The Mythical Printing Press Belongs Somewhere Outside the Fed
AP Photo/LM Otero, File
The Mythical Printing Press Belongs Somewhere Outside the Fed
AP Photo/LM Otero, File
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Was it worth saving a single million? There was a time period when such a sum was significant. That time is beyond the memory of anyone alive. In the years since the Great Inflation of the seventies, millions had given way to billions as any standard for “big.” Thus, sitting inside the hallowed halls of Congress in November 2005 and using a million-dollar savings as an excuse, there must’ve been far more than that to justify the more obvious flippancy.

This was not a per-institution kind of deal, either. According to a Federal Reserve spokesperson, the entire depository industry was about to be spared a collective million dollars of expense as nothing more than being set free from filling out tedious bureaucratic forms. On the opposite side of the paperwork, the central bank itself was counting on half a mil in its own savings.

Texas Congressman Ron Paul wasn’t buying this. Introducing the Sunshine In Monetary Policy Act on March 7, 2006, the well-known central bank critic smelled a rat. The Fed planned on terminating the publication of M3 over a measly five hundred thou? Oh, the irony.

“Discontinuing reporting M3 will only save 0.00000699% of the Federal Reserve Board's yearly budget. This savings hardly seems to justify depriving the American people of an important measurement of money supply, especially since Congress has tasked the Federal Reserve Board with reporting on monetary aggregates.”

The stench Congressman Paul collected in his nasal passage, however, wasn’t the one he always believed it had been. By eliminating the broadest money supply statistic, monetary authorities, he said, were up to no good about “fiat” currency.

In March 2006, the Fed did indeed toss M3 onto the historical scrap heap. It barely rated public notice (outside the gold community); in Congress, Ron Paul’s proposed bill attracted a meager three co-sponsors and died almost immediately following its introduction. The matter was never taken up any further.

Back in November, at Bernanke’s confirmation hearings for his nomination to lead the Federal Reserve, the nominee had already plainly stated the rationale. The central bank wasn’t hiding a thing; as he answered in one question from Senator Jim Bunning, “The Federal Reserve will not withhold the M3 data from the public; rather, it will no longer collect and assemble that information.” Why?

“The benefits of continuing to publish M3 appear to be minimal, because M3 has not been actively used in the formulation of U.S. monetary policy and, at least within the Federal Reserve, has not been found to have much value for economic forecasting.”

How worthless had it been? Enough to go ahead and save the depository banking system a measly million dollars in red tape.

Fed critics like Paul simply missed more evident clues in what the future Chairman was disclosing. Rather than get worked up over “fiat” money, there had been a whole lot more to the story, and a relatively easy connection to what was then a raging housing bubble across the US, and an even bigger monetary explosion throughout the rest of the world.

And all of it in “dollars.”

To begin with, what had been included within M3 that so irked these people? The rest of M2, obviously, but then added to these more traditional deposit types of money were things like large-denomination time deposits, eurodollar balances, and repurchase agreements reported by US bank dealers. The last one otherwise known as repo.

Now we’re getting somewhere. Had Congressman Paul known more about the central bank’s tortured history with the last two items on that list, perhaps he could have used his opportunity to go further beyond “fiat” just as the housing bubbles destructive tendencies were being exposed.  

The Federal Reserve all the way back in the seventies, right in the thick of the Great Inflation, mind you, was having a whole lot of trouble keeping track. Realizing in the early part of the decade that M1 and even M2 were likely obsolete, the idea was to develop a more comprehensive M3 so as to make sense of the monetary world undoubtedly responsible for out-of-control consumer prices. 

This is the key element to the Great Inflation which needs to be revised, though it should’ve been dealt with as it happened. All the information was available.

What had been lacking was the frame of reference to interpret the data and figures. More than anything, a failure of imagination combined with bureaucratic institutional inertia. On the subject of repo alone, there was a great deal of effort put into finding some answers way back when.

In September 1979, as one example, Norman Bowsher of the Federal Reserve Bank of St. Louis had put together a neat synopsis of the problem. Not a new development by then, but a discrepancy that demanded reply when none seemed easily forthcoming after looming over the entire decade. The issue was demand; specifically, money demand.

Using the measurements available at the time, M1 and M2, staffers and Economists just couldn’t make sense of them. Time and time again, their statistical models depicting money demand functions kept coming up with estimates that were substantially higher than what ended up occurring within the monetary system. Estimated demand for liquid deposit balances, for one, would regularly come in six, seven, sometimes eight percent greater than the actual growth in money demand for those monetary types.

These were significant misses.

The inconsistency, as Princeton Economist Stephen Goldfeld had investigated in 1976, was “missing money.” Except, the money hadn’t actually been missing; it just wasn’t included in the concepts that central bankers were using. The real world, the actual banking system, had years before turned to different kinds to accomplish real world tasks, confounding the official classifications.

Among the chief violators was this thing called repo. According to Bowsher’s estimates, the amount of volume in the repo market, so far as researchers could tell from limited surveys of some participants in it, at the end of 1970 there had been something like $2.8 billion; a not insignificant number, but hardly game-changing.

At the same time consumer prices would truly spiral out of control, however, the repo market would experience dizzying levels of rapid growth. By 1975, that near-three billion had become more than fifteen. By June of 1979, a whopping $45 billion – back when billion had meant something.

There was no doubt this was meaningful, but what had it truly meant in terms of monetary conditions? Start with the problem interpreting the appearance of each transaction as it looked from the outside; for the most part, this seemed to be nothing more than a redistribution mechanism for existing reserves, particularly when repo was conducted on a strictly interbank basis.

In such a setting, it would merely be one bank transferring funds to another. To count this in a monetary aggregate would be double counting, one packet of funds being moved from place to place getting counted in each one. But it wasn’t necessarily the same when introducing non-bank participants – and then mixing the whole lot of them together. Though there was a link to maybe initial deposits of cash, what happened when non-banks (like large corporations, or municipal governments) began to regularly use repo and further contribute to what was being called “liability management?”

This was nothing more than an unnecessarily fancy term for what we today call wholesale money. The textbook convention on banks is the depository model; a bank receives cash from customers and makes loans (multiples of cash) based on its receipts. Liability management, or wholesale, was when banks might instead obtain funds in these other, shadowy ways; from repos to federal funds to that other thing called eurodollars, securing financing (using securities as collateral) for investment positions on an open market for…something that sure looks monetary in nature.

In other words, reimagining what can take place on the liability side of any depository’s balance sheet; its money side.

On the other side of repo, in terms of cash lenders, that’s ultimately what it came to resemble. A demand deposit had also come to be thought of as a form of money decades before after having been denied that status initially, and here was the repo market, as eurodollars, accomplishing something similar. In the seemingly ancient words of Bowsher:

“Preliminary analyses suggest that the apparent shift in the money demand function would have been somewhat smaller if RPs [repo] are included in the stock of money. The evidence does not settle the conceptual issue of whether RPs are money, but the studies do provide some empirical support for including RPs in the definition of money for policy purposes. Even if RPs are not judged to be money, they are closer substitutes to it than other near monies and help explain the problems in estimating the money demand function.”

In other words, since repos were being used outside the monetary definitions of the time to do real world things the question was primarily how to account for them. Some were eventually stuck in an expanded M3 definition, acknowledging both the repo market’s ultimate usage as well as the difficulties in deciding exactly what these things do, what things are done with them, and where all that might happen.

As a result of the numerous complications, Bowsher essentially asked:

“Everything else being equal, the pronounced expansion in RPs has stimulated total demand for goods and services. Because of data limitations and many offsetting impacts, however, knowledge of the net extent of this stimulative effect is limited. It is unsettled whether analysis of the impact of RPs would be improved by considering them (or a portion of them) as money or as a force affecting the demand for money.”

This open question, however, wouldn’t be completely settled until November 2006 when Ben Bernanke sat before Congress and told them the Fed hadn’t used M3 in a very long time and therefore it wouldn’t be any skin off his nose if they just stopped collecting the information altogether. Might as well try sell it as saving the institution a half million, and the depository system only twice that, rather than face up to the alternative.

And what was that alternative? To definitively answer, once and for all, the repo-as-money debate. In order to do so, however, the Fed’s enormous staff of Economists realized they would also have to admit to the “missing money” and how it hadn’t been solved in so many decades since it went missing.

Which, in fact, Ben Bernanke did – as had Alan Greenspan. The problem, therefore, was that no one seemed to listen; or, hadn’t appreciated the real significance. Ron Paul worried about the Fed hiding “fiat” money printing when here was Bernanke effectively telling him, point blank, we ain’t the ones fiat-ing.

You want money, ask the banks themselves. Here’s now-Chairman Bernanke discussing Goldfeld’s “missing money” and what that had meant for monetary policy through the decades in a truly significant speech delivered in November 2006, just a year after his nomination. No one noticed this one, either, certainly not in the same fashion as his vastly more famous, and infinitely more disingenuous, “we have a printing press” passage from 2002.

“As I have already suggested, the rapid pace of financial innovation in the United States has been an important reason for the instability of the relationships between monetary aggregates and other macroeconomic variables. In response to regulatory changes and technological progress, U.S. banks have created new kinds of accounts and added features to existing accounts. More broadly, payments technologies and practices have changed substantially over the past few decades, and innovations (such as Internet banking) continue. As a result, patterns of usage of different types of transactions accounts have at times shifted rapidly and unpredictably.” [emphasis added]

The “maestro” Alan Greenspan had used the term “proliferation of products” six and a half years before for this same thing; banks do the money while the Fed does other things. Therefore, fiat or not, the mythical printing press belongs somewhere outside the DC offices of the FR Board, or the NYC epicenter of FRBNY’s situation on Liberty Street.

For the coming crisis, already unfolding in late 2006 (the eurodollar curve, for example, would invert just a month after this particular speech), the repo market blindspot was an incredibly unforced error of gratuitously overconfident blowhards.

Bowsher had framed the question all the way back in 1979, and over the intervening 28 years so-called monetary officials hadn’t just failed to answer, they stopped caring altogehter. They no longer wanted to much investigate. Bye bye M3, we hardly knew you.

Worse, even after the 2008 crisis, which pivoted entirely on repo and collateral (see: Lehman emails I highlighted in last year’s final columns), the Fed still makes no effort to discover what’s really up with it. Introduced to repo, as well as eurodollars, a very long time ago, what’s the excuse for this?

A pitiful million dollars? No. The central bank doesn’t do money, doesn’t care much about doing money, and instead does something surprising to most people. There are quite a few today, some influential, who still point to M1 or M2 and believe they are looking at substantial, useful figures. Even the Economists who worked a long, long time ago at the Federal Reserve knew they’d be wise to stop.

The issue is more knowledge versus less knowledge. It isn’t any better over in Europe or in other geographical locations in which wholesale money has become standard, common practice. Across the Atlantic, as I also noted late last year, the Europeans have at least taken more of an interest in these “securities financing transactions” (mostly repo, but also including more recent proliferations of financial products).

Yet, even they are in no hurry to do much about it. Why?

Quite simply, this puts the current central bank model out of business. What use is it in such a context? The question answers itself given the history of these last few decades of one monetary disaster after another. When you don’t know what you’re doing, fake it.

What’s really interesting about the middle 2000’s is how brazen they were about being uninformed. Bernanke wasn’t lying to Congress, nor was he attempting to hide anything; on the contrary, he was openly flaunting his ignorance and putting it on display for anyone to see provided they didn’t get lost chasing “fiat” instead of repo, eurodollars, and wholesale.

He basically told the world they really had no idea what they were doing. More than that, he was weirdly proud. While the Europeans have put some minimal effort into a repo investigation begun more than forty-five years ago, and still unfinished, the Federal Reserve, what people presume as the dollar-system’s central agent, continues to make operation in repo more difficult than it needs to be because the central bank model doesn’t factor repo into it.

In that, it doesn’t factor money at all.

Only such a neglectful institution would use something like QE to strip the thing bare and let the rest of the world, on its behalf, call this money printing.

Jeffrey Snider is the Head of Global Research at Alhambra Partners. 

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