The common misconception that the Fed is adding massive amounts of liquidity to the system continues to run rampant, both in the mainstream financial infomercial media and, disappointingly, in the blogosphere. While the BOE and ECB have made enormous increases in their monetary bases over the past couple of months in response to a frozen credit market and a banking system in crisis in the Europe, the Fed has yet to join the party.
I did a quick calc on the ECB’s adds last week and the net was “only” around €125 billion, not €348 billion ($500 billion). That is still enormous. It all expires on January 4, so it will be interesting to see how much is rolled over. We have to see this in the context that the EU credit markets are frozen, and the banking system, virtually so. The EU also faces unusual year end rollover pressures. So it remains to be seen how much of this credit becomes permanent. It also remains to be seen just how much offsetting “money” has been destroyed in the ongoing chaos.
In contrast, over the past 5 days through 12/24 the Fed has drained a net of $15.7 billion from the system, reducing the System Open Market Account (SOMA) by that amount. This includes whatever the Fed has added via the TAFs. They have fully offset that and then some by redeeming T-bills and reducing outstanding repos. The Fed has now redeemed $35 billion of its T-bill holdings in the SOMA over the past 3 weeks, including the announced $14 billion redemption settling Thursday 12/27. The Fed has stated on the NY Fed website that it intends to continue these transactions as necessary, along with considering reverse repurchase agreements and Treasury bill sales. This is the flip side of their announcements regarding the TAF auctions. Strangely, virtually no one in the media or the blogging world has reported on these developments, which are virtually unheard of terms of the Fed’s standard operating procedures.
Over the past 4 weeks the Fed has drained $8.2 billion from the SOMA. In contrast, at this point last year the Fed had added a net of $4.2 billion to the system over the previous 4 weeks. The annual growth rate of the SOMA as of 12/24/07 was a paltry 1.34%. In contrast, at this point last year the annual growth rate was 3.4%. While I would expect the Fed to push back toward that rate, it is surprising and puzzling that, at a time of year when the Fed is normally aggressively adding reserves, this year it is going in the opposite direction. While the ECB and BOE have made enormous increases in their monetary bases over the past month in response to the crisis in the EU, the Fed has yet to join the party.
Most of the analysis out there assumes that the Fed has been aggressively adding reserves or that it will. The first assumption is false. The second makes a leap of faith that I’m not ready to make until I see the evidence that it is in fact happening.
I can only speculate that the Fed’s tightness may be geared toward restraining the surge in the growth of broad money measures, such as MZM, that began last summer concurrent with the emergence of the crisis in the Asset Backed Commercial Paper market. If that is what the Fed is doing, it could be a deeply flawed strategy.
The rapid growth of MZM and other broad measures is directly correlated with the flight of investor cash out of the ABCP market. The declines in ABCP outstanding match, virtually dollar for dollar, the simultaneous growth of dollars held in Institutional Money Funds and Non-transaction deposits in banks, which are counted in broader measures of money. This is a temporary phenomenon that will end when there’s no more cash to be had from the ABCP market.
Considering that much of what is reflected in the data in the broader M’s is fictitious capital, that is, backed by weak or even worthless credit that is yet to be written off, I believe that the reported data on money supply is grossly overstating the actual totals. This should become clear at some point next year. As the writedowns and writeoffs grow, some institutions, rather than bailing out their money market funds as we have repeatedly seen this year, will choose instead to allow these funds to break the buck, in turn revealing that published money supply figures are wrong. As the values of money market funds adjust to the new reality, so will the data on broad money supply.
Obviously, the Fed can turn on a dime. So far it hasn’t. Rather than spend too much time speculating on why the Fed is acting as it is, I think it’s important not to get caught up in the hysteria based on what is so far, a false premise. For whatever reason, contrary to conventional wisdom, which the Fed has done nothing to dispel, the Fed has not been adding liquidity to the system. The Fed has promoted the idea that it is doing so, and the financial media, in its ever present desire to avoid reporting and analyzing the actual facts, is more than happy to go along with the fantasy. Surprisingly, so are many financial bloggers.
I think it’s important that investors who care to think critically about these things arm themselves with the facts, rather than the hype and superstition that dominate today’s environment.
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