Q&A With Lacy Hunt
Mish: Lacy, what what do you make of the Surge in M1 Money Supply?
I focus entirely on M2 and have not looked at M1 for years.
Federal Reserve Credit and the monetary base increased by 64% and 37%, respectively, on a yearly average basis in 2020. Due to weak loan demand and frail capital position of the depository institutions, M2 increased 19.4%, on a yearly average basis.
Reserve requirements have been eliminated. Hence, the only regulatory restraint on the depository institutions is the liquidity coverage ratio, but this only applies to the large banks or those with heavy foreign exposure. Hence, for 2020, there was no effective regulatory constraint.
The depository institutions were simply not in position to utilize their deposits at the Fed to acquire additional assets even though the Fed has amended the Liquidity Coverage Ratio (LCR) to include Treasury holdings. The LCR will not be a factor in 2021 unless dramatic changes occur that I do not expect.
Thus, as long as the Fed purchases $120 of Treasury and agency paper, there will continue to be a first round increase in M2, but no second round increase. The increase in M2 will remain inactive, resulting in the excess liquidity trapped in the financial markets.
Emphasis was Mine.
Mish: Did you have any use for M3 that the Fed stopped publishing?
Lacy: The value of M2 versus M3 has been an empirical question for me. Both are explained by complex functions but the one for M2 is far more stable. This empirical finding has made M2 the preferred monetary aggregate. I have revisited this issue several times and the empirical results have continued to favor M2.
Mish: Thanks Lacy
That is a synopsis of several emails. I changed no words but did add emphasis.
My question on M3 was in response to these Tweets.
Reconstruction of M3
Despite the Fed halting publication of M3 it is easy enough to partially reconstruct as I did above.
Wikipedia Money Supply Discussion notes M3 consists of M2 + all other CDs (large time deposits, institutional money market mutual fund balances), deposits of eurodollars and repurchase agreements.
The Large Time deposits lag by a month so in my chart I used the November number for December as well.
Except for eurodollars, the rest is easy enough to add together.
Investopedia notes “Eurodollars are U.S. dollar-denominated deposits at foreign banks or at the overseas branches of American banks. Because they are held outside the United States, eurodollars are not subject to regulation by the Federal Reserve Board, including reserve requirements.“
Thus, eurodollars have nothing to do with either euros or dollars. The term was invented before the euro came into existence.
It’s even more confusing because eurodollar futures are not a measure of the supply of eurodollars but rather the implied interest rate on eurodollars.
I do not know how to estimate the actual supply of eurodollars, so I don’t.
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