All the best charts get discontinued
You may have heard of the different types of money. M0, M1, M2 etc. What would you think if I told you the FED decided to ‘discontinue’ their M1 chart as of December 2020.
M1 is basically all the ‘money’. It’s basically what people think of as ‘actual money’. It doesn’t include investments and bonds but does include all the physical cash as well as all the other readily accessible ‘money’ in your bank accounts. As discussed last week M1 on is mostly actually just promises. Promises that banks make to each other (and to their customers). It stands to reason therefore that banks only accept M0 to settle their debts.
So anyway. The St Louis Fed discontinued the M1 series as of Dec 2020. Awww. And just when it was starting to get interesting! Check it out.
Woah! Where’d all that money come from? Well, what if told you it came from a big spike in the M0. Lets take a look at another chart — this time the chart of all the reserve bank money aka the “total reserves of depository institutions’.
So yup. It went a bit bonkers in 2008 when the Fed decided they had to print money to get us out of the global financial crisis. That worked, kinda. But then came the European banking crisis and other problems and they kept churning out the QE. They tried hard to kick the habit and to their credit even managed to ‘sterilize’ some of the money out of existence in recent years. But then 2020 came along, and suddenly all bets were off again. Time for more quantitative easing!
Quantitative easing is very complicated actually. It involves numbers like $600 Billion Dollars (just what was created in 2020) and all kinds of complicated things like ‘open market operations’ and ‘the deposit window’ and such big important numbers you really probably can’t understand how it all works. So, here’s a diagram that explains how this very complicated process works.
What’s new in 2020 is that this time the Fed has also been giving money directly to massive corporations. Sorry. That’s not entirely fair. Of course they don’t just ‘give’ money to businesses, what they’ve been doing is only lending to businesses at very good rates and with very favorable conditions.
Maybe this can help explain the difference between what happened after 2008 and what’s happening now.
Honestly, I have to admit I might be getting a bit out over my skis here. But it does make sense to me that giving/lending directly to businesses (as opposed to lending only to banks) will cause all of that stimulus to show up directly in the M1 figures when previously it was only in the M0 figures.
Either way. The Fed (and other reserve banks all around the world) sure are printing a lot of cash right now and this will inevitably have a lot of flow on effects in the economy.
But then they decided to discontinue the M1 series in December 2020, apparently because it longer “[correlates to] .. other economic variables”.
Or. In other words. They printed an absolutely ungodly large amount of money (even before taking into account the 1.9 trillion dollar “Biden stimulus”). And then, somehow, the other main economic variables didnt respond in the way you might expect. Specifically, both inflation and employment remained low.
‘Normally’ (not that there is anything very normal about a reserve bank printing money like this) when there is a stimulus (of any kind, fiscal or monetary) you would expect either a correspondingly large growth in the size of the overall economy or you a spike in inflation. And yet, somehow we don’t have either of those things (yet).
Before we try to explain that discrepancy let’s look at some charts.
Employment first. We could look at the unemployment rate but I’m going to suggest we look at the employment-to-population ratio chart instead. The chart tells a similar story, but to my mind, employment ratio is a more objective measure in that you don’t need to answer the question of who is ‘actively looking for work’ versus ‘permanently out of the job market’ in order to come up with a figure. You do, however, need to take into account that employment, as a percent of population, has generally been increasing as women come into the workforce. But either way, it’s obvious looking at any kind of employment figures, that the COVID recession was a real doozy. It’s also clear that a big part of that stimulus has helped get people back to work — but even now we are still a long way from where we were.
Secondly, let’s look at inflation. Which strangely, given the size of the monetary stimulus, also remains low.
So. How do we explain this apparent discrepancy. Well, if you increase money supply then you can avoid inflation if the velocity of money goes down. And will you look at that. The velocity of money took an absolute nose dive and is still insanely low.
But what does that mean? It just means that money isn’t shifting hands very quickly at the moment. ‘Velocity of money’ may seem like a hard concept to some, but its pretty simple really. It’s just a measure of how often money changes hands.
If you add up all the transactions to get like the total turnover in a given period — aka ‘all then things bought or sold last year’ — then the total amount of all those transactions is going to be the total money supply (M) times the average velocity (V) of that money. Basically, everything bought or sold has to have been sold at a given price so just take the total of all transactions and divide by the money supply to get the average velocity of money. See below for the precise definition [1] but it’s basically just how many times every dollar is used in a transaction, on average, in a given period of time
So. The velocity of money took a nose dive during the lock down. People were staying at home and buying less stuff. We also know that households o have bigger savings and tend to be making fewer transactions. Certainly that was my experience. Bigger ticket items, however, have been benefiting from all that pent up savings. Purchases for larger items like gaming consoles and couches as well as the price of large items like houses or investments and cryptocurrency have all gone up. People are spending money less often, on bigger things.
The Fisher equation looks like this
M*V = P*T
Where M = money supply, V = velocity of money, P = the price of things and T = total amount of trade taking place.
And from this equation, if you have a massive expansion in the money supply then one of three things is going to happen.
- The total amount of trade taking place has to go up
- The prices of things starts to go up (aka inflation) .. or ..
- The velocity of money goes down
So far velocity is very low, and this money is not really ‘moving around’ . The stimulus hasn’t (yet) affected the price of things and we don’t have inflation. But what happens when people do start getting out there and actually spending their stimulus checks and newly printed money? Either the total economic activity in the economy suddenly shoot up by unprecedented amounts or settle in for a painful spike in inflation.
Here’s another complex diagram to explain the details of the situation:
So. What happens next?
Well I don’t pretend to be fancy economist but now might be a good time to think about how this might affect you personally, and your loved ones, once we get out of this pandemic. Do you think the economy is going to start roaring back into shape and grow beyond any thing that’s happened before? Because if not, get ready for high interest rates and high inflation again.
More next week. Thanks!
Miles _Week 3
[1] If math is your thing here is all the details you need to understand Velocity of money quite precisely, from Wikipedia.
