If you want it to pay interest, it can. If you want it to decay over time (negative nominal rates) you can do that too.
An IOU is not money. An IOU is DEBT. When the IOU is settled, the medium used to settle it is money.
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