Money multiplier falls below 1

[hugh_lawson]

A post by Karl Denninger on the Market Ticker blog today http://market-ticker.denninger.net/a...Flat-Spin.html points out the M, the M1 money multiplier, has fallen below one according to Federal Reserve data. His take on the consequences is that it is not just a symptom of deflation, but a possible cause of further unrestrained deflation should the fed continue creating money.

Says Denninger--The problem with an M1 multiplier below one is that the effect of printing money is of course multiplied by the velocity. That is, if you print up $10 into the economy the impact it has on economic activity depends on how many times that $10 circulates in a given amount of time. The more it circulates the higher the impact and the more your efforts do for the economy.
The bad news is that when the multiplier is less than one the more money you spew into the economy the worse the impact, as you get less for each additional dollar.

I'd like to hear some discussion of this, particularly the idea that more money creation becomes deflationary. I can understand the concept mathematically, but not on a practical level. The article makes no attempt to explain it further because "most readers will have their eyes glaze over." Usually when someone does this it is because he himself does not fully understand the concept. Neither do I.

[mlg120856]

Re: Money multiplier falls below 1

Isn't this the black hole effect. The more money that is printed and spent on non-productive business (giving money to GM so they can lend it out so that you can use your own money (via taxes paid to the govt to pay back the debt) to buy their crappy cars) the less is available for productive businesses and production of real things (making good cars and the right amount of cars). As long as the true debt and bankruptcy of businesses (commercial RE, credit cards, etc) are not recognized, then it takes more money to bail out more businesses because no one is making anything of real use....sucked into the black hole.

[aaron]

Re: Money multiplier falls below 1

So, if the government prints 1 dollar, it really equals 99 cents in effectiveness?

Would this not be a good thing for the U.S. ? It would seem like a "free" way to pay off the national debt. Just send China and Japan a trillion dollars that they cannot/won't spend. The U.S. would no longer need to pay interest on t-bills.

[Starving Steve]

Re: Money multiplier falls below 1

The Fed does not know how to measure the velocity of money. It can not measure the money supply, other than for what M1 is. The whole idea of measuring the unmeasurable is mathematical nonsense.

These idiots at the Fed with their printing press, their econometric models, and their mathematical nonsense now have the ability to convert this economic crisis (which they have caused by their tinkering) into an inflationary disaster.

[c1ue]

Re: Money multiplier falls below 1

Ka-Poom states that the government will fight deflation by creating credit, but will overshoot.

It is implicit that one consequence of this behavior - obviously if correct - is for velocity to drop to low levels. The key is whether velocity is then able to return BEFORE the excess credit or money is re-absorbed.

Given that government credit policies have at least 3 month and possibly as long as 1 year lags before effects are felt, the iTulip thesis seems eminently reasonable.

Of course the question is whether the resulting inflation is hyper- or merely very high.

I absolutely agree that the government will not itself create hyperinflation (iTulip defines this as 100% or more in 1 year), but the question has always been: what are the secondary effects?

In another thread I post some of the already existing 2nd order dynamics which are untested concerning local/city governments with income restrictions due to tax increase limits - such as California and Proposition 13. As with many things, behavior and restrictions are often linked.

[jtabeb]

Re: Money multiplier falls below 1

A post by Karl Denninger on the Market Ticker blog today http://market-ticker.denninger.net/a...Flat-Spin.html points out the M, the M1 money multiplier, has fallen below one according to Federal Reserve data. His take on the consequences is that it is not just a symptom of deflation, but a possible cause of further unrestrained deflation should the fed continue creating money.



I'd like to hear some discussion of this, particularly the idea that more money creation becomes deflationary. I can understand the concept mathematically, but not on a practical level. The article makes no attempt to explain it further because "most readers will have their eyes glaze over." Usually when someone does this it is because he himself does not fully understand the concept. Neither do I.

Okay, I'm just "a guy" but this sounds like total crap.

What it really means is that increasing amounts of money are required to sustain the same level of Total Money Supply, because as you said if you increase the amount but the velocity falls further then a injection of further money is required.

The argument seems to be that money injection IS causing the velocity to drop. That is the part that bothers me. This could be explained due to the crowding out of private monies from the marketplace, but I'm not sure.

An Excellent person to ask would be this guy $#*, as he has some very good insights into the subject.

To me, this is setting the ground work for very large inflation, because if the the multiplier EVER TURNS AROUND, holy crap batman, watch money supply go to the moon due to the newly added cash that is now circulating at a faster and faster speed.

Like I said, just me, but this seems more hyper-inflationary (at some point) than sustained deflation.

[mlg120856]

Re: Money multiplier falls below 1

But isn't this the concept of compound interest in reverse. Applied to debt instead of savings, the rate of debt grows so fast that there is no longer the ability to service the interest and the interest goes back into the amount of debt, spinning out of control.

[hugh_lawson]

Re: Money multiplier falls below 1

I have thought about this a little more. Denninger's assumption may be that M falling below 1 is the same as falling below zero. A fall below zero would mean injecting more money into the economy would have the paradoxical effect of removing money from the economy. If that is his idea, it probably is crap.

Falling below 1, though, could have the effect of decreasing velocity further causing a downward spiral. I think instead he is confusing cause and effect. M falling below 1, in other words, does not cause velocity to spiral downward. Falling below 1 is only a measure of the effect of banks hoarding cash.

Once banks dis-hoard, once the bubble in bonds has played out, M will go back above 1 and we get jtabeb's "holy crap batman" effect. Then the banks will move on to the next bubble with their money--gold perhaps? Could this override EJ's idea that gold will not bubble into a complete spiral because it will not be supported by the Fed?

[metalman]

Re: Money multiplier falls below 1

I have thought about this a little more. Denninger's assumption may be that M falling below 1 is the same as falling below zero. A fall below zero would mean injecting more money into the economy would have the paradoxical effect of removing money from the economy. If that is his idea, it probably is crap.

Falling below 1, though, could have the effect of decreasing velocity further causing a downward spiral. I think instead he is confusing cause and effect. M falling below 1, in other words, does not cause velocity to spiral downward. Falling below 1 is only a measure of the effect of banks hoarding cash.

Once banks dis-hoard, once the bubble in bonds has played out, M will go back above 1 and we get jtabeb's "holy crap batman" effect. Then the banks will move on to the next bubble with their money--gold perhaps? Could this override EJ's idea that gold will not bubble into a complete spiral because it will not be supported by the Fed?

karl has his rep staked on a deflation spiral. he said years ago that no way, no how the fed will ever, ever engage in quantitative easing... will never print money.

recently his posts have bashed the kapoomers... says that all of the talk of 'printing' is bullshit. all of the fed's money creation has been double entry balanced with new debt, he says. dead silence over the recent admission by the fed that it will monetize asb's... true printing, just as ej said they would.

agree with your assessment that a multiplier below one means just that, the money ain't multiplying but it isn't shrinking. obviously, it's just piling up. from ej's piece today...



the banking system needs a big, fat market clearing enema. ej says the fed/fdic need to take over all the big banks that used credit derivatives and clean out the bad loans to get them lending to each other again ala s&l crisis and bank holiday 1934.

can't see that happening. so then what?

agree with you on gold, too. there's only one explanation for why it has not tanked with other metals... it's the last place to hide besides treasuries and when the inflation scare throws everyone out of those, what's left?

[Sapiens]

Re: Money multiplier falls below 1

agree with you on gold, too. there's only one explanation for why it has not tanked with other metals... it's the last place to hide besides treasuries and when the inflation scare throws everyone out of those, what's left?

Kill the creditors... . . ?

[pksubs]

Re: Money multiplier falls below 1

the banking system needs a big, fat market clearing enema. ej says the fed/fdic need to take over all the big banks that used credit derivatives and clean out the bad loans to get them lending to each other again ala s&l crisis and bank holiday 1934.

Some corroboration from the NYTimes op-ed.
http://www.nytimes.com/2009/01/04/op...l?pagewanted=1
It's a long article in 2 parts, some nuggets:

If a failing firm is deemed “too big” for that honor, then it should be explicitly nationalized, both to limit its effect on other firms and to protect the guts of the system. Its shareholders should be wiped out, and its management replaced. Its valuable parts should be sold off as functioning businesses to the highest bidders — perhaps to some bank that was not swept up in the credit bubble. The rest should be liquidated, in calm markets. Do this and, for everyone except the firms that invented the mess, the pain will likely subside.

This is more plausible than it may sound. Sweden, of all places, did it successfully in 1992. And remember, the Federal Reserve and the Treasury have already accepted, on behalf of the taxpayer, just about all of the downside risk of owning the bigger financial firms. The Treasury and the Federal Reserve would both no doubt argue that if you don’t prop up these banks you risk an enormous credit contraction — if they aren’t in business who will be left to lend money? But something like the reverse seems more true: propping up failed banks and extending them huge amounts of credit has made business more difficult for the people and companies that had nothing to do with creating the mess. Perfectly solvent companies are being squeezed out of business by their creditors precisely because they are not in the Treasury’s fold. With so much lending effectively federally guaranteed, lenders are fleeing anything that is not.