Sunday, March 18, 2012

Exponential Growth in the Adjusted Monetary Base: What Is It Telling Us?

Updated September 27th, 2012

As my regular readers know, I like graphs.  I guess it's the scientist in me.  To me, graphs are a very simple way of explaining things, particularly things that are transpiring in the economy, particularly when comparing the present to the past.  I source quite a number of my graphs from FRED, the  Federal Reserve Economic Data, a database which is maintained by the Federal Reserve Bank of St. Louis.  This database contains data on more than 41,000 time series on many aspects of the economy, some mainstream and some very rarely used.  FRED's data is gleaned from the Federal Reserve, the United States Census Bureau and the Bureau of Labor Statistics among other sources 

I was researching information from FRED for a future posting and stumbled on two graphs that I found, one of which is the one of the most shocking graphs that I have seen.  Before I show you the graph, let's me supply you with a bit of background information so that you can put what you are seeing into context.

Central bankers often use the term Adjusted Monetary Base (AMB).   The Adjusted Monetary Base is defined by the Federal Reserve as "...the sum of currency (including coin) in circulation outside Federal Reserve Banks and the U.S. Treasury, plus deposits held by depository institutions at Federal Reserve Banks.".  It is basically M0 which is the narrowest definition of money and is the ultimate source of the nation's money supply.

Now, here's the first of the promised graphs from FRED showing the growth in the Adjusted Monetary Base since the beginning of 2009:

Certainly, it looks like the AMB has grown; it started at $1.59 trillion in early 2009 and grew by $1.14 trillion or 71.7 percent to $2.73 trillion at the beginning of 2012.  That's a very steep growth curve but things get worse when we look at the next graph which shows the growth in the Adjusted Monetary Base back to 1920:

Over the past century and certainly since prior to the Great Depression, the Fed's Adjusted Monetary Base grew at a slow, steady rate with a slight increase in the growth rate during the period from 1990 to the beginning of the Great Recession.  In the 1960s, the AMB grew by 1 to 2 percent per year, in the 1970s by 6 to 8 percent per year, in the 1980s by 6 to 10 percent per year and in the 1990s by 5 to 10 percent per year.

Here's a graph showing the annual percentage growth in the Adjusted Monetary Base since 2000 noting that the data shows growth from January 1 of a given year to January 1 of the following year:

Notice the massive growth in the AMB in 2008; the Adjusted Monetary Base grew from  $851 billion to $1730 billion in just 12 months, a 103.2 percent increase.  In 2009, the AMB grew by 16.2 percent, nearly triple the average annual growth rate of the previous decade, in 2010 it grew by a very modest 2.3 percent but that changed in 2011 when the AMB grew by 28.7 percent or $591 billion from $2.057 trillion to $2.648 trillion, a growth rate that is roughly four times the average annual growth rate of the previous decade and the second highest annual growth rated since 1920 by a wide margin.

The expansion in the Adjusted Monetary Base since 2008 is unprecedented.  If we look at another crisis of confidence in the American economy, after the attacks of September 11th, 2001, the AMB grew by only 9.2 percent in 2001 (for the entire year) and 6.8 percent in 2002, growth rates that were on par with the previous two decades despite the severity of the crises.  

It is generally believed that rapid growth in the monetary base has preceded accelerated inflation in the United States and other countries.  The massive growth is related to the "printing" operations carried out by the Fed during the bailout/rescue operations of 2008 - 2009.  The increased "printing" operations in 2011 were most likely related to the Fed's quantitative easing and "Twist" programs, both of which have been only marginally successful considering the risk to the economy over the long-term. 

I have a couple of questions.  Is the current level of the Adjusted Monetary Base the new baseline for the economy?  If it is, what will happen if all of those electronic digits sloshing around in the system create inflationary pressures, asset bubbles or other unforeseen issues?  If this is not the "new norm", what effect will contracting this vast amount of money lurking within the system have on the economy?

As I've said before, economics is the furthest thing from a science.  The impact of monetary policy have far-reaching impacts that are totally unpredictable and which cannot be foreseen by those that we are "trusting" with our future.  For one, I find the massive and rapid expansion of the adjusted monetary base a very frightening issue.  Only time will tell if my feelings are justified.


  1. An uneducated view.

    I read that Fed reserves, I think, were a key number also as against money supply.

    Whatever the name of the indicators what is key is money making out into the economy.

    Hence M0 may not in itself be the big cahuna, especially if bank reserves have been heavily boosted to stop the interbank market freezing up.

    Perhaps money velocity?

  2. Replies
    1. I have used the original graph, and I have even got 109% if you do the calculations with respect to May 2009, and not January.

      Starting from your graph (not to mix the numbers), one can make a discounting curve. Say one has $203 in 2008. Their NPV, using this discounting curve, will be $100.

      Now, let's take the EUR as reference, in a cross currency swap in 2007: 70 EUR, against 100 USD. The historical exchange rate for 2007 was 0.7 and for 2008 was 0.65. This means that, if
      1.the notional = 100 USD. I'll receive 100 USD in 2008, and their value would have been 100*0.65=65 EUR. I have lost 5 EUR
      2.the notional = 70 EUR. Invested in 2008, they would have the present value of 100/203=49 USD. Since I have to give back 70 EUR, I transform my 49 USD*0.65 and get 32 EUR. I have lost 70-32=38EUR=\=5EUR

      If I am in 2007 and want to model 2008, how should I model the discounting interest rate and the EUR/USD FX: IR(2008)=130%/year and FX(2008)=0.65 for the 2008 cash flows in USD?

  3. Although I'm concerned about pumping up the money supply, I wonder whether this is just partial replacement of the wealth that was destroyed in the recession. I wonder what the capital positions of the banks are, and whether QE1 and QE2 were largely to help them get on a firmer footing so they could lend again, but with better judgment this time.

    The most important issue is stopping the inflationary behavior before a bubble occurs, while avoiding sending the economy into recession again. (My layman's guess.)

  4. This comment has been removed by the author.

  5. If Congress enacted a bi-metallic standard using gold&silver...the Feds would not have the ability to steal from people who save!

    1. I've written an analysis of the advantages and disadvantages of the gold standard here. But the pithiest argument came from a commenter on another blog. Let me paraphrase:

      "So if I want to buy a house, I have to wait for someone to dig up some metal before I can have a mortgage."

      In a time when we have so many sources of wealth, it's very arbitrary to pin the money supply and the defacto limit of wealth to two metals.

    2. "In a time when we have so many sources of wealth, it's very arbitrary to pin the money supply and the defacto limit of wealth to two metals."

      You clearly dont understand deflationary pressures on prices and how they encourage efficiency and real growth. Do some research before spouting some limited money supply BS...

  6. This silly argument again?

    A rebuttle from someone with actual qualifications:
    "The Monetary Base is exploding. So what?"

  7. Bernanke recognizes that he is the only actor in the economy that doesn't have his hands tied. He did what he could to rescue the economy but there is only so much that monetary policy can do. Fiscal policy stimulus - real stimulus not neutralized by the contraction of local and state spending - is what was needed. Bernanke did the only thing that he could while Republicans stalemate fiscal stimulus.

  8. Milton Friedman used to say that inflation would follow expansion of money after 6 months. Maybe monetary base has increased as much as money circulation has decreased?

  9. "Bernanke did the only thing that he could while Republicans stalemate fiscal stimulus."

    Typical lib/neocon blame game... talk real critical analysis with empirical facts and maybe someone educated will listen to you.

    Who in their right mind would want monetary expansion? Like a share of stock the more money that is printed the lower the purchasing power of your dollar. I dont want my purchasing power diminished!!

    Bankruptcy court exists for a reason, weed out mal-investment... just wait to see what is coming and you'll wish you lived through 2008 again.

  10. The simple arguments don't always seem to apply to what appears to be complex

    1) Gold and silver … NO ! … we can't limit the supply of money …
    ( assets MUST back currency … inevitably trust will devolve … and … )

    2) Monetary expansion is necessary in times of Recession.
    ( what this denies is the truth that inflation literally robs, steals from those who can least afford it … while … inflation enriches those in charge of the expansion )

    Take the medicine … Our "modern" … our "civilized" economy … is not truly either … nor is it truly "complex" … money is something valued (representative of value) that can be used in exchanged for something else, product or service, of value.

    Gold and Silver have value, so does oil, so does soil, crops, water …

    All the resources, including human, can … voluntarily … be used as assets … backing the creation of "currency".

    Loss of trust in those who "print the currency" … because they operate in secret … and what we do know … is that they steal … and cover their mistakes and lies … with taxes from those who are not responsible … save that they don't vote or rise up and Revolt …

    The trust is gone … or it should be … and we can have a transparent currency creation policy, monetary policy, fiscal policy.

    Let's agree and do it … otherwise … all these words … do not seem to have … over the nearing 250 years of our country unless you count to Jamestown … these words do not seem to have changed the fact that Power claimed the land and resources and indebted the rest to play / pay by their rules.

    That is how it is.

    The banks are run more and more without a check and balance.

  11. Monetary base is merely half of the equation my friend. Money multiplier - i.e. Velocity - is the other. Velocity has plummeted which is why core inflation is nowhere to be found.

  12. It's time to get rid of corporate and banking regulations. Countries are in the way.

  13. Interesting points regarding the importance of velocity to inflation but it would seem to me that changes in velocity would recover much faster than the Fed's deflationary response(particularly in the United States with an aggressive consumer culture and easy electronic transfers).
    If the base really is as large as the author suggests an economic turnaround (with a corresponding increasin in V) could leave us flatfootedly chasing inflation at the moment when consumer confidence is finally daring to improve.

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