Re: Money supply

["Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>]

Money supply is a complex issue and at this moment in history it is a term of considerable
chaotic meaning.  The official definition by the Fed: M1, 2 & 3, is quite clear, but its
usefulness even to the Fed is as limited as it is clear.  Alan Greenspan, at the 15th
Anniversary Conference of the Center for Economic Policy Research at Stanford University,
Stanford, California  September 5, 1997 admiited, with Milton Freidman in the audience, in
defense of the accusation that Fed policy failed to anticipate the emerging inflation of the
1970s, and by fostering excessive monetary creation, contributed to the inflationary upsurge,
and the claim that some monetary policy rule, (such as the taylor rule on which I posted on
this list sometime ago), however imperfect, would have delivered far superior performance,
admitted that our knowledge of the full workings of the system is quite limited, so that
attempts to improve on the results of policy rules will, on average, only make matters worse.
Greenspan observed that the monetary policy of the Federal Reserve has involved varying
degrees of rule- and discretionary-based modes of operation over time. very often historical
regularities have been disrupted by unanticipated change, especially in technologies. The
evolving patterns mean that
 the performance of the economy under any rule, were it to be rigorously followed, would
deviate from expectations.Such changes mean that we can never construct a completely general
model of the economy, invariant through time, on which to base our policy, Greenspan asserted.

Greenspan admitted that in the late 1970s, the Federal Reserve's actions to deal with
developing inflationary instabilities were shaped in part by the reality portrayed by Milton
Friedman's analysis that ever-rising inflation rate peaks, as well as ever-rising inflation
rate troughs, followed on the heels of similar patterns of average money growth. The Federal
Reserve, in response to such evaluations, acted aggressively under newly installed Chairman
Paul Volcker. A considerable tightening of the average stance of policy--based on intermediate
M1 targets tied to reserve operating objectives--eventually reversed the surge in inflation.

The fifteen years before 1997 had been a period of consolidating the gains of the early 1980s
and extending them to their logical end--the achievement of price stability.

Although the ultimate goals of policy have remained the same over these past fifteen years,
the techniques used in formulating and implementing policy have changed considerably as a
consequence of vast changes in technology and regulation. Focussing on M1, and following
operating procedures that imparted a considerable degree of automaticity to short-term
interest rate movements, was extraordinarily useful in the early Volcker years. But after
nationwide NOW accounts were introduced, the demand for M1 in the judgment of the Federal
 Open Market Committee became too interest sensitive for that aggregate to be useful in
implementing policy. Because the velocity of such an aggregate varies substantially in
response to small changes in interest rates, target ranges for M1 growth in its judgment no
longer were reliable guides for outcomes in nominal spending and inflation. In response to an
unanticipated movement in spending and hence the quantity of money demanded, a small variation
in interest rates would  be sufficient to bring money back to path but not to correct the
deviation in  spending.

 As a consequence, by late 1982, M1 was de-emphasized and policy decisions per force became
more discretionary. However, in recognition of the longer-run relationship of prices and M2,
especially its stable long-term velocity, this broader aggregate was accorded more weight,
along with a variety of other indicators, in
 setting our policy stance.

 As an indicator, M2 served us well for a number of years. But by the early 1990s, its
usefulness was undercut by the increased attractiveness and availability of alternative
outlets for saving, such as bond and stock mutual funds, and by mounting financial
difficulties for depositories and depositors that led to a restructuring of business and
household balance sheets. The apparent result was a significant rise in the velocity of M2,
which was especially unusual given continuing declines in short-term market interest rates. By
1993, this extraordinary velocity behavior had become so pronounced that the Federal Reserve
was forced to begin disregarding the signals M2 was sending.

 Greensapn recognizes that, in fixing the short-term rate, the Fed loses much of the
information on the balance of money supply and demand that changing market rates afford, but
for the moment the Fed sees no alternative. In the current state of our knowledge, money
demand has become too difficult to predict.
In the United States, evaluating the effects on the economy of shifts in balance  sheets and
variations in asset prices have been an integral part of the development  of monetary policy.
In recent years, for example, the Fed has expended considerable effort to understand the
implications of changes in household balance sheets in
 the form of high and rising consumer debt burdens and increases in market wealth from the
run-up in the stock market. And the equity market itself has been the subject of analysis as
the Fed attempts to assess the implications for financial and economic stability of the
extraordinary rise in equity prices--a rise based apparently on continuing upward revisions in
estimates of our corporations' already robust long-term earning prospects. But, unless they
are moving together, prices of assets and of goods and services cannot both be an objective of
a particular monetary policy, which, after all, has one effective instrument--the short-term
interest rate. We have chosen product prices as our primary focus on the grounds that
stability in the average level of these prices is likely to be consistent with financial
stability as well as maximum sustainable growth. History,
 however, is somewhat ambiguous on the issue of whether central banks can safely ignore asset
markets, except as they affect product prices.  Greenspan was very wrong about the "robust"
long term warning prospects by 2000.

 Greenspan also admitted that over the coming decades, moreover, what constitutes product
price and, hence,
 price stability will itself become harder to measure.

In the years 1997 through 2000, M3 increased by about 460, 600, 500 and 600 billions per
year, respectively. In 2001 M3 expanded much more rapidly -- by about 1.1  trillion -- to a
total of about 8 trillion.The surge in the money supply since the attacks on Sept. 11 was
equal to about $300 billion, which significantly represents about 3.0% of GDP.

Market participants look at money supply differently.  To M1, 2 and 3, they add L which is M3
and other liquid assets such as Treasuries, Agencies, savings bonds, commercial paper, bankers
acceptance, Eurodollar holdings of US residents (nonbank) and since the 1990s, derivatives and
swaps, generally coming under the heading of structured finance instruments.  Ther term MZM
(money with zero maturity) came into general use.  The Fed has poor if any information on L
and it does not seem to want to know as it persistently declines to support its regulation on
it.  OTC derivatives now involved notional values of over $150 trillion.  Economist have no
idea if notional values are part of the money supply.  As we now know, creative accounting has
legally transform debt proceeds  as revenue. With the telecoms, the IRUs swaps were perfectly
legal means to inflation
revenue.  Andersen's White Paper in 2000, well known in telecom financial circles, defined IRU
swaps between telecom carriers by accounting each sale as revenue and each purchase of a
captial expense which is exempted from operating results empahsized by Wall Street and
investors.  While common sense would see this as inflation of revenue by hiding underlying
true cost, AA argues that these capacity exchanges are not barter agreements, but are sales of
operating leases and purchases of capital leases.  Thus by accounting logic, swaps are not
acquisition of "equivalent interests" because risks and rewards of buying a capital lease is
greater than that of an operating lease. Since operating leases are not similar assets as
capital leases, there is logic in booking revenues over the life of a contract when they are
fully paid at closing.  It can also be argued that such accounting logic on the operating
leases strengthens the value of the capital assets.  Which was exactly what happened.

GECC on March 13 2002 launched a multi-tranche dollar deal that was almost doubled in size
from $6bn to $11bn, making it the largest-ever dollar-denominated corporate bond issue.
Officially the bond sale was
explained as following the current trend of companies  with large borrowing needs such as GECC
locking in favourable funding costs while interest rates are low.
On March 18, Bloomberg reports that GECC is bowing to demands from Moody's Investors Service
that the
biggest seller of commercial paper reduce its reliance on short-term debt securities.

The financing arm of General Electric Co., the world's largest company, is seeking bigger
lending commitments from banks and replacing some of its $100 billion in debt that matures in
less than nine months with bonds. GE Capital is asking banks to raise its borrowing capacity
to $50 billion from $33 billion.

Moody's, one of two credit-rating companies that have assigned GE Capital the highest "AAA'"
grade, has been increasing pressure on even top-rated firms to reduce short-term liabilities
since Enron Corp. filed the biggest U.S. bankruptcy in December. Moody's plans to release as
early as today reports analyzing the ability of 300 companies to raise money should they be
shut out of the commercial paper market.

GE Capital and H.J. Heinz Co. said they responded to inquiries by Moody's by reducing their
short-term debt, unsecured obligations used for day-to-day financing. Concerns about the
availability of such funds
have grown this year after Qwest Communications International Inc., Sprint Corp. and Tyco
International Ltd. were suddenly unable to sell commercial paper.

Moody's lowered a record 93 commercial paper ratings last year as the eonomy slowed, causing
corporate defaults to increase to their highest in a decade. One area of concern for the
analysts is the amount of bank
credit available to repay commercial paper.

While many companies have credit lines equivalent to the amount of commercial paper they sell,
some of the biggest issuers do not. GE Capital, for example, has loan commitments backing 33
percent of its short-term debt. American Express Co. has commitments that cover 56 percent of
its commercial paper. Coca-Cola Co. supports about 85 percent of its debt with bank
agreements, according to Standard & Poor's.

Moody's new reports will measure companies' ability to repay debts with cash and asset sales.
The reports will also indicate conditions that would allow banks to refuse to lend. Moody's
assigns ratings of ``P1'', ``P2'', ``P3'' and ``Not-Prime'' to commercial paper issuers.
Typically, only ``P1'' and ``P2'' companies can sell unsecured short-term debt.

S&P, the largest credit-rating company, said it is also focusing more attention on risks posed
by short-term liabilities, though it hasn't yet decided whether to issue separate reports.

Companies have sold $107 billion of investment-grade bonds this year, up from $88 billion
during the same
period in 2001. The amount of unsecured commercial paper outstanding has fallen by a third to
$672 billion during the past 12 months.

GE Capital, which has reduced its commercial paper outstanding from $117 billion at the
beginning of the year, plans to continue to reduce short-term debt, said spokesman Stack. It
took one step in that direction last week when it sold $11 billion of long-term bonds, some of
which will be used to reduce its outstanding commercial paper.

As part of last week's sale, GE Capital sold 30-year bonds with a coupon of 6.75 percent. The
company usually swaps some or all of those fixed-rate payments for floating-rate obligations.
Last year, GE Capital paid on average 3.23 percent for its floating-rate, long-term debt, 70
basis points more than on its commercial paper, according to a company filing.

The bottom line of all this is that the funding cost of GECC will go up, which is hit GECC
profit which constitutes 60% of its parent's profit. This in turn will hit GE share prices
which in turn will force rating
agnecies to further pressure GE to shift from low cost commercial papers to to bonds or bank
laons, which will further reduce profit which will further increase rating pressure.........

PIM (Pacific Investment Management), the world's largest bond fund, having dumped $1 billion
in GE commercial paper, publicly criticised GE for carrying too much debt and not dealing
honestly with investors.  GE announced it might sell as much as $50 billion in bonds only days
after investors bought $11 million of new bond in the biggest US sale in history.  PIM
director Bill Gross said that disputes GE's contention that the new boond sales were designed
to capture low rates, but because of troubles in its commercial paper market.  If GE shortterm
rate rises because of poor credit rating, the engine that drives GE earnings would stall out.
Gross dismissed GE eraning growth as being from brilliant management, Jack Welch books not
withstanding, but from financial manipulation, seeling debt at cheap rate and using stock for
acquisition.  GE had $127 billion in commercial paper as of March 11, 2002, according to
Moody's. It amounts to 49% of its total debt.  Banks credit line only covers one third of the
short term exposure.

The erosion of market capitalization value does impact money supply.  Asset vaulation is the
collateral for debt. As asset value falls, credit rating fall, which affect interest cost
whichaffect profits which affect asset value.  Moreover, a major counterparty default in
structured finance will render the Fed helpless in keeping the money supply from sudden
contraction, unless the Fed is prepared to depart from its traditional practice of relying
solely on interest rate policy to effectuate monetary ease.

Henry C.K. Liu


Steve Keen wrote:

> I'm not sure whether this post was in response to something posted on Hayek
> or PKT, so I'm cross-posting to both as well as to Mason.
>
> When I said the money supply, I meant the money supply--not asset market
> prices or gross valuations. The following is taken from:
>
> http://www.federalreserve.gov/releases/H6
>
> FEDERAL RESERVE STATISTICAL RELEASE
>
>   H.6 (508)
>   Table 1                  These data are scheduled for release each
> Thursday at 4:30 p.m.
>                                                                         March
> 21, 2002
>   MONEY STOCK AND DEBT MEASURES
>   Billions of dollars
>   ----------------------------------------------------------------------------------------
>        Date                   M11               M22              M33
>        Debt4
>   ----------------------------------------------------------------------------------------
>   Seasonally adjusted
>   ----------------------------------------------------------------------------------------
>    2000-Jan.                   1123.3            4673.8           6573.0
>       17434.9
>    2000-Feb.                   1108.4            4690.9           6612.2
>       17491.0
>    2000-Mar.                   1108.9            4715.9           6670.9
>       17596.4
>         Apr.                   1112.0            4752.4           6713.6
>       17695.0
>         May                    1106.0            4759.8           6746.5
>       17767.2
>         June                   1106.4            4781.3           6799.3
>       17852.9
>         July                   1105.1            4802.9           6854.5
>       17925.9
>         Aug.                   1102.1            4837.0           6927.7
>       17988.8
>         Sep.                   1099.1            4869.0           6986.9
>       18067.5
>         Oct.                   1099.2            4886.7           7010.6
>       18116.6
>         Nov.                   1091.7            4901.3           7031.6
>       18192.4
>         Dec.                   1088.9            4942.3           7116.0
>       18277.9
>
>    2001-Jan.                   1095.8            4987.2           7213.6
>       18327.0
>         Feb.                   1098.9            5025.6           7279.5
>       18401.7
>         Mar.                   1107.4            5073.8           7331.7
>       18496.6
>         Apr.                   1109.7            5114.8           7433.3
>       18575.8
>         May                    1116.6            5138.7           7522.6
>       18674.0
>         June                   1125.6            5183.3           7607.9
>       18766.9
>         July                   1138.6            5224.1           7651.5
>       18825.2
>         Aug.                   1147.2            5265.1           7667.7
>       18932.3
>         Sep.                   1204.6            5383.6           7824.7
>       19060.5
>         Oct.                   1161.6            5373.2           7872.2
>       19153.1
>         Nov.                   1163.8            5417.0           7960.4
>       19267.7
>         Dec.                   1178.3            5458.9           8029.6
>       19373.2
>
>    2002-Jan.                   1181.3            5469.1           8029.7
>       19425.5 p
>
> The percentage changes over this two year period are respectively 5.16%,
> 17.02%, 22.16%, and 11.42%. M3 in particular has expanded dramatically, and
> on my past statistics that show a roughly 2:1 ratio between Debt and M3 as
> the Federal Reserve define them, I'm extremely suspicuous about the Debt
> measure only growing at half the rate of M3; I think we may see some
> serious revisions of this data as Enron and related corporate "spins" about
> debt and off-balance sheet activities come home to roost.
>
> Taking the growth of M3 as the more trustworthy indicator here, you have a
> rate of growth of the money supply that is more than three times the rate
> of growth of the economy, and over four times the rate of growth of M1.
> Notice that most of this growth occurred after the stock market bubble
> stopped rising (in April 2000), yet consumer prices have been relatively
> stable and asset prices deflating. It's this sort of behaviour that I think
> both raises interesting questions for money supply theorists.
>
> Cheers,
> Steve
>
> At 08:02 AM 23/03/2002 Saturday, you wrote:
> >William,
> >
> >I noticed Steve Keen type:
> >
> >" the huge expansion of the money supply in the USA "
> >
> >I'm not certain what "money supply" he has in mind but the
> >context suggests to me the stock market.
> >
> >Elsewhere I noticed, in an article by an economist, a mention
> >of the unexplained huge disappearance of money when the
> >stock market fell.  And elsewhere I've heard comments such as,
> >"no one knows where all that money went" when the stock
> >market went down.
> >
> >I don't know what the money supply has been doing this
> >last decade, but does any *accepted* definition of "money"
> >include the market value of the stock market?  Surely that
> >value is subject to change with a minuscule quantity of trading.
> >
> >        Mason C
>
> Home Page: http://www.debunking-economics.com
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>             http://www.stevekeen.net
> Dr. Steve Keen
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