Boring is good.

Once again, this is the graph of excess reserves and the base money supply. While the base money supply has exploded, excess reserves has kept pace. The last time I plotted this out, it looked like the beginning of a possible divergence to the upside. We’re back to boring, which means we aren’t at the point of burning dollars for warmth (sadly, I can’t say much about the predictive qualities of this graph. You probably knew we weren’t currently experiencing hyperinflation).

I just read a paper by Professor (Emeritus) Herbert Grubel about the costs, benefits, and likelihood of success in using inflation as a means of reducing the US debt burden. It discussed the significant excess reserves being held by banks as well as the technical capabilities of the Fed for keeping those excess reserves from causing the M1 to explode. It made me think of this graph. Honestly, I was kind of expecting a little more of an uptick in the green line.

(source: St. Louis Fed: FRED Graph)

Hmmm….

I’ve used this graph for a while as a reason to dismiss concerns about big inflation (or likened it to a coiled spring, depending on the mood I’ve been in). So when I read some alarmist headlines about growth in M2, I regenerated this image to see if there was any reason for concern. For the first time, I am not comfortable with the outcome. It is still early as far as the data is concerned, but the green line seems to be diverging from the red line. If this continues, and M2 growth accelerates, there could be genuine reasons to be concerned about big inflation.

Now, having provided an alarmist paragraph myself, I do feel obligated to point out that this may be but a temporary win for inflation. Inflation currently is winning. However, there are significant deflationary pressures (default, always default). Commercial real estate delinquencies are still growing, and there’s some real concern about state finances. Since debt is the most important aspect of the money supply, a turn for the worse in the bond market would make the growth in the base-minus-reserves meaningless.

(via research.stlouisfed.org)

Screw it, let’s panic.

We’ve been waiting for a move in the green line substantially up or down from the trend. That would be a nice indicator (two months delayed) of an inflationary explosion or deflationary collapse. From a strictly monetary perspective, neither option seems to be winning right now.

If we examine prices, it is possible that money has moved out of certain asset classes and into other asset classes that we, as a society, are more price sensitive to. Wheat prices have spiked recently, though they are still down significantly from their peak in 2008. This could be due to export restrictions in Russia, and not money movements. Coffee prices are way up, though this too might be due to supply issues. In general, food and beverages seem to be increasing in price. These are the prices we care about on a day-to-day basis. Despite this, CPI growth is rather muted. Part of that is due to the fact that the CPI is weighted in interesting ways and then built up out of statistical voodoo. Part of it is due to the stickiness of consumer end prices.

The Fed seems to be embarking on a journey of new and unproven policy decisions. However, those calling for hyperinflation may still be too early on the call. Prices thus far have been more sensitive to politics, trade, and normal supply and demand issues than they have been to actions by the Fed. And the Fed’s journey may not be into territory all that unexplored. QE2 seems to be more of a continuation of current policies than something new. The Fed’s POMO activity is a weekly occurrence. They are now the number 2 holder of US treasuries after China. They surpassed Japan today.

It isn’t that I don’t believe this will end badly. I certainly think that’s the case. However, when it ends is a huge guess. We can panic now, if we like, but it might take some serious determination to maintain a level of panic into the end. It could be days, months, or even years in the future.

(source: St. Louis Fed: FRED Graph)

Still no reason to panic?

I starting looking at this graph to help convince myself (and a few others) that hyperinflation wasn’t going to be the immediate impact of the exploding monetary base. In the passing year, bread still isn’t a thousand dollars a loaf, so it is possible that we haven’t yet had hyperinflation.

At this point, I’m a little surprised these two have managed to track each other so perfectly. As before, the explosion (and wiggly increase and contraction) in the base money supply is entirely explained by the excess reserves plugging the gaping holes on banks’ balance sheets. Neither inflation nor deflation has emerged as a true victor here. All of this is merely a chart of the Federal Reserve’s (successful, so far) attempt to prop up the banks.

Do you know what would be really impressive? If that green line manages to keep on its current trend through the next crisis. Whether that crisis is crunching state budgets, bank failures in Europe, stock market collapse in the US, or any of the other big potential problems, if those red and blue lines manage to track one another, that would be impressive. There’s only a single small bump in the green line during all of that chaos. And do you know what would be scary? If that green line deviates too far from the trend. That means the Fed has lost control of monetary policy. Unfortunately, sometimes authority and effort aren’t enough to determine outcome.

(source: St. Louis Fed: FRED Graph)

The Minutes of the Federal Open Market Committee were released today. As expected, interest rates will stay “exceptionally low … for an extended period.” Hoenig dissented, as expected.

The interesting bit starts with this language (emphasis mine):

While the recent data on production and spending were broadly in line with the staff’s expectations, the pace of the expansion over the next year and a half was expected to be somewhat slower than previously predicted. The intensifying concerns among investors about the implications of the fiscal difficulties faced by some European countries contributed to an increase in the foreign exchange value of the dollar and a drop in equity prices, which seemed likely to damp somewhat the expansion of domestic demand. The implications of these less-favorable factors for U.S. economic activity appeared likely to be only partly offset by lower interest rates on Treasury securities, other highly rated securities, and mortgages, as well as by a lower price for crude oil. The staff still expected that the pace of economic activity through 2011 would be sufficient to reduce the existing margins of economic slack, although the anticipated decline in the unemployment rate was somewhat slower than in the previous projection.

Two predictions important to many, GDP and unemployment, have been revised to be more pessimistic.

In the accompanying Summary of Economic Projections, negative revisions continue:

Participants generally anticipated that, in light of the severity of the economic downturn, it would take some time for the economy to converge fully to its longer-run path as characterized by sustainable rates of output growth, unemployment, and inflation consistent with participants’ interpretation of the Federal Reserve’s dual objectives; most expected the convergence process to take no more than five to six years. About one-half of the participants now judged the risks to the growth outlook to be tilted to the downside, while most continued to see balanced risks surrounding their inflation projections. Participants generally continued to judge the uncertainty surrounding their projections for both economic activity and inflation to be unusually high relative to historical norms.

Five to six years just to get back to a normal economy? That’s not much of a V-shaped recovery. Worse, this may all prove to be too optimistic, as everything was subject to the disclaimer:

Longer-run projections represent each participant’s assessment of the rate to which each variable would be expected to converge over time under appropriate monetary policy and in the absence of further shocks.

Now, what are the odds of there being no shocks over the next five to six years?