The Sunshine Report

Sunshine Travel Log Blog – I Went Fishing And The Fed Slowed Money Supply Growth

Last week­end I went fish­ing in Tokyo harbor.

The below pic­ture is my friend Masura Ono with a really big fish that he caught on his boat. Ono-san is a famous lawyer in Tokyo. He is a senior part­ner at the largest law firm in Japan as well as a law pro­fes­sor at the Uni­ver­sity of Tokyo. But, most week­ends, Ono lives his dream which is to be the best fish­er­man in Japan.

OK…so we didn’t catch that fish when we went out last week­end. But we could have if we tried (I guess).

Instead, we went out on Ono-san’s boat (see below) and went on an eat­ing and drink­ing extravaganza.

Below are some pic­tures of the foods that we ate at lunch. The raw squid def­i­nitely reminded me of “Squid­ward” from Sponge Bob Square Pants.

While I was off in Tokyo boat­ing and fish­ing, the Fed­eral Reserve was qui­etly cut­ting back on the pace of mon­e­tary stim­u­lus. The rate of increase in money sup­ply growth (as mea­sured by sea­son­ally adjusted M1 and M2) has notice­ably slowed and a rough mea­sure of the Fed­eral Reserve’s bal­ance sheet has actu­ally shown shrink­age in recent weeks. The size of the Fed­eral Reserve bal­ance sheet is a proxy for qual­i­ta­tive eas­ing while the rate of growth in money sup­ply is a proxy for quan­ti­ta­tive easing.

It isn’t sur­pris­ing that the Fed­eral Reserve is slow­ing down given the tor­rid pace of mon­e­tary eas­ing that took place from Sep­tem­ber through Decem­ber. The Fed­eral Reserve has to walk a mon­e­tary tightrope; too lit­tle eas­ing and the US could tum­ble into uncon­trolled defla­tion and a depres­sion while too much eas­ing will result in hyper­in­fla­tion and the destruc­tion of the Dollar’s posi­tion as the world’s reserve currency.

Set forth below are some graphs that illus­trate the slow­down in mon­e­tary eas­ing by the Fed­eral Reserve. The source for all data was the Fed­eral Reserve’s weekly reports (Fac­tors Affect­ing Reserve Bal­ances – H.4.1 and Money Stock Mea­sures – H.6).

As the below graphs illus­trates, while I was off gal­li­vant­ing in Asia, the Fed­eral Reserve stopped increas­ing M1 and actu­ally caused the amount of money (as mea­sured by M1) to drop. M1 is the Fed­eral Reserve’s most nar­rowly defined mea­sure of money sup­ply and is basi­cally cash and near cash equivalents.

The pace of growth of M2 (a more broadly defined mea­sure of money sup­ply that includes most types of bank deposits) slowed to a more nor­mal pace of mon­e­tary eas­ing in January.

And, the size of the Fed­eral Reserve’s bal­ance sheet actu­ally shrank in early 2009.

The mon­e­tary data indi­cates a pause in the fre­netic pace of Fed­eral Reserve activity.

Such pause doesn’t indi­cate restric­tive mon­e­tary pol­icy; quite the con­trary, mon­e­tary pol­icy con­tin­ues to be extremely accom­moda­tive and expan­sion­ary. The pause prob­a­bly indi­cates that the cur­rent phase of mon­e­tary stim­u­lus ran its course and the Fed­eral Reserve needs to reassess its cur­rent posi­tion and the effect of the stim­u­lus that it injected into the finan­cial sys­tem before doing more.