26 Oct 2009

Former Fed Official Calls for Audit

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William Barnett–who’s not the Fed-watching William Barnett of Loyola College, I checked–calls for an audit of the Fed in the NY Times (HT2 Jeff Hummel). Barnett made me feel less of an idiot when he wrote:

Consider the data the Fed presented last year on nonborrowed reserves. Nonborrowed reserves are total bank reserves minus money borrowed by banks and held as reserves. Clearly, the money borrowed cannot exceed the total reserves, so nonborrowed reserves should not be negative. Yet for a few months last year, the Fed reported banks’ nonborrowed reserves at billions of dollars below zero. In its calculations of nonborrowed reserves, the Fed included in borrowed reserves new forms of bank borrowing not being held as reserves. Such incompetent accounting would not survive an unconstrained, fully informed audit.

Phew! That screwed with some of your heads’ too, right? I mean, even if the Fed held 100% borrowed reserves, then “nonborrowed reserves” should have been zero, not negative. Here’s the chart:

What I don’t know is if the rapid “improvement” was due merely to injections of new reserves, or if the Fed changed its bookkeeping too.

Another interesting point:

The information the Fed releases on bank deposits is similarly biased and contaminates data on the money supply and thereby on the liquidity of the economy produced by Federal Reserve policy. In order to evade reserve requirements, which mandate that a certain fraction of deposits be held in reserve and not lent out, many banks sweep much of their checking account deposits into shadow money-market-deposit savings accounts before reporting those deposits to the Fed. Since such accounts have no reserve requirements, this allows the banks to decrease the amount of total reserves they’re required to have. But the liquidity provided to the economy from checking accounts is the pre-sweeps amount, not the reported post-sweeps amount.

This was something we had to deal with at Laffer Investments; i.e. we would report to clients on the “sweep-adjusted” M1.

In normal times, I wouldn’t think it was that big a deal, if you were just interested in rates of growth. But these aren’t normal times. If banks are now less (more) willing to sweep checking deposits into money market accounts, then that means the reported growth in M1 is higher (lower) than it actually appears. I’m not saying banks are less willing to do so, but they might be, in which case the stagnant monetary aggregates are actually concealing a shrinking money stock held by the public. It is entirely possible that looking at FRED for the M1 and M2 updates isn’t a great way to understand what’s really happening with the money supply.

Like I’ve said in the past, any of you sugar daddies who want to pony up the $$ for me to take a month and get to the bottom of all this, please feel free to email me.

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