by
Michael S. Rozeff
Up a great deal. More than at any time since World War II. How much is a great deal? Probably far more than you expect. Read on. We’d like to know what’s going to happen in the future to a host of variables, such as stock prices, commodity prices, the price of gold, short and long-term interest rates, consumer goods prices, real estate prices, gross domestic product, employment, etc. This article focuses on the prices of consumer goods. Instead of examining theories, this article uses an FAQ format to answer the question: where are consumer goods prices headed? This provides a degree of simplicity and clarity. Calculations do not always add because of variations in dating, seasonal adjustments or not, rounding, etc. The specific references are all to U.S. data. 1. What is the monetary base? The monetary base is the sum of notes and coins in circulation and in bank vaults and reserves held by banks on deposit with the central bank. In the U.S., the central bank is the Federal Reserve (or Fed) and the notes primarily are Federal Reserve notes. 2. What is the current size of the U.S. monetary base? Approximately $1,774 billion, as of 1/14/09. This consisted of about $951 billion of bank reserves and $823 billion of currency in circulation. 3. What are bank reserves? Bank reserves consist of currency banks hold (vault cash) and reserves they hold on deposit at the Fed. Their reserves at the Fed are like a checking account they hold at the Fed. 4. At what level are current bank reserves, and what is the usual level? Bank reserves as of 12/1/08 were $821 billion. Bank reserves were $40–$44 billion from late 2005 until August of 2008. 5. What are excess reserves? Excess reserves are bank reserves (or deposits) held at the Fed in excess of reserves required by the Fed’s regulations. As of 12/1/08, total bank reserves were $821 billion; required reserves were $54 billion; and excess reserves were $767 billion. 6. What is the usual level of excess reserves? Prior to September of 2008, excess bank reserves were about $2 billion. 7. What is the importance of excess bank reserves and, by extension, the monetary base? Excess reserves and the monetary base provide banks with the capacity to make loans to customers. In the fractional-reserve banking systems that nations have today, the loans are a multiple of these reserves. 8. What is a money multiplier? A money multiplier is a ratio with a measure of money in the numerator and the monetary base in the denominator. The M1 money multiplier is the ratio of the M1 money measure divided by the monetary base. The M2 money multiplier is the ratio of the M2 money measure divided by the monetary base. 9. How large is the M1 money multiplier and what is its recent behavior? The M1 money supply is currently less than the monetary base. M1, which is primarily currency plus demand deposits, is $1,602 billion. The multiplier is about 0.9 as of 1/14/09. The M1 multiplier has been about 1.6 in recent years. The drop to 0.9 has occurred starting in late September of 2008. It is due to the greater rise in the monetary base than M1. M1 has risen from $1,392 billion in early September to $1,602 billion at present, or at an annualized rate of about 36 percent a year. The monetary base has risen from $870 billion to $1,774 billion. The annualized rate is about 249 percent. 10. How high would M1 rise if the M1 multiplier were to return to its level of 1.6? M1 will rise to about $2,563 billion if the multiplier of 1.6 is restored. That is an increase of about 84 percent over its early September level of $1,392 billion. 11. What are borrowed and non-borrowed reserves? Member banks can borrow from the Fed via the "discount window" or by other "facilities." This borrowing is analogous to going to a teller’s window in a bank and borrowing from the bank. When the banks borrow and do not withdraw the amounts they borrow, it goes into their checking accounts (reserves) at the Fed. That borrowed portion of their reserves is borrowed reserves. The rest is non-borrowed reserves. 12. What are the levels of borrowed and non-borrowed reserves? As of 12/1/08, borrowed reserves were $654 billion. About $407 billion of this were reserves obtained through the Term Auction Facility (TAF), and the rest were mostly from discount window borrowing (about $210 billion). Non-borrowed reserves were $167 billion. 13. What are the usual levels of borrowed and non-borrowed reserves? Total bank reserves were $40–$44 billion from late 2005 until August of 2008. This approximated required reserves, and excess reserves were small. Non-borrowed reserves also approximated total and required reserves during this period. Borrowed reserves were small or nil. 14. In what forms have banks borrowed from the Fed? Borrowing from the discount window has traditionally been negligible (often under $100 million.) Starting in March of 2008, this borrowing shot up to $19 billion. By October of 2008, discount window borrowing reached a peak level of $404 billion. The Fed offered a new way to borrow using a different form of collateral in December of 2007. This is the TAF. The TAF borrowing maxed out at $150 billion in June of 2008. The Fed expanded the program in October, at which point TAF borrowing rose sharply. It replaced some of the discount window borrowing. 15. Why did bank borrowing from the Fed increase so sharply? (i) Bank borrowing increased because banks wanted financing (cash inflows). Banks faced a sharp rise in loan losses and nonperforming loans that reduced their cash inflows. They faced declining demand for the commercial paper that they use as a means of finance. Inter-bank lending slowed. The banks needed to pay out cash to meet their obligations, but their cash flows were falling. Some banks obtained long-term sources of cash by issuing long-term debt and equity, but this source of cash is much more expensive that borrowing from the Fed. (ii) The Fed provided hundreds of billions of dollars of loans at low cost to the banks. (iii) The Fed took questionable bank loans as collateral. The banks were able to dress up their balance sheets. They were able to inventory cash for future use at low cost. 16. Why have banks kept much of the bank reserves and not loaned them out? Loan demand declines during and for 2 to3 years after recessions. This occurs as households and businesses retrench and business activity slows. Banks may also be reluctant to make loans aggressively because they want to rebuild their balance sheets. After several years, loan demand picks up and then continues to rise. 17. What has been the past behavior of the consumer goods prices (as measured by the CPI) after recessions? There have been 12 recessions since 1945. The CPI usually stabilizes, rises more slowly, or occasionally declines during these recessions. Most typically, it rises more slowly during the recession but still rises. In the recovery period, prices tend to rise much more. For example, from 1975 to 1980, the CPI advanced by 55 percent. 18. What determines the rate of increase of the CPI? An important factor is prior rates of growth in money supply over periods of 5 to 10 years. The CPI rose by 33 percent between 1945 and 1950, reflecting high money growth during World War II. Money growth was subdued in the 1950s and so was CPI growth. Money growth accelerated in the 1960s and 1970s, and so did CPI growth. 19. What is the prognosis for future rates of increase in the CPI? The current M1 growth is the steepest in 25 years. Past accelerations in M1 growth were accompanied or preceded by rates of growth in the monetary base of almost 12 percent a year. The M1 growth rates were at least as high as the growth rates in the monetary base.
The prognosis is for much higher rates of CPI growth than at any time in post-World War II U.S. history. These price increases are not going to be immediate. There are lags. There is no smooth or mechanical relation between today’s money growth and today’s consumer prices. These things take time. General price level increases depend on both the growth in money supply in past years and on whether that growth is sustained over many years. The Obama administration and the Fed have both told us that they intend to sustain their stimulus for years to come. Add that to the fact that the existing rate of growth of the monetary base already is at a rate that is typical of a banana or coconut republic. Similar results are highly likely. January 29, 2009 Michael S. Rozeff [send him mail] is a retired Professor of Finance living in East Amherst, New York. Copyright © 2009 LewRockwell.com
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The
current rate of growth of the base is 249 percent a year. The M1
money growth rate can rise from its current 20 percent year-over-year
rate to a substantially higher rate. This typically leads to higher
CPI growth.