M1 money multiplier below 1

Discussion in 'Economics' started by MrDODGE, Jan 5, 2009.

  1. http://market-ticker.denninger.net/archives/703-Uh-Oh.....-Monetary-Flat-Spin.html

    <img src="http://research.stlouisfed.org/fred2/data/MULT_Max_630_378.png">

    That has gone "just below" 1.0.

    What is this?

    I could go through the derivation of how money supply works in a fractional reserve monetary system (any), but won't, because most readers would have their eyes glaze over.

    The important part of this graph is what it denotes. Bernanke has lost control of "N" (or velocity), which is the actual knob that he is trying to diddle when borrowing rates are changed (and in fact its the market that sets that, despite his protests.)

    In fact the most useful tool in The Fed's box in terms of influencing monetary policy is the soapbox, that is, jawboning (whether it be by cajoling or threatening.)

    The problem with an M1 multiplier below one is that the effect of printing money is of course multiplied by the velocity. That is, if you print up $10 into the economy the impact it has on economic activity depends on how many times that $10 circulates in a given amount of time. The more it circulates the higher the impact and the more your efforts do for the economy.

    The bad news is that when the multiplier is less than one the more money you spew into the economy the worse the impact, as you get less for each additional dollar.

    If you remember the "GDP for each dollar of debt" graph....

    <img src="http://market-ticker.org/uploads/debt-contribution.serendipityThumb.jpg">

    M1's multiplier going below 1 strongly implies (but does not yet prove) that we have reached that "zero hour".

    Why? Because all money is in fact debt; this is inherent in all modern monetary systems.

    When Bernanke "creates" money he is doing so against an asset - that is, he is issuing debt. A Federal Reserve Note (whether electronic or paper) is in fact effectively a bond of zero maturity and indefinite expiration against the future tax collection capacity of The United States.

    That is, it's a treasury bond (via a circuitous route)

    The paradox that Bernanke is in danger of discovering (the hard way) is the paradox of a pilot who finds himself in a flat spin. As the ground approaches he wants to pull back on the stick but if he does so, the spin simply tightens as the wings are not producing lift - the angle of attack is too high, not too low. As such if he does what his brain screams at him to do instinctively, he dies.

    Or the scuba diver who sucks on the reg and gets nothing. Your instinct is to hold your breath and kick for the surface. If you do it you die.

    In both cases your only hope of survival is to do exactly the opposite of your instinct. In the case of the pilot you must not only give counter-rudder (to stop the rotation) but also push the stick forward. In the case of the diver you must exhale that last breath you have in your lungs, knowing there are no more in the tank while you kick to ascend.

    If you succumb to instinct you are dead. Really dead, as in splat (or exploded lungs.)

    Bernanke is effectively in the same box. The foundation of his entire thesis as a banker is that a central bank can always reverse a deflation by printing money. Unfortunately as he has done so velocity has fallen and the multiplier has now gone below 1. If this induces him to do even more of what caused this decrease there is a very real risk that the actual market reaction will be to tighten the monetary flat spin.

    This is because the underlying problem in the economy isn't the lack of debt (money) in the system. It is that there is too much debt of all sorts, and since money is in fact a form of debt, you can't fix the problem by playing helicopter drop!

    As I have said for more than a year the only way out is to force the bad debt out into the open and default it. Yes, this will produce bankruptcies - lots of them, including some for "inconvenient" people like Paulson's buddies on Wall Street.

    But until and unless that happens adding more debt to the system depresses the multiplier effect of that debt on circulation further, and harms, rather than helps the situation.

    I don't expect our government officials to understand the math on this, nor would trying to go through it help 99% of the readers, but unfortunately, mathematics is the only true science - and you can't twist it, no matter how hard you try.

    Bernanke knows this at an intellectual level, just as the diver - or pilot - knows that if he holds his breath (or pulls the stick) he is going to die.

    The question now becomes whether Bernanke can overcome not only instinct but also political pressure to do the wrong thing and instead use his intellect - and the math - to do the right thing.

    What is the right thing? Paradoxially, it is to withdraw liquidity and by doing so force the bad debt into the open where it does (and must) default.

    How far can the above ratio contract before we cross an "event horizon" from which there is no escape?

    I don't know.

    But I do know that there is a "too late" point, as there is for all such things, and that we are approaching it, as I have been saying for months.

    BTW, evidence that Bernanke's Monetary Flat Spin is already impacting the economy in ways that may do critical (if not fatal) damage was found this morning in the Case-Schiller numbers. Everyone, including Bernanke, was expecting the rate of home price declines to start to slow in the second half of the year. Instead, they accelerated.

    We're in uncharted territory folks, and the forecast is for dark-and-stinky storms.

    Buckle up.

    PS: Congress, and the rest of America, can't say they weren't warned.
  2. errr!!! Denninger is a nut pot.

    This 'money multiplier' is a function of the Monetary base.. Do your homework guys before posting this crap.
  3. Ed Breen

    Ed Breen

    Mr. Dodge, who are you...you are the only person I have encountered who sees clearly what is going on...and I have been reading and talking to quite a lot of people who are supposed to know this stuff. You have it right.

    As for the spurius comment after your post...the money multiplier is a ratio of one definition of the monetary base (M1-defined by the Fed as money in circulation plus demand deposits but not reserves) divided by another definititon of the monetary base, the St. Louis Fed adjusted monetary base('AMB'-defined by the Fed as M1 plus reserves on deposti at the Fed adjusted by changes in the reserve requirement in a chained index measure).

    So, basically the adjusted monetary base measures the accumulation of excess reserves in the banking system compared to money in ciruclation. That is a reasonable measure of velocity in the system.

    The phenomenon of build up of excess reserves only occurs when there is deleveraging....see Great Depression and Long Deflation in Japan. This build up of the reserve is, as Mr. Dodge posits above, a symptom of deleveraging and not a cause of inflaition.

    It is not the money supply per se that creates inflaton by being too large....its is the money supply as it is leveraged that creates the inflation. Leverage is the financial mechanism that transmits the theoretical money multiplier effect. It is a leverage effect. Leverage is the accelerator in the system that creates the 'velocity'; that creates the money multiplier effect that is the basis of monetarist theory. Levergage is the monetarist 'missing link' that deprived the theory of its demand measure and so, its 'velocity' measure.

    So, we are in a Fisheresqe collateral asset devaluation credti collapse spiral that is manifesting in deleveraging....a spin, as Mr. Dodge observes.

    I have been telling people for years what I learned during the S&L collapse, that you cannot solve a debt problem with debt, it requires income. It seems like a tautology but it took me years to realize the implications. Mr Dodge gets it....money is debt.
  4. Velocity of money is decelerating in a digital economy... LoL...

    it's the end... :D

    Debt or not... trust is the key to speed.

    No trust, no speed...

    Full trust, full speed :D
  5. morganist

    morganist Guest

    i think there is more to it than this. there are other ways you can increase the velocity of money who the money is given to and their propensity to consume for example.
  6. promagma


    Good analysis, what (according to Denninger) happens at the "too late" point?
  7. fhl


    Yes, very insightful. The only comment i'd have is that M2 and analyst computed m3 expanded smartly during this whole thing and has only recently flattened and/or turned down slightly. So, while the deleveraging was taking place, broad measures of money supply were still expanding. If the fed takes their foot off the accelerator, which they may do with their possible decision to stop buying mortgages and other bonds?, we could be headed swiftly to a deleveraging that actually causes a big drop in money supply. The fed and pols won't stand for it. They'll print like there's no tomorrow, and there just might not be. lol imo
  8. Ed Breen

    Ed Breen

    One of the problem with modern 'economics' is that has evolved seperate from 'finance.' So, economic theorists traffic in unsupported assertions of mysterious unexplained psychological basis to consumer and producer behavior (the same thing in my mind). Clearly, as the post above implies there are 'expectations' involved in notions of velocity. From a finance prospective, I would say thati in the aggregate, the decision to invest, to risk capital, to borrow, is based on an expectation that informs the spread discount between one"s average weighted cost of capital (AWCC) and ones projected net operating profit less taxes (NOPLT). The entrepreneur adusts the spread with notions and expectations of risk attached to the projection of profit above cost. Where that projection is uncertain or where conditions are changing then that spread must be very large indeed...certainly larger than any basis point change in interest rate is likely to effect.

    One of the posts above seems to imply that 'velocity' would change depending on who is spending money. This is a mistaken notion that springs from a confused keynesian paradigm. Spending has no money multiplier effect no matter who has the money. Spending is always a one off. The main paper on this subject was written by the unfortunate Christina Romer who is today's leading example of the truth of the 'Peter Principle.' If you actually read Christina's famous paper you will discover that she found no multiplier effect from either government spending or from tax reductions. She theroized that if she could find a statistically significant proof that it was more likely to come from tax reduction....hardly an endorsement of the bizarre notion that spending begets spending. Understand that real money multiplier effect, what we call velocity, occurs through leverage and leverage is based upon capital. Spending is not capital.

    So, today expectation of future profit after tax informs actors to pay off debt as the best investment. That's deleveraging and it destroys velocity in the money system.
  9. I don't understand your last sentence, but i think u are saying paying off debt is deleveraging? I may have missed it but what asset exactly is this money being printed against? Or are you referring to private companies, in which case I get it.
  10. Ed Breen

    Ed Breen

    Of course paying off debt is deleveraging...that is a tautology...'deleveraging means paying off more debt than you initiate. Observe aggegate private sector debt in the U.S. which is declining in an accelerating curve at historically unprecedented rates right now.

    The fed has assets on its balance sheet becuase it recieved the money from Treasury to buy those assets. It was called TARP. The Treasury borrowed the money it loaned to the Fed by auctioning off Treasury securieties. In some cases the Treasury loaned Treasury securieties directly to the Fed. The Fed in turn, think TARP again, bought 'toxic', i.e. illiquid securites from the banks...exchanging money from treasury for securities that had no market demand. In some instance it swapped treasury instruments for illiquid paper. This removed the threat of write down of the illiquid assets that would have undermined bank balance sheets and destroyed thier capital ratio's making them technically insolvent. In contrast the Fed does not have any capital reserve requirement and it does not have to write down any assets. Now the Fed bought these assets at a discount depending on thier particular nature and we really still don't know what these assets are really worth, but the Fed carries them on its balance sheet at its purchase price and at its discretion with no risk to its continued operation (So long as the Treasury remains credit worthy). So, the banks got the new money and good securietes and they inturn deposited the money at the Fed as excess reserves. This was of course the same money the Fed gave them for the illiquid assets. So, now both are in the Fed balance sheet...ie. TARP funding times 2, becuase there is no loan demand in the private market and short term rates are at practicle zero basis so banks might as well leave excess reserves on deposit at the Fed...since they get the same rate or more than they would get on short term paper. As a consequence of borrowing money from the Treasury at very low interest and using it buy high yield securities from the banks at a discount and then recieving the proceeds of the purchase from the banks back as low cost deposits that they in turn use to purcahse longer term treasuries at a spread the Fed earned a profit of 48 Billion last year...most in its history....see, this is what Dodge was talking about...you can't solve a debt problem with debt.
    #10     Jan 27, 2010