Central Bankers Have Wholly Perverted the Meaning of Money

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Somehow I came to find in my possession a $1 coin with William Henry Harrison's image stamped on its front. While there is some fixation on the $20 bill, specifically the presidential image on that one, Harrison seems at least innocuous compared to the others that have achieved and delivered far more for their time in that office. The answer from the US mint was not a celebration of Harrison as it was a series on US Presidents. The 2016 versions struck for the $1 coin will be the last in the array, featuring Presidents Nixon, Ford, and Reagan.

It raises the issue as to what the coin is supposed to represent, particularly given that by even anachronistic standards the $1 coin was never popular. Is it intended, like stamps, as art for collectors? That would be an odd way to "sell" money to the public, especially as physical cash is increasingly out of style from both ends: the public that has less and less use of physical payment forms; and the economists, particularly those dealing in monetary policy, that cannot achieve any economic growth for their increasingly massive and deliberate disruptions.

Harrison's portrait, and really any of the others, isn't even the most striking aspect of the program, as the mint's website explains. "The size, weight and metal composition of the Presidential $1 Coins are identical to that of the Native American $1 Coins." The metal assuredly isn't gold, which means nobody really cares that the coins are identical chemical elements and the same fixed quantity. The number of people who can even recall that being a relevant factor has to be such a dwindled proportion as to be irrelevant (the coin's composition, not the people). It can only be "tradition."

That, too, would be somewhat absurd given that the nation's chief monetary agent prior to Janet Yellen in July 2011 famously decried gold itself as nothing but "tradition." We are certainly a nation of contradictions at times, but Bernanke's reply to Rep. Ron Paul was especially ripe.

The timing of that exchange could not have been more perfect on that count. The Chairman had just completed QE2 only a few weeks before, an active management approach to "money" which had seen the Open Market Desk buy assets from Primary Dealer banks in order to swell the Fed's balance sheet on the asset side. Total assets of the (consolidated) Federal Reserve System when the program began were $2.3 trillion (having gained already, of course, from the events and activities of QE1); at its end there were $2.87 trillion. That wasn't money, either, not even in the sense of the monetary statistics. Base "money" isn't Federal Reserve assets, it includes only "reserve" balances at the Fed - the central bank's liability side.

To get from one to the other there are subtractions, called "absorptions" in the parlance of central bank accounting. The primary absorption is ironically US currency, including all those $1 coins still weirdly (in terms of pretending, not that hard money holds no place in this modern world) devoted to identical metal composition. The level of bank "reserves" had dwindled to "just" $992 billion in the first week of November 2010 from a local peak of $1.23 trillion toward the end of QE1 earlier that February. I write "just" because everything is relative; bank reserves prior to the events of 2008 just weren't a factor at all. The week before Lehman Brothers failed, total bank reserves held at the Fed were $9 billion - and they had been at or around that level for decades.

By the time Bernanke was decrying gold to Rep. Paul, the level of bank reserves had risen to $1.68 trillion, meaning there were smaller additional factors in the calculation beyond the QE balance sheet expansion. Among those "other" factors, which in this case would be a negative absorption, or a smaller number on a liability side account that increases reserves relatively, was a huge reduction in "Deposits with Federal Reserve Banks, other than reserve balances." The specific account was a deposit (like) balance for the US Treasury called the Supplementary Finance Account. The balance had dropped to just $5 billion in early July 2011 from just shy of $200 billion when QE2 had launched.

Thus, base money or the balance of bank reserves being supplied throughout QE2 was a bit more than QE2 itself. The Supplementary Finance Account, however, as a strange conception should ring some bells as to its existence in the first place. It was created in the mess after Lehman specifically to "absorb" excess "money" during the panic. What I just wrote should sound like another huge contradiction, but it is not. There was a bank panic, most assuredly, but it was nothing like prior panics. The federal funds rate, which is supposed to measure systemic liquidity for the dollar money supply in the aggregate, was seriously below the Fed's target rate and began a dastardly habit of remaining there.

To the contrary, LIBOR rates, which measure broad dollar liquidity but centered in London upon the eurodollar market (offshore "dollars"), went disastrously in the opposite direction of federal funds. How could there be two money supplies, one centered in NYC with "too much" and one centered in London (and Tokyo, it should not be forgotten) at panic levels?

The Supplementary Finance Account was more than just a federal funds absorption tactic, though, as it was in essence reverse repo. The balance in that account was built on entirely separate US Treasury borrowing (for purely these monetary purposes, not in any way tied to the fiscal budget) which then created what was an additional supply of US Treasury securities very much like T-bills. In other words, the Treasury in cooperation with the Fed was trying to add to the supply of usable repo collateral. The reasons were obvious, given that the repo market immediately after Lehman almost ceased function. Repo fails (hoarding collateral exactly like the public used to be accused and denounced by economists for hoarding money) reached more than $5 trillion while at the same time, conspicuously, the banking panic in early October 2008 became a general, global liquidation event. Soon thereafter, as economy often follows money, it was an economic event the entire global economy is still dealing with more than seven years on. "Monetary" policy failed in every facet possible.

A huge part of that enduring chain of insufficiency in the economy runs through July 2011. Again, QE2 had swelled the asset side of the Fed's balance sheet, which in "tradition" is termed "Factors Supplying Reserve Funds", combining with the reduction in the Supplementary Finance Account to increase bank reserves by nearly $700 billion (specifically, an increase in physical currency of $70 billion offsetting SFA on the liability side, meaning -$200 billion SFA +$70 billion currency leaves bank reserves +$130 billion in addition to the $570 billion from the asset side). Despite this massive "money printing" operation, the global banking system in just three weeks' time was once more engulfed in near panic and disintermediation.

Repo fails had been far tamer in the aftermath of the 2008 panic, not just due to calmer prevailing conditions but also a new, after-crisis 3% penalty enforced on UST collateral in any fail. While that placed a defined and large cost to hoarding collateral, hoarding collateral did not cease, including undoubtedly though intermittently Supplementary Finance bills. There were a couple of spikes in fails in 2010, notably the week of December 15, but for the most part it wasn't attracted to anything more than vague concern.

During the week of Bernanke's assessment of tradition FRBNY reported just $44 billion in repo fails using UST collateral. That total includes both sides, failures "to deliver" and "to receive", even though by then the US Treasury had been withdrawing its SFA balances due to increasing uncertainty about the "debt ceiling." Though the SFA had nothing to do with the federal budget, it was US debt and was counted as it should have been with all (mostly all) other borrowings. In other words, the count of bills and bill-like securities available for UST repo was $195 billion less (and would be withdrawn to $0 before much longer).

This was a bigger problem than it sounds, as not only was $200 billion a relatively large single source it was among the most prized of collateral - since these were rolled bills, they were always OTR (on-the-run) and thus fully liquid. On-the-run relates to newly minted (pun intended) securities fresh from auction which receive in the secondary market the most attention and trading activity because their intrinsic (par) characteristics most closely match current conditions.

The debt ceiling drama and uncertainty was resolved on July 31, 2011. In the midst of that, asset markets had already been under pressure, with even US stocks enduring what looked like another systemic liquidation into early August. Then in early September, US "dollar" repo markets suddenly braced for perhaps a secondary systemic event, with fails surging to $462 billion, ten times the amount from early July and comparable only to 2008 and 2009 (without factoring the 3% fails penalty). The same exact week, the Swiss National Bank shocked the world by pegging the franc to the euro, which doesn't seem much to do with dollars. The week after that, however, the ECB, the Bank of Japan, the Bank of England, the Swiss National Bank and the Fed announced a coordinated "auction" of "dollars" in three-month maturities at "full allotment."

That last term was the most important of the "dollar" action, as it meant that any single bank could bargain for any amount of "dollars" so long as it had eligible collateral in good standing, meaning something other than UST's (if they had those, they would have been funding via private repo). If that arrangement also sounds familiar, it should - it is exactly the Discount Window, only now applied to banks overseas mostly in Europe (hint: Swiss). The difference is only mechanical, meaning that these foreign central banks are the "window" while the Fed is one step more remote. When this auction was announced, the ECB disclosed that two (to this day) unnamed European banks had been forced to obtain $575 billion in non-market "dollar" funding.

Obviously we are missing "something." M1 money supply, which includes all of M0 "base money" like bank reserves at the Fed, had grown from $1.767 trillion at the start of QE2 in November 2010 to $2.11 trillion when two undisclosed European banks were suddenly and again near the brink. Which was more monetary: bank reserves that increased as the SFA declined, or the SFA collateral in repo? It is debatable, of course, but the events of that summer come down far more in favor of the latter.

In fact, the history of the M's had become quite tortuous across recent decades, a fact that the Federal Reserve admitted in the early the 1970's. The answer they proposed (somewhere in the 1980's) was this "holistic" regime of interest rate targeting, which essentially meant they cared nothing for the exact nature of money believing instead this ability to just direct the whole. It was and remains "shoot QE's first and let the market sort it out" kind of reasoning. It's at least plausible where money is money, but what happens at contradictions?

The most glaring was the fact that money no longer took its historic forms exclusively. In fact, money became something else entirely especially after 1995. M1 reached a peak in late 1994, then declined until 1997, stayed at that level until the dot-com recession, grew gently during it and immediately after before settling down again in 2005 until Lehman. There were, of course, enormous asset bubbles and credit growth not just in the US but globally and obviously financed by some "dollars" somewhere. M2 grew steadily starting in early 1995 but nothing so much as would suggest such extremes. M3, however, doubled from January 1995 to April 2003 (M2 doubled its early 1995 level by the end of 2006, taking two and a half years longer).

As much as that might suggest M3 was just a somewhat faster M2, M3 itself wasn't really M3, either, or at least not what it was purported to be. Ostensibly, the components were claimed as all of M2 plus institutional money funds plus eurodollar deposits plus repurchase agreements (repo). But in terms of the latter two, the Fed only collected very limited data. In eurodollars, they only counted specifically eurodollar deposits held by American bank holding companies (just the kind that were highly relevant in 1969, as if banking might not change again); in repo, M3 only captured transactions between the Fed and Primary Dealers. Even under those extremely narrow terms, that M3 grew appreciably faster than the rest of the M's suggested at minimum "something."

Instead, in November 2005, the Fed announced it was discontinuing M3 but really just the eurodollar and repo components. It would still report institutional money activity and balances as memorandum items. The reason they gave was "cost" and really the difficulty in figuring it all out. It was a huge clue about money alterations, and yet nobody wanted to see it; they still don't. The official statement reads that, "M3 does not appear to convey any additional information about economic activity that is not already embodied in M2 and has not played a role in the monetary policy process for many years." That last part is absolutely true, as "M3" was not mentioned at all in any of the FOMC meetings deciding monetary policy in 2005 or 2006 (I didn't check 2004 because I can easily guess it wasn't then, either). They had throughout those two years, however, started discussing housing more and more.

The first part of the official statement about M3 is also true, but more so in the lawyerly sort of way that infects any of these kinds of political processes. Measuring only eurodollar deposits among US bank holding companies is almost intentionally too narrow an objective, as is limiting repo coverage to the slightest sliver of the whole works. In other words, if the Fed were not to expand the definition of M3 to be something more meaningful and useful, it was correct not to bother. Their reasons even provided a useful service by ending the farce. That, however, is an entirely different matter than suggesting a "true" M3 would also have been not meaningful.

In November 2005, at the Senate hearings to confirm Ben Bernanke as Alan Greenspan's successor, Senator Bunning asked him a direct question about M3 (which, again, the Fed had already announced it was ending). Specifically, Senator Bunning phrased his question in a way that (likely) unintentionally let Bernanke off the hook, but in a manner that is revealing in this overall context. He asked the rationale behind the Fed's "decision to keep the M3 information from the public" to which Bernanke replied, in Clintonian fashion, "The Federal Reserve will not withhold the M3 date from the public; rather, it will no longer collect and assemble that information."

There was unusual honesty in that response, honesty that if the political processes of this nation had moved enough in 2008 would have buried him. In other words, he was saying "it isn't meaningful to the Federal Reserve" and that the orthodox treatment of money was all that was necessary for him and his agency to perform his duties as he saw it. M3 and "dollars" didn't matter to Ben Bernanke not because they didn't matter but because Ben Bernanke's view prevailed. That was disastrously incorrect as was proven beyond doubt less than two years later starting on August 9, 2007. It is being proven still to this day, with Janet Yellen standing in as the latest monetary agent to ignore money.

What should be common conception and easily apparent is just these basics; no need for extra-special treatment or understanding of exactly what goes on in central bank balance sheets let alone the rabbit hole of commercial eurodollar banks ("investment banks" as they were once called). The orthodox world has it all upside down; their view on money, base money and all that, barely grew up to 2007 especially after 1995. M3, which didn't capture but a fraction of overall eurodollar activities (and I am not even including dark leverage like credit default and interest rate swaps that function every bit like currency at times), jumped, while the "real" M3, the global dollar short, exploded. Thus, "money" was calm and tame while "not money" looked a lot like the asset bubbles did. Greenspan, Bernanke, et al., suggested that meant there was no money in asset bubbles when in fact there was no money in monetary policy.

Worse, however, what economists claim as meaningful money doesn't even fulfill the functions of money. Bank reserves, for example, are entirely financial and can never reach the real economy without bank intermediation. No person can walk into a Federal Reserve branch and withdraw from a "bank reserve" balance and then spend whatever you might get for conversion in real goods and services; bank reserves perform only a purely financial function. A eurodollar, quite on the other hand, is used all the time in the real economy here and especially everywhere else. The entire system of global trade, at the very least, depends upon them and nothing upon what is stuffed idle into the accounting conventions supply or absorbing "reserves." In short, eurodollars are more money than base money, yet the Fed has declared itself (damningly consistent) the country's monetary agent uninterested in all that.

This upside down nature even "works" in symmetrical fashion, which is really the whole point here. In other words, "not money" was exploding in asset bubbles and asset inflation while "money" did nothing, but on this side of 2008 (really August 9, 2007) "money" is exploding and "not money", though we can't know for sure because nobody in position to do so is interested enough to check, is disappearing at an increasingly worrisome rate. The world, world markets, and especially the world economy are once again following "not money" and do nothing like what all these bank "reserves" propose. All that has changed is the direction, leaving, again, breathtaking symmetry (I could start on the fractal nature of it all, but that's better left for another time).

It is so obvious that you would think that economists would be all over it; contraction in money supply, building deflation (not the good kind) and the synchronizing universal downbeat of the global economy is pretty much what monetarism was made for going back to Milton Friedman. But monetarism is really a political animal, leaving behind purely financial and economic tasks almost as soon as it assumed credibility and power. It has been corrupted into control and management, a soft version of central planning. To admit the eurodollar as money would be to completely upend all theories that allow(ed) Janet Yellen or Ben Bernanke to assert control. Control is predicated upon precision (quantity most of all; as in the "Q" of QE) of not just correlations but basic measurement. You can't stake a claim to monetary control of the economy if you are forced to admit you can't even define let alone measure money. Apparently it is better to suggest it isn't meaningful, even after it is proven, devastatingly and continuously, to be so.

One of these days, however, maybe sooner than anyone is prepared, the world will again catch on to money; and that will still be long before central bankers. A fitting tradition.

Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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