Commercial Banks' Excess Reserves, M1, and the Monetary Base: Why Prices Are Rising Slowly
Dec. 22, 2009
Prices are not going up in recent months, if we use the Median CPI. They are flat. They are going up if we use the CPI. November 2008 to November 2009, the CPI rose by 1.8%. The Median CPI rose by 1.3%.
There is no price deflation. This is evidence that the deflationists have once again misforecast the coming change in consumer prices. This has been true ever since 1955. That year's 1% increase was the only exception after 1938. Deflationists predict falling prices. Their prediction is wrong. So, they predict deflation again.
They never fess up -- none of them. Ever. Not "Mish" Shedlock (a newcomer -- five years). Not Rick Ackerman (20 years). Not Robert Prechter (30 years). Especially not Martin Weiss (27+ years -- back to 1967, if we count his father, J. Irving Weiss) -- although he finally switched this fall to predicting inflation. They never say, "Yes, I predicted deflation last year. Also, the year before. And the year before that. I was wrong every time. Here is why I was wrong last year. Here are links to each of my explanations over the past (X number) of years for why I was wrong. Here is why I will be correct this time. You'll see. Trust me."
Deflationists in the hard-money camp would like to have an explanation of cause and effect in pricing that conforms to some theory of economics: Keynesian, Chicago, supply-side, or Austrian. They don't have one. In over 40 years, they never have. (I am unaware of any hard-money deflationists prior to 1967.)
Prechter invokes Elliott Wave theory, which has no theory of economic causation or pricing -- only a series of arcane charts that supposedly allow the skilled user to predict stock market changes. It surely has not worked for Prechter with respect to consumer prices and the price of gold. Prechter at least is consistent to this extent. He predicts a falling price for gold, which is consistent with long-run deflation. His hard-money deflationist peers predict a rising price of gold, which makes no sense. I have written about this repeatedly.
http://www.lewrockwell.com/north/north497.html
http://www.lewrockwell.com/north/north680.html
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Neevertheless, their joint 54-year track record of complete failure to predict consumer prices the following year still persuades a never-ending stream of investing newcomers, all of whom are ignorant about economic theory, modern American price history, and banking.
WHY SO LITTLE PRICE INFLATION?
There has been no serious price inflation this year, despite an increase of a trillion dollars in the FED's monetary base in late 2008. The inflationists have an answer: excess reserves at the FED that have been deposited by commercial banks. This answer is consistent with all schools of economic opinion, all of which explain fractional reserve banking process with the same conceptual tools. For a standard account, see Modern Money Mechanics, published by the Federal Reserve Bank of Chicago. I have posted it here:
The argument is easy to make: excess reserves are not lent into the money markets. They are sterilized. This has exactly the same effect as an increase in the reserve requirement by the Federal Reserve, which is deflationary in the absence of an increase in the monetary base. This is standard analysis found in any money and banking textbook, including Murray Rothbard's book, The Mystery of Banking. There is nothing novel here.
The charts are consistent with the inflationists' answer.
The Federal Reserve Bank of St. Louis publishes the statistics on excess reserves. Here is the latest chart.
This $1.1 trillion in excess reserves is what is offsetting the growth in the Federal Reserve's monetary base.
The St. Louis FED also publishes a chart on the adjusted monetary base. Here is the latest chart.
Notice that the $1.1 trillion increase in excess reserves is in the same order of magnitude as the increase in the adjusted monetary base: from a little over $800 billion to $1.8 trillion.
I think any rational economist who looks at these figures would say that the increase in commercial banks' excess reserves offset the increase in the monetary base.
Then we look at the chart for M1. You can monitor it here.
Then there is the M1 Money Multiplier. The chart is here.
For a presentation by an Austrian School economist, see this article by Robert Murphy. This was a follow-up to an article he wrote last July It was a critique of Mike "Mish" Shedlock, whose blog site defends the idea that a great price deflation is coming. Both articles were published on the Mises Institute site. Dr. Murphy is the author of two study guides, one on Mises' Human Action: A Treatise on Economics and the other on Rothbard's Man, Economy, and State: A Treatise on Economic Principles. Both of these are published by the Mises Institute. When the Mises Institute publishes an economist's detailed exposition of the meaning of the two most important treatises on economics ever written from the Austrian economic viewpoint, we can be sure that this economist is an Austrian School economist.
Dr. Murphy is the author of the introductory book on economics, The Politically Incorrect Guide to Capitalism. He is also the author of The Politically Incorrect Guide to the Great Depression and the New Deal. In short, Dr. Murphy has the ability to apply Austrian economic theory to the economic system. He understands economic cause and effect.
I will add this. Anyone who publicly takes on Dr. Murphy to prove that he does not understand how the banking system works is in danger of biting off way, way more than he can chew.
Mr. Shedlock has decided to show the world that Dr. Murphy doesn't understand economic cause and effect.
MISH SHEDLOCK IS NO AUSTRIAN SCHOOL ANALYST
The reader may not understand that Mr. Shedlock is a former photographer. He got into the blogging world a few years ago. He is not an economist. His expositions show no signs of any school of economic opinion. He does not apply the theoretical arguments of any school of economic opinion. He offers lots of observations, but they are not integrated into any systematic economic theory. He has not written an economics book. He has not published anything on the Mises Institute's site, or in The Freeman, or in any journal of Austrian economics.
He is in no sense an Austrian School economist. He is in no sense an economist. An economist has a theory of economic causation. Mr. Shedlock does not have one. If he does, he has not written a book to explain it, or where he got it, or who else has taught it, or who else believes it.
He has challenged Dr. Murphy in a recent post on his blog site. He denies that there are any excess reserves. What seem to be economic reserves really aren't. That is, Mish Shedlock has denied the entire theory of fractional reserve banking, as taught by all schools of economic opinion. The Austrians are incorrect. The Chicago School monetarists are incorrect, which includes the Federal Reserve Bank of St. Louis. In short, everyone is incorrect. So argues Mr. Shedlock.
No economist would pay any attention to Mr. Shedlock. His audience is mostly recent converts to the hard money camp, who are unaware of Mr. Shedlock's background and the 54-year history of erroneous predictions made by all hard-money deflationists, not one of whom was (or is) a trained economist. By "trained economist," I mean someone who has been taught how to apply a formal theory of economic causation, who then presents his case for future consumer prices through an application of this theory to publicly available data. I mean, in short, someone who doesn't just make it up as he goes along.
Mr. Shedlock needs to explain why prices are rising. He has told us that they would fall. He is spending time attacking one of the most gifted expositors of Austrian economics. Why? Because Dr. Murphy has taken apart Mr. Shedlock's case in full public view . . . twice.
He has yet to respond line-by-line to my argument, namely, that the Federal Reserve could get banks to withdraw their excess reserves and lend out their money merely by charging banks interest on depositing excess reserves. Commercial banks could not operate with these guaranteed losses. They would lend, hoping for profits. I presented this argument in February 2009. I amplified it in early December.
This is so obvious that anyone who understood fractional reserve banking could understand it. Mr. Shedlock does not understand fractional reserve banking. This is a serious blind spot for a man whose career is now dependent on persuading readers that he understands economic theory, money, and banking.
When a man with no training in economics, no theory of economics, and no understanding of fractional reserve banking rejects the entire world of modem monetary theory, he may persuade amateurs with no knowledge of economics, money and banking, but he will not persuade anyone else.
I will respond to his post in detail tomorrow, but it is necessary that readers first understand what the debate is about. It is about the deflationists' 54 consecutive years of failure to forecast the direction of consumer prices for the following year -- mot getting it right even once -- and the inflationists' explanation for the failure of consumer prices to rise much since September 2008.
Bottom line: in the hard-money deflationist camp there has not been a single trained economist. Not one of them has ever written a book on economic theory. Not one of them has written a book on money and banking. Not one of them has been able to forecast the direction of consumer prices for a single year. Not one of them related his arguments to a body of economic theory -- Austrian, Keynesian, monetarist, or supply side.
If there is one, none of the rest of them quote him or use his work to bolster their positions.
All of them make it up as they go along.