No, There Is Nothing Strange About The Surge In The Adjusted Monetary Base In The Past Two Weeks

Tyler Durden's picture

In the past two days, both UBS Andy Lees, Dennis Gartman (of the world renowned Gartman ETF which is just off its all time lows), and now even Art Cashin, have been stumped by the "dramatic" increase in the M2 and the Adjusted Monetary Base. To wit, per Art Cashin's take of Andy Lees' recent note: "US M2 money supply surged by USD88.7bn for a 2 week gain of USD165.6bn without any compensatory rise in the Fed’s balance sheet. Andy goes on to ponder whether this has been conscientious attempt by the government to beef up as QE2 ends. There is some evidence but not fully conclusive." Actually no, there is no evidence, and unlike many other instances of shadiness involving the Fed, this is not one of them.

Here is some more from Cashin's note today that explains the confusion:

Trading pit veteran, Dennis Gartman, took note of the continuing surge in the monetary base (or stock).

Finally regarding “economics,” we’ve included a chart at the bottom of p.1 this morning of the Federal Reserve Bank of St. Louis’ adjusted monetary base. Once again we shall refer to this figure as the “stock” from which the broader “soups” of monetary aggregates are derived. As is clear, the base is still expanding despite the ending of QE II at the end of June. The Fed is not contracting the base, and it will not do so, but certainly we can expect the growth of the base to halt rather quickly for right now it is “hugging” the green line in the chart which is 30% simple growth in annualised terms. That is obviously unsustainable… impressive perhaps… but unsustainable.

It is very important to know what the components of base are. If a large part of the growth is cash (currency), as it was a year or so ago, that is deflationary (that’s what led to QE2). We asked our old pal Dennis if he had examined the components. This was his reply:

Since May of ’10, the adjusted base has risen from $2.000 trillion to $2.722 trillion, a gain of 36% and $720 billion. The currency component of M1 has risen from $880 billon to $965 billion, an increase obviously of “only” $85 billion, so it is clear that nearly ever single bit of the increase in the base has been high powered money: real purchases by the Fed of agencies and Treasury securities from fed dealers. IN fact, in the past three weeks, the currency component has fallen ever so slightly, while the base has gone on to new highs.

The sharp spikes in money bear careful watching. It is not dangerous of and to itself but has the potential to explode into
an inflationary fireball. That would occur if it suddenly gained velocity (lending and spending). Let’s keep an eye on
monetary velocity.

Lots of wordy speculation there. Here's what actually happened, and in this one case there is absolutely nothing ulterior.

Simply, between July 1 and July 13, as we pointed out before, the Treasury's cash balance plunged from $130 billion to $39 billion. This is cash that is held at the Fed, and represents a liability on the Fed's balance sheet under the "U.S. Treasury, general account" entry. This can be found each week int he Fed's H.4.1 update. And while the Fed's assets have been flat now that QE2 has ended, the only plug to compensate for this major move is to adjusted the Excess Reserves held at the Fed, which as everyone by now knows is the most abstract concept known to man, and is much more of a Fed balance sheet plug than actual representation of cash (hard or electronic) held in bank vaults.

Anyway, since the Adjusted Monetary Base fluctuates exlusively due to fluctuations in the Fed's Reserve balance, the rapid drop in Treasury cash is what prompted reserves to surge even without any change in assets whatsoever.

This can be seen on the chart below, which shows the balance of Fed reserves since 2010.

What are the implications: simply, that next week when $66 billion in new bonds settle we will see a drop in both the M2, the Adjusted Monetary Base, and most importantly, the Fed's Reserve Balance will drop by a comparable amount. The irony is that on a synthetic basis, as the Treasury runs out of money at an ever faster rate courtesy of increased cash burn due to not rolling bills, the transposition into the monetary base is an increase in actual 1s and 0s in bank vault currency. And vice versa.

The truth is that since the Treasury needs to keep at least $10 billion in cash at any moment, there is both a lower and an upper bound as to how much cash can fluctuate in the Reserve balance account, and thus Adjusted Monetary Base, on a weekly basis.

Regardless, readers now know, and don't have to speculate, why the surge in the monetary base in the past two weeks happened, and why there is nothing really ulterior about it.

As for those looking for Fed shadiness, look no further than the Fed's "Other Assets" which last week hit a fresh all time high of $136 billion, and which still nobody really knows what they are.