Coffee With Michael – 9.6.10
What The Fed Is Doing (and How To Track It)
The Fed operates quietly, but the numbers are not hard to find. You can track the path to inflation and verify that my inflationary outlook is right with only three sources: The St. Louis Fed, John Williams’ shadowstats.com, and the Fed itself. Here’s what you want to watch – and it won’t cost you anything (although I encourage anyone who can afford to support John Williams to contribute).
The Federal Reserve Bank of St. Louis
The St. Louis Fed has always been the most monetarist of the regional Federal Reserve Banks, and has been faithfully chronicling the money supply, inflation, interest rates and almost everything else you need to know ever since I’ve been in the investment business. You can find their full list of publications at http://www.stlouisfed.org/publications/show_all.cfm. The only two you need to follow are the weekly U.S. Financial Data found at http://research.stlouisfed.org/publications/usfd/ and the monthly Monetary Trends found at http://research.stlouisfed.org/publications/mt/.
U.S. Financial Data
Right under the current date on the U.S. Financial Data home page, you will find a link for “Entire Publication (Final Edition).” This is a .pdf file that requires a .pdf reader like Adobe Acrobat to open, available free from http://www.adobe.com. The publication includes weekly updates for:
• Page 4 — Adjusted Reserves
• Page 5 — MZM
• Page 6 — M2
• Page 7 — Composition of Federal Reserve Assets and Liabilities
• Page 8 — Reserve Bank Credit and Selected Categories
• Page 9 — Other Federal Reserve Balance Sheet Items
• Page 10 — Yields on Selected Securities
• Page 11 — Corporate Bond Spreads and Mortgage Interest Rates
• Page 12 — Yields on Nominal and Inflation-Indexed Treasury Securities
• Page 13 — Federal Funds Futures Market
• Page 14 — Equity Price Indices
• Page 15 — Crude Oil Prices
• Page 16 — Natural Gas Prices
• Page 17 — Exchange Rates
• Page 18 — Currency, Savings, and Small Time Deposits
• Page 19 — Institutional and Retail Money Funds, and Borrowings from Federal Reserve Banks
• Page 20 — Bank Loans
• Page 21 — Commercial Paper Outstanding
• Page 22 — Reference Tables
Each page can be downloaded separately, and the ones you will care about most are pages 3, 5 and 6, which measure the monetary aggregates that are more-or-less ignored by Keynesian economists. The others are very useful from time to time; for example, to track whether banks are actually making loans.
The Adjusted Monetary Base on page 3 is defined as what households and businesses use as media of exchange, and that depository institutions use to satisfy statutory reserve requirements and to settle interbank debts. This includes currency (including coin) held outside the Treasury and the Federal Reserve Banks (referred to as currency in circulation) plus deposits held by depository institutions at the Federal Reserve Banks. The demand by the private sector for these forms of money is what gives the Federal Reserve leverage to affect money market interest rates.
Although most of the other Federal Reserve Banks and the Fed in Washington pay little attention to the monetary base, I focus on the long-run implications of monetary base growth for the price level and inflation rate. Milton Friedman famously said: “Inflation is always and everywhere a monetary phenomenon.” In the long run, the inflation rate is determined by the growth rate of money because without such growth, inflation could not continue. So it doesn’t matter whether policymakers are targeting interest rates, as they are today, or monetary aggregates, as they used to target and will again. As long as their actions permit the necessary increases in the central bank’s balance sheet, inflation will follow.
Skipping ahead to page 6, M2 is the most-watched measure of the amount of money in the economy. M1 is physical money, all the currency and coins in circulation, plus checking accounts. It is a measure of the most liquid part of the money supply. M2 is M1 plus savings accounts, bank CDs and retail or individual money market mutual funds. These are all jest slightly less liquid than cash and checks.
M3 is, or was, M2 plus all large CDs, institutional money-market funds, short-term repurchase agreements and some other large liquid assets. The Fed suddenly decided that it cost too much money to calculate M3 and it wasn’t a very useful number, so they discontinued publishing it on march 13, 2006. One guy with a personal computer now calculates it (so much for cost) and provides it to a large number of subscribers (so much for usefulness). It probably will not surprise you that shortly after the Fed discontinues calculating the series, M3 shot up in the early days of the 2007-2008 downturn.
Money Zero Maturity (MZM) on page 5 is M2 minus small-denomination time deposits, plus all money market funds. It is calculated by the St. Louis Fed. They are trying to track the amount of money readily available for current spending and consumption transactions.
Clicking through on the individual pages will give you a long-term graph like this one on M2 from 1981 to the present:
The weekly U.S. Financial Data page 6 for M2 covers a shorter period, about 14 months, in more detail:
The very useful part of this you might not immediately recognize is the triangle at the bottom. Publication dates run both up and down and left to right. The numbers in the table are the annualized growth rate between any two dates. You can watch money supply growth rates rise and fall on this chart, and see if the Fed is changing direction or running very loose or very tight. The St. Louis Fed puts a table like this at the bottom of each page in U.S. Financial Data.
Monetary Trends
As with U.S. Financial Data, you can get the individual pages or just click “Published Issue (8.5×11)” to get the whole thing. The monthly Monetary Trends includes a major essay on the cover, and then:
• Monetary Aggregates and Their Components
• Page 4 — Aggregates
• Page 5 — Components
• Page 6 — Reserves Markets and Short-Term Credit Flows
• Page 7 — Senior Loan Officer Opinion Survey on Bank Lending Practices
• Page 8 — Measures of Expected Inflation
• Page 9 — Interest Rates
• Page 10 — Policy-Based Inflation Indicators
• Page 11 — Implied Forward Rates, Futures Contracts, and Inflation-Indexed Securities
• Page 12 — Velocity
• Page 13 — Gross Domestic Product and M2
• Page 14 — Bank Credit
• Page 15 — Stock Market Index, Foreign Inflation and Interest Rates
• Page 16 — Monetary Data
• Page 17 — Interest Rates
• Page 18 — Monetary Aggregate Growth Rates
Page 4 shows the aggregate indices M1, M2 and MZM one above the other, but I find page 5, which shows the components of the indices, the most interesting. It looks like this:
(Click for bigger graphic in same window)
You also will want to look at page 8 – Measures of Expected Inflation, page 10 – Policy-Based Inflation Indicators, and page 12 – Velocity. Page 12 is especially important right now, as the Fed’s efforts to simulate the economy by shoveling money into the banks are being thwarted by the banks sitting on it, not loaning it out, and simply reinvesting it in Treasury securities. That has caused Velocity to fall, and economic activity equals money times velocity. As velocity picks back up, inflationary pressures rise.
Shadowstats.com
John Williams of Shadowstats.com continued calculating M3 after the Fed said it was too expensive to collect the data. He also calculates the Consumer Price Index as if various changes since the Reagan Administration had not been made.
Courtesy of ShadowStats.com
The dramatic fall in the year-to-year change of M-3 reflects a collapse in short-term repurchase agreements as banks at first refused to do business with each other due to fear of the unknown damage in the counterparty’s real estate exposure, and then due to the huge amount of nearly free money from the Fed that flowed onto their balance sheets.
Courtesy of ShadowStats.com
The Bureau of Labor Statistics has steadily changed the Consumer Price Index to “improve” it, with the result that the annual adjustment in Social Security payments, union contracts and numerous other costs and incomes has been much lower than it would have been. For example, the Social Security adjustment for 2010 was zero, based on the red lower line. It should have been about 6% based on the blue upper line.
This becomes important in making decisions about how to protect yourself against inflation or hyperinflation. Treasury Inflation-Protected Securities (TIPS) are inflation-indexed bonds offered in 5-, 10- and 30-year maturities, where the principal is adjusted by changes in the Consumer Price Index. They now account for about 8% of all Treasury debt. In an accelerating inflation, it is likely that more and more individuals and institutions would buy them. It therefore becomes more and more attractive for the government to continue to “improve” the Consumer Price Index calculation in a way that shows smaller increases in the CPI.
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As always, this article will remain up until the next Coffee With Michael is posted, and then will be taken down to use in my next book. Thanks for understanding!
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© Copyright – Next Paradigm Press – 2010. Coffee With Michael does not act as a personal investment adviser or advocate the purchase or sale of any security or investment for any specific individual. The recommendations and analysis presented to members is for the exclusive use of members. Members should be aware that investment markets have inherent risks and there can be no guarantee of future profits. Likewise, past performance does not assure future results. Recommendations are subject to change at any time. Nothing in this presentation should be considered personalized investment advice. No communication to you by Michael Murphy or any of our employees or contractors should be deemed as personalized investment advice.
