The Federal Reserve has officially embarked upon quantitative easing and inflation hawks are concerned this increase in the money supply will lead to hyper-inflation. The financial world has changed since the Friedman and Schwartz analyzed the mis-steps of the Great Depression and the definition of money has changed as well.
Credit is money and thus can be considered money supply. The securitization market allowed both corporations and individuals to monetize assets. Credit card companies increased cash by tapping the asset backed securities markets, car companies sold cars and received cash by issuing securities backed by auto loans, and individuals used their homes as ATMs through the alchemy of the home equity line of credit. In the middle of this game of musical chairs was, and still is, the financial institutions, both bank and non-bank entities (shadow banks).
US “Aggregate” Money Supply - Issuance of Unconventional Money
(Billion $USD)
Source: CMSA, Asset Backed Alert, SIFMA, Federal Reserve
The “aggregate” money supply includes all instruments that enable monetization. This open definition admittedly leaves room for multiple interpretations. It could be argued that credit default swaps and even equity IPO’s are forms of monetization. However, using the issuance of the “big three” (CMBS, ABS, and RMBS) as a proxy for the “shadow” banking system, provides a simple and crude estimate of the “aggregate” money supply.
When the non-conventional sources of “money” are included, the money supply is actually decreasing, not increasing. Including other instruments like CDS and equity would result in an even steeper decline in money supply. From the peak in 2007, the aggregate money supply has declined $1.9 trillion dollars or 18.5%. As measured by M2, money supply fell by 33% during the Depression. Once again, broadening the definition of money would easily result in a contraction in money supply of at least 33%.
As of March 11, 2009, the Federal Reserve’s balance sheet had increased by $1.02 trillion. To restore the aggregate money supply to 2007 levels the Fed needed to increase its balance sheet by another $880 billion. That is, current aggregate money supply ($8,486b) less 2007 aggregate money supply ($10,408b).
The FOMC announced on March 18, 2009 that it would increase its balance sheet by $1.15 trillion; approximately $270 billion more than is required. Recall that the “aggregate” money supply is a crude estimate and assumes that only CMBS, RMBS, and ABS are considered money. This simple assumption likely underestimates the real “aggregate” money supply.
Nonetheless, the increase in the Fed’s balance sheet is exactly what was needed to combat a deflationary spiral like the one that occurred during the Great Depression. Indeed, it was Milton Friedman himself, who declared the Fed did not increase money supply during the Depression and thus exacerbated the impact of the downturn.
Monetarist’s Rejoice!
Disclosures: none
