Saturday, February 28, 2009

Bank Credit Down-Money Supply Up

One interesting fact in this weekäs U.S. monetary reports is that even as money supply increases, bank credit is contracting. While M2 in the week to February 16 is up 1.55% compared to the monthly average in December and while MZM is up 2.7% during that period, Bank Credit is down 1.8% in the week to February 18 compared to the monthly average in December. Those changes might seem small, they are in fact large considering how we are only talking about roughly 2 months.

Given how money creation these days is processed mainly through the banking system, it might appear puzzling that bank credit could contract even as money supply increases.

One possible explanation would be that it reflects increased printing of paper and metal money, also known as cash or currency in circulation. But while currency in circulation has indeed increased rapidly, 2.7%, but as it was only about a tenth of these aggregates to begin with, that is nowhere near enough to explain it.

Another explanation would be that money creation has occurred outside bank
balance sheets, through money markets. But while big increases in holdings of Institutional money funds explain some of the strong MZM growth, that is not enough either.

So, to find out the main explanation you have to look more closely at the different items of the bank balance sheets. As it turns out, it is 3 items that can explain the above apparent discrepancy.

First of all, while deposits included in M2 and MZM is increasing, large time deposits (which is not included in either, but was included in the now discontinued M3 statistics) have declined in value by almost $50 billion.

Secondly, "net due to related foreign offices" (borrowings from foreign offices) is down $145 billion. That number increased dramatically during 2008, but has now started to shrink.

The third item that is shrinking on the liability side is "other liabilities". It is not immediately apparent just what that is supposed to mean, but if you scroll down, you can see that it means mostly "Derivatives with a negative fair value", meaning losses on derivatives that banks hold. That too increased sharply during 2008, only to fall in recent weeks.

The first factor simply reflects decreased customer preference for large time deposits relative to other accounts. The two latter factors reflects that while people are depositing more, banks at this point prefer to (or are forced to) use those funds to pay off debts to foreign offices and settle the implicit liabilities in these derivative contracts instead of lending more money.


Blogger Celal Birader said...

So bank de-leveraging continues, it would seem.

I also wonder what these "debts to foreign offices" might be? Are these primarily loans taken out in Yen to run the carry-trade which are also now being unwound ? Or something else ?

12:59 AM  
Blogger Blurry said...

Bank deleveraging would lead to a contraction of the money supply (due to fractional reserve banking) - so should central banks intervene to stop this?

But even if we were to target a particular money supply measure, it's hard to intervene due to the time lag involved.

8:44 AM  
Blogger newson said...

to stefan:
bottom line, is it imaginable that a rising price environment could come about with money supply rising but bank credit falling?

commodities look set to fall further to 1999 levels

11:31 AM  
Blogger stefankarlsson said...

Newson, yes it is certainly imaginable that rising prices could be combined with rising money supply but falling bank credit. That would in fact be the most likely scenario, though it is not a certainty to the extent that declining bank credit reflects falling velocity

11:39 PM  

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