What's Behind the Surge in M1 Money Supply?

 

Jan 7, 2021

M1 money supply is on a tear. Let's investigate what's happening and why.

M1 Money Supply Components

Here's a list of M1 components.

1. M1 consists of currency outside the U.S. Treasury, Federal Reserve Banks, and the vaults of depository institutions; plus
2. Demand deposits at commercial banks (excluding those amounts held by depository institutions, the U.S. government, and foreign banks and official institutions) less cash items in the process of collection and Federal Reserve float; plus
3. Other checkable deposits (OCDs), consisting of negotiable order of withdrawal, or NOW, and automatic transfer service, or ATS, accounts at depository institutions, credit union share draft accounts, and demand deposits at thrift institutions.

The St. Louis Fed M1 Description also includes Traveler's checks, but the amount is tiny. The Traveler's Check series was discontinued in 2018 with the last value at a mere $1.7 billion.

The St. Louis Fed description contains this lie: "M1 includes funds that are readily accessible for spending."

Derived Number

The St. Louis Fed does not have data on #2 exactly as stated above. It does have OCD and Currency and M1. 

I derived Demand Deposits by subtracting Currency and OCDs from M1.

The jump in currency is likely an artifact of Covid. Some businesses want the exact change or don't take it at all. People pile up coins and dollars in their pockets or at home. 

Important Background

I will tackle the rest of the current spike momentarily, but the background is important too.

What Happened in 1994? 

Note that M1 declined between December 1994 and September 2001.

M1 was $1.153 trillion in September of 1994. It did not exceed that amount until it hit $1.208 trillion in September of 2001. 

I discussed this on November 29,2007 in Where’s the Cash?

The answer is Sweeps.

What are Sweeps?

Sweeps are automated programs that “sweep” funds from one type of account into another type of account automatically. In this case we are talking about programs that allow banks to “sweep” funds from checking accounts to other types of accounts such as savings accounts that allow money to be lent out. Sweeps were initiated by Greenspan in 1994. 

Money that is supposed to be in your checking account isn't really there at all. It is swept into savings accounts nightly so that it can be lent out. 

There are no reserves on savings accounts. Coupled with sweeps, that meant there really no reserves at all. 

That's what inspired my 2009 post Fictional Reserve Lending and the Myth of Excess Reserves. 

Fictional Reserve Lending 

I did a follow up post on March 27, 2020 in Fictional Reserve Lending Is the New Official Policy.

Official Announcement

With little fanfare or media coverage, the Fed made this Announcement on Reserves. 

"As announced on March 15, 2020, the Board reduced reserve requirement ratios to zero percent effective March 26, 2020. This action eliminated reserve requirements for all depository institutions." 

Amusingly, a few days ago yet another article appeared explaining how the Money Multiplier works. The example goes like this: Someone deposits $10,000 and a bank lends out $9,000 and then the $9,000 gets redeposited and 90% of the gets lent out and so an and so forth. 

That is not remotely close to how loans get made. Deposits and reserves never played into lending decisions. 

What's Changed Regarding Lending? 

Essentially, nothing.

The announcement just officially admitted the denominator on reserves for lending is zero.

With that explanation of what happened to M1 after 1994, let's turn the discussion to what is happening now. 

The Wrong Answer

There are some wrong answers out there including some wild theories about Biden in this Seeking Alpha Post that also discusses how cash "circulates". Well, no it doesn't.

Think Fed's Balance Sheet

The spike in M1 looks surprisingly similar to the Fed's balance sheet. 

It's from my September 25, 2020 post The Fed Now Owns Over $2 Trillion in Mortgages, What Else?

Let's take a current look at M1 vs Fed Assets.

M1 Components vs Fed's Balance Sheet

Let's hone in on that with some additional math to see what appears to be happening. 

M1, FTHO, Currency+OCD+FTHO, Currency+FTHO

Balance Sheet Explanation of M1

Fed Treasuries Held Outright (FTHO) are a component of the Fed's balance sheet. 

OCD is other checkable deposits. Currency is the M1 component of currency.

Currency plus FTHO is a good estimate of M1. I do not have a handle yet on the difference.

As noted above, Required Reserves are $0.00 which once and for all kills the Money Multiplier Redeposit Theory of credit. 

The Fed discontinued reporting on Excess Reserves but it still pays Interest on Excess Reserves, currently 0.10%, at least as noted on Fred.

Conclusion

The Fed's balance sheet tactics are the key driver of M1, not people moving money into or out of checking accounts, not Biden, not the rich jumping ship, not real estate taxes nor any of the other claims tossed around.

Addendum 

I just found a New York Fed article that explains why QE drives up M1: What’s Driving Up Money Growth?

M1 growth is highly positively correlated with the growth in reserves generated by Fed asset purchases. The reason for this is simple: Reserves held with the central bank are assets for banks. As the Fed expands reserves, banks must either sell other assets (keeping the overall level of assets unchanged), issue more liabilities or equity (expanding the level of assets), or some combination of the two. In fact, banks did not reduce their overall holdings of other assets as reserves increased. Instead, banks mainly funded these new assets by issuing additional liabilities, including deposits. Over the same period, interest rates were low, reducing the incentive for households to place their funds in interest-earning savings accounts rather than checking accounts. Correspondingly, much of this increase in bank liabilities has been in the form of checkable deposits. This helps explain why M1 has grown more than M2.

Mish