Repos and Eurodollars in Stealth Mode

The Bernanke era at the Federal Reserve is not off to a very good start if two of its primary goals are to become more transparent while at the same time shaking the "inflationist" label, rightly or wrongly earned after discussing the dropping of money from helicopters a few years back when there was talk of deflation.

The lack of transparency seems to have started last Thursday when this rather terse notice appeared on the Federal Reserve website. The shaking of the "inflationist" label, on the other hand, has everything to do with whether stocks are to housing as the 2002 deflation scare is to a deflation scare in the next year or two - there have yet to be any preliminary indications on this issue.




This announcement makes very clear that the Federal Reserve no longer intends to make available for public scrutiny the statistical data for repurchase agreements (repos) or Eurodollars, which, along with M2, large time deposits, and international money market funds make up the M3 total as shown in the somewhat old and blurry chart from the website of the Federal Reserve Bank of New York .



Why would they do such a thing with no explanation at all?

Economists with blogs have been mostly silent on this subject, the notable exception being Stephen Kirchner where we first learn the term "fever-swamp Austrians", apparently referring to the folks over at the Ludwig von Mises institute who feel that Austrian economics makes a bit more sense than a series of asset bubbles of ever-increasing diameter:

As Barry notes, this is the sort of thing that excites the tin foil hat brigade and fever-swamp Austrians, but I would suggest that there is a rather innocent explanation. Growth rates in broad money and credit aggregates tend to be dominated by trends in financial intermediation and thus have only a very tenuous relationship with monetary policy and even a somewhat loose relationship with economic activity. There is in fact no necessary connection between a central bank’s targeting of an official interest rate and changes in the money supply, although there is often a link in practice under current central bank operating procedures. Even under a system of free banking in which the money supply was market-determined, a central bank could still independently target an official interest rate (see Michael Woodford’s Interest and Prices for a more formal argument in this regard).

I’m much more sympathetic than most economists to the idea that money matters. Base money arguably has a neglected role in monetary policy transmission that is independent of the official interest rate and some of that role may also be reflected in broad money aggregates. However, it is mistake to interpret broad money and credit aggregates as being predominantly a function of exogenous monetary policy decisions. They have a much stronger relationship with individual portfolio choices and innovations in financial technology, in other words, capitalist acts between consenting adults. When the fever-swamp Austrians point to growth in these aggregates as being symptomatic of the supposed monetary depredations of the Fed, they are inadvertently condemning what are largely market-determined outcomes in relation to financial intermediation.

It would be interesting to hear the view of an economist who is less sympathetic about the money supply mattering ...

The Barry of course that Stephen in referring to is Barry Ritholtz over at the Big Picture who keeps cranking out post after post after post after post on this subject, getting the gold bugs, conspiracy theorists, and now fever-swamp Austrians all lathered up, after having been prompted by Toni Straka of The Prudent Investor who was understandably outraged by both the wording and possible implications of the Fed announcement.

All this commotion has gotten little attention from other econobloggers - Mark Thoma and William Polley, who previously seemed to be too busy grading papers to ponder the question, have promised to put down their red markers and offer an opinion.

Over at Economy.com (also known as Dismal Science Central), they had this to say:

Yesterday, the Federal Reserve announced that it will discontinue releasing the M3 monetary aggregate as of March 23, 2006. M3 is the broadest measure of money in the economy and includes all of M1 and M2, in addition to certificate of deposit accounts over $100,000, deposits of eurodollars and repurchase agreements. Measuring money growth as an impetus for inflation has fallen out of central bankers' favor over the past decade. With the evolution and expansion of financial markets across the globe, it has become measurably harder to control growth in money supply. Because of this, central banks have almost universally transitioned to targeting interest rates instead of money in their fight against inflation. The move to discontinue reporting M3 monetary aggregate data (though large-value CDs will continue to be reported in the Flow of Funds data), is largely operational, however, because M1 and M2 still give a well-balanced picture of the growth in money supply. Nevertheless, this confirms that that money supply measures are far from the most important indicators used in policy decisions.

As a non-economist who has read a little Milton Friedman, it is difficult to understand how the money supply does not matter. If price stability is the Fed's number one job and if "inflation is always and everywhere a monetary phenomenon", how can you fight inflation without a complete picture of the money supply?

Back in the Swamp

On the other side of the discussion is the always interesting view of Bill Cara who opines:

That folks tells me the rest of what I suspected was going down in mid-September when Greenspan summoned the top 15 banks to the NYC Fed offices. I believe Refco was discussed, and I believe Greenspan floated Ben Bernanke’s name by those bankers as a smell test, which he took back to the President, giving two thumbs up. But the big deal was the two changes in policy that the Fed has never disclosed to the public: (i) reflate, and (ii) drop the M3 because it is too obvious an indicator of reflation.
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You know, this stuff is awfully important to Mom & Pop. We need transparency. Not the joke played on us by government regulators, but true transparency.

A couple weeks ago I wrote in my blog re Refco that the VIP's in Washington -- if they really wanted to do a public service -- would be to ask Greenspan everything that happened in that mid-Sept meeting with the 15 biggest bankers in America, and now I think they should bring the bankers (not the oil men) to Congress, and get them to talk as well.

and this view from DailyKos:

To give some background, there are more Eurodollars out there than there are dollars in circulation in America. To stop counting Eurodollars is to stop counting an enormous percentage of dollar-denominated assets in the world. Hence, the relationship to the M3 monetary supply again.

At this point it is worth noting that America's trade deficit spiked to a new all-time record the exact same day as this Federal Reserve report. The coincidence can hardly be more obvious, since a huge trade deficit means more American dollars going overseas and becoming Eurodollars.

Most interesting of all was an exchange over at the message board with a name even longer than the name of this blog - The Epic American Credit and Bond Bubble Laboratory (TEACABBL) at Silicon Investor:

Not Elroy: Monetizing the debt cannot be hidden in M3, it would show up all the way down in M0. M3 is a pretty useless number, the Fed can't do much to influence it anyway, so its little more than busywork. They've got more important things to deal with.

Elroy: Utter nonsense. When the Fed bails Fannie Mae out with a $1 trillion interest rate swap, that will show up in M3 but not M2, M1 or MZM. All of the container loads of new $100 bills the U.S. is spending in Iraq will show up in M3 as soon as they are deposited in a foreign bank - but will not show up in MZM, M1, or M2 unless the money comes back to our domestic economy. Perhaps you should wonder why even U.S. based contractors are being paid with suitcases of $100 bills, when they would prefer the payments be made by direct deposit to their U.S. account.

Not Elroy: new $100 bills. That's MO. You're completely out to lunch on this.

Elroy: Let's review. New $100 bills inside the United States are counted in MZM. New $100 bills outside of the United States in Iraq are not counted - until they are deposited into a foreign bank, then they become M3. If the money is repatriated, they become MZM as you assume.

There is a reason why the U.S. military is paying contractors, even U.S. contractors, in Iraq with suitcases of $100 bills rather than direct deposits to their U.S. accounts as they wish.
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Currency is only included in money supply total when it enters circulation. This particular currency is entering circulation in Iraq. That is not even money until it becomes M3 in a foreign bank. Then becomes MZM when repatriated back to the United States.
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Currency is only counted as money when it enters circulation -- normally when it gets shipped to a bank, but there are exceptions, like Iraq.

Fascinating stuff!