Money Supply, M3, Conspiracy Theory
I started to do a piece on the nature of the Internet. What I had in mind is that the Internet is a vast repository of facts, opinions and fiction disguised as fact. In a sense, the problem is that Google does not separate search results by fact, opinion, and fiction. A consequence is that someone can do a search on a topic and be unfamiliar with the sources and reach an erroneous conclusion about what is going on. For example, the Federal Reserve has announced that in March 2006 it will stop reporting M3 (a broad measure of money supply). What does this mean? I will devote this newsletter to discussing money supply and next week (or the week after) will talk about what is wrong with the Internet and the blending of fact, opinion an fiction.
Every Thursday the Federal Reserve releases a report on the money supply. There are 3 money supplies: M1, M2, and M3.
M1 consists of (1) currency outside the U.S. Treasury, Federal Reserve Banks, and the vaults of depository institutions; (2) travelers checks of nonbank issuers; (3) demand deposits at commercial banks (excluding those amounts held by depository institutions, the U.S. Government, and foreign banks and official institutions) less cash items in the process of collection and Federal Reserve float; and (4) other checkable deposits (OCDs), consisting of negotiable order of withdrawal (NOW) and automatic transfer service (ATS) accounts at depository institutions, credit union share draft accounts, and demand deposits at thrift institutions.
M1 is money ready to be spent. It buys groceries and gas for the car and pays the rent or mortgage.
M2 consists of M1 plus (1) savings deposits (including money market deposit accounts); (2) small-denomination time deposits (time deposits in amounts of less than $100,000), less individual retirement account (IRA) and Keogh balances at depository institutions; and (3) balances in retail money market mutual funds, less IRA and Keogh balances at money market mutual funds. Seasonally adjusted M2 is constructed by summing savings deposits, small-denomination time deposits, and retail money funds, each seasonally adjusted separately, and adding this result to seasonally adjusted M1.
M2 buys groceries and gas for the car and pays the rent or mortgage plus it buys the car and makes a down-payment for the house. It also is a source of capital investment.
(If you cannot see the graph - I am trying graphics here for the first time-) it may be found at http://research.stlouisfed.org/fred2/data/M2_5yrs.png
M3 consists of M2 plus (1) balances in institutional money market mutual funds; (2) large-denomination time deposits (time deposits in amounts of $100,000 or more); (3) repurchase agreement (RP) liabilities of depository institutions, in denominations of $100,000 or more, on U.S. Government and federal agency securities; and (4) Eurodollars held by U.S. addresses at foreign branches of U.S. banks worldwide and at all banking offices in the United Kingdom and Canada. Large-denomination time deposits, RP's, and Eurodollars exclude those amounts held by depository institutions, the U.S. government, foreign banks and official institutions, and money market mutual funds.
M3 consists of M2 - the money in play in the U.S. economy and two other big ticket items: Eurodollars, which are not in play and RP's which are in play, theoretically, only in the short term. Much of M3 is not "money in play" in the economy. Eurodollars are not and large-denomination time deposits are held by folks with wealth who have no intention to spend those dollars any time soon. RP's are more difficult to get a handle on. These are short-term borrowings but if they keep getting loaned out they are in play. In fact, the entire purpose of RP's is to put dollars in play.
(If you cannot see the graph - I am trying graphics here for the first time-) it may be found at http://research.stlouisfed.org/fred2/data/M3_5yrs.png)
The most commonly watched money supply is M2.
Eurodollar are dollar denominated assets held at financial institutions outside the United States and, consequently, not under any regulation by the Federal Reserve. Subsequent to World War II the U.S. started pouring money into Europe for rebuilding. That money was in the form of dollars and those dollars stayed in Europe. During the 1960's the Soviet Union became a holder of dollars and feared seizure of those dollars if they were kept in US banks. British banks agreed to hold those dollars for the Soviets and make deposits in U.S. banks in dollars. In essence the Soviets were able to hold dollar based assets satisfied of their safety.
The popularity of such transactions has expanded vastly. The expression "eurodollar" is now used to refer to any currency held outside its native country and banking system.
When the Federal Reserve uses the term "eurodollars" they refer to U.S dollars held outside their control. That could be dollars held in foreign countries including dollars held by U.S banks in branches outside the U.S.
A current topic of discussion is why the Federal Reserve is dropping regular reporting of M3 - a measure of the money supply which includes Eurodollars. Presumably the Fed does not regard those dollars as being "in play" in the U.S. economy. In short, the substantial increase in Eurodollars has not had an inflationary effect (too many dollars chasing too few goods) in the U.S. Those dollars are not really doing any chasing of goods with the exception, perhaps, of real estate of both coasts.
The following 2 paragraphs are from the web site for the Federal Reserve Bank of New York:
Among the tools used by the Federal Reserve System to achieve its monetary objectives is the temporary purchase and sale of United States Government securities and federal agency obligations in the open market.
In conducting these operations, the System uses "repurchase agreements" ("RP's" or "repos") and "reverse repurchase agreements" transactions which have a short-term, self-reversing effect on bank reserves.
Such repurchase agreements are instigated by the Fed's trading desk for the purpose of controlling money supply. In theory, they are used to offset day-to-day fluctuations in bank reserves. In would seem to me that repos should be included in regarding the money supply and regularly reported. Nevertheless more attention has always been paid to M2 than M3 so dropping the regular reporting of M3 is not exactly drastic. The Fed has not used money supply but rather interest rates to spearhead monetary policy for the past 20 years. The fact that M2 and M3 have increased so dramatically with modest inflation speaks volumes to this disconnect.