'...The Fed and global central bankers are working diligently to control an experiment in electronic “money” and Credit gone terribly awry...'<blockquote>
'Money has throughout history demonstrated its dangerous side. Abuse money and “moneyness” at your own peril – although this fundamental lesson is invariably unlearned given enough time (and the seductiveness of monetary booms). The fiascos are always a little different, inevitably created by clever new wrinkles in the many faces of “money” and Credit. We are in the midst of another sordid episode. John Law’s experimentation with paper “money” in France ended with the spectacular bursting of the Mississippi Bubble in 1720. Today’s backdrop is much more complex: The Fed and global central bankers are working diligently to control an experiment in electronic “money” and Credit gone terribly awry. If it were only the printing press, it would be easier to appreciate what was developing and how to administer some restraint. Instead, the Fed has banked everything on its capacity to inflate marketplace liquidity, sustain massive government debt issuance, and maintain market perceptions of moneyness.'</blockquote>
The Fed and MoneyBy Doug Noland
December 10, 2010
Source“One myth that’s out there is that what we’re doing is printing money. We’re not printing money. The amount of currency in circulation is not changing.” Federal Reserve Chairman Ben Bernanke, December 5, 2010.
Dr. Bernanke was pilloried this week for his “we’re not printing” comment from Sunday evening’s 60 Minutes interview. I’ll pile on, but from a different angle. It seems strange to me – perhaps disingenuous – for our Fed Chairman to suddenly take such a narrow view of “money.” At $917bn, outstanding currency comprises just over 10% of the “M2” monetary aggregate (savings deposits are the largest component at $5.343 TN). And I have argued over the years that “M2” is a much too narrow definition of “money” to provide a useful barometer of overall Credit and liquidity conditions. Certainly, the expansion of paper currency has been inconsequential to the grand scheme of Washington stimulus.
In the “old days,” the banking system dominated system Credit creation. Bank lending was integral to Credit growth, with new bank deposits created through the process of expanding bank loans. “M2” provided a good indication of bank lending - that was a decent indicator of overall Credit conditions. As such, the Fed reigned supreme over the Credit mechanism through its careful regulation of bank reserves. Rather mechanically, our central bank would add reserves – the fodder for new bank loans – when it sought a boost in lending. It would extract reserves when it preferred to lean against the wind. Bank deposits were the critical component of “money” supply, and our central bank judiciously monitored their expansion.
The financial world – certainly including monetary management - was turned upside down with the unleashing of (unconstrained) non-bank Credit instruments. No longer did the banks dominate system Credit creation. In a process that gained fateful momentum throughout the nineties, the bank loan was relegated to second class citizen in the age of the booming Wall Street securitization marketplace. Meanwhile, the Fed’s entire process of manipulating bank reserves became moot. Fed policy immediately gravitated toward manipulating the securities markets, and Alan Greenspan – “The Maestro” – absolutely relished his new “activist” role.
I have defined contemporary “money” as the most precious of Credit instruments. “Money” is as “money” does. The great Austrian economist Ludwig von Mises recognized the crucial monetary role played by “fiduciary media” that had the economic functionality of a more narrowly defined stock of money. Especially with the advent of non-bank Credit, the definition of what might operate as “money” in the markets and real economy had to be broadened significantly. And the greater the boom in marketable debt instruments the more paramount the role of market perceptions in determining the stability of our financial markets and real economy.
Over the years, I have explored the concept of the “moneyness of Credit.” Moneyness is driven by the marketplace’s perception of safety and liquidity. Generally speaking, “money” is a debt instrument perceived as a highly liquid store of nominal value. Money has always enjoyed a special role and, hence, unique demand characteristics: folks simply can’t get enough of it, which nurtures a propensity to create it in overabundance. Money operates with its own problematic supply and demand dynamics, and never has moneyness enjoyed such capacity to wreak global havoc as it does today. With all their good intentions, central bankers are nonetheless at the root of the problem.
The Fed may not be running the currency printing press around the clock, but Fed policies have certainly been instrumental to the unending expansion of Treasury borrowings. And, clearly, any meaningful definition of contemporary “money” must include government debt instruments. Indeed, with bank (and, more generally, private-sector) Credit suffering from post-housing mania stagnation, never before has government debt so dominated system “money” and Credit creation.
Importantly, the Federal Reserve’s zero-rate policy and massive monetization program have been instrumental in maintaining the perception of “moneyness” in the face of unprecedented Treasury debt issuance. I can’t envisage a more powerful Bubble Dynamic: The Fed intervenes and manipulates the Treasury market – the predominant debt market underpinning fixed income and securities markets more generally. Enormous fiscal stimulus then works to stabilize system incomes, corporate cash flows, state & local tax receipts, and asset prices more generally. In the final analysis, Trillions of dollars of government-created purchasing power ensure that a structurally maladjusted U.S. economy has, at the minimum, the appearance of viability – and the stock market booms.
The Fed may not be “printing,” but its operations as “backstop bid” are fundamental to the U.S. and Global Government Finance Bubbles. In a replay of how the Fannie, Freddie, the Fed and Treasury “backstop bid” created the “moneyness of Credit” for mortgages and related securitizations, the Fed’s quantitative easing program distorts market perceptions of various risks (Credit, interest rate, liquidity and systemic) and promotes over-issuance. From this perspective, our central bank’s operations are more dangerous than the traditional printing press.
“Moneyness” was fundamental to the doubling of mortgage debt in just about six years during the mortgage finance Bubble. Over time, the expanding gulf between market perceptions of moneyness and the true underlying state of the mortgage Credit ensured a crisis of confidence. Moreover, the Trillions of additional mortgage Credit had played havoc with spending and investing patterns and, increasingly over time, the underlying economic structure. These days, the attribute of “moneyness” in Treasury debt is on track to ensure the doubling of federal borrowings in the neighborhood of four years. For this round, the “expanding gulf” is much more pernicious and the consequences of a crisis of confidence potentially more devastating.
Money has throughout history demonstrated its dangerous side. Abuse money and “moneyness” at your own peril – although this fundamental lesson is invariably unlearned given enough time (and the seductiveness of monetary booms). The fiascos are always a little different, inevitably created by clever new wrinkles in the many faces of “money” and Credit. We are in the midst of another sordid episode. John Law’s experimentation with paper “money” in France ended with the spectacular bursting of the Mississippi Bubble in 1720. Today’s backdrop is much more complex: The Fed and global central bankers are working diligently to control an experiment in electronic “money” and Credit gone terribly awry. If it were only the printing press, it would be easier to appreciate what was developing and how to administer some restraint. Instead, the Fed has banked everything on its capacity to inflate marketplace liquidity, sustain massive government debt issuance, and maintain market perceptions of moneyness.