Current Analysis of Bank Reserves, Money Supply, Money Velocity, and Monetization

[gonegolfin]

Current Analysis of Bank Reserves, Money Supply, Money Velocity, and Debt Monetization

Gaining insight into where the economy and financial markets are heading requires, among other things, some knowledge of the monetary system, the various indicators and statistics published on a periodic basis, and the ability to interpret the actions of the Federal Reserve, Treasury, and government in general. Particularly in this environment where the markets are in turmoil and the banking and financial industry is in shambles ... and particularly in an environment where the Fed and Treasury have taken over roles that should be held by the private sector. That is, the undue influence of the Fed and Treasury in these times requires investors to pay particular attention to their actions, whether they are up front and center or they require a bit of unearthing. Several of these types of items were discussed in my essay published last month (included below).

I have discussed non-borrowed reserves on several occasions, the last time being in October when they were heavily negative reaching over -$360 billion. Non-borrowed reserves are simply the total reserves of all the depository institutions (banks) in the Fed system minus the total borrowings of these same institutions from the Fed. A negative reading means that on the whole, banks actually have negative real reserves. To meet reserve requirements, banks have borrowed vast sums of money from the Federal Reserve in the past year. But the plummeting of non-borrowed reserves took place when the Fed was sterilizing most of its monetary injections (see below article). Now with the Fed engaged in quantitative easing, net reserves are being added to the banking system (new money is being created). The result is that non-borrowed reserves have turned positive, in fact significantly so. Non-borrowed reserves turned positive in December and are $338.633 billion (not seasonally adjusted) as of 1/14, while total borrowings from the Federal Reserve have actually declined modestly to $562.358 billion. The result is a pile of excess reserves held in aggregate by the banking system. Reserves that the Fed feels are required to keep the banking system afloat.

All of these newly created reserves (remember that only the Fed can create bank reserves) have led to an explosion of the monetary base, discussed here several times in the past. Total reserves of the banking system as of 1/14 are $900.991 billion, with excess reserves totaling $843.508 billion. The result is a monetary base that continues to rise and is now $1.752007 trillion (more than double what it was in September). Meanwhile, the M1 and M2 money supply aggregates are beginning to grow in the last several months, but not alarmingly so. M1 has grown about 7.5% since the beginning of September while M2 has grown 6.6%. The banks are sitting on a pile of reserves, which are needed to cushion their deathly ill balance sheets. Banks are lending, just not near the recent peak levels. Aggregate lending is down, but still near 2006 levels. Real Estate lending has been hardest hit, but loans are still taking place at about early 2004 levels (peak was in 2006). There is also less incentive for the banks to lend at present (also discussed in the article below). It is worthy to note that the monetary base has now exceeded the M1 money supply. This tells us that the money multiplier has been decreasing and is now less than 1. So while lending in aggregate is still happening, lending relative to the amount of bank reserves is extremely low.

Lending is not the only way the money supply can grow. The Fed can encourage investment of these excess reserves ... such as in treasury bills and bonds (which in this case is lending to the government). But I suspect this will only happen when the Fed unplugs the drain (ceases to pay interest on excess reserves held on deposit with the Fed). I suspect that the Fed intends to encourage treasury investment (by the banks using these excess reserves) when it comes time to float more treasury debt. With the size of the stimulus package and other bailout provisions being discussed by our political leaders, this time will be soon in coming.

But also a key component in the reversal of falling prices and declining economic output is the velocity of money, which has been declining. Money velocity is the frequency with which a given unit of money is spent, measured in a specified period of time. A typical measure of money velocity can be found in the equation P = M * V. Here, P represents Gross Domestic Product (GDP), M represents a given money supply aggregate (say M1, M2, or TMS), and V represents the velocity of money. Hence, with the velocity of money dropping, a similar increase in money supply is necessary to achieve a constant level of economic output. Money supply has been growing modestly while GDP has been falling, thus the velocity of money has also been falling (at a greater clip than money supply has been growing). Troubling inflation is typically the result of governments attempting to extricate the economy from a deflationary downturn (which we are certainly experiencing). The harder the downturn, the greater the risk of problematic inflation in the subsequent cycle as governments will be more aggressive and typically overreach. Should the banks increase their lending and investment (fueled by their mountain of bank reserves) and money velocity picks up once again, the Fed will suddenly have a serious inflation problem on its hands (in addition to the inflation potential represented by massive amounts of US Dollar reserves being held overseas). Accurate Fed timing in the draining of reserves from the banking system (while not crushing the banks) will be crucial in managing this inflation ... something with which the Fed has had a poor track record. It usually goes like this ... 1) Horses stampede out of the barn 2) Farmer closes the barn door. With the banking system arguably insolvent at present, the Fed may have little option other than keeping the barn door open.

Recent Fed actions indicate that bank reserves will continue to grow. The Fed recently (1/5) commenced purchases in its Agency Mortgage-Backed Securities (MBS) Program (http://www.newyorkfed.org/newsevents.../ma090105.html). That is, the Fed is now monetizing agency backed mortgage-backed securities (Fannie Mae, Freddie Mac, Ginnie Mae, and Federal Home Loan Bank). This shifts more risk from the lending institutions to the Fed ... and by extension our currency. Through 1/21, $52.627 billion in MBS purchases have been made by the Fed (http://www.newyorkfed.org/markets/mbs/) and this number will be growing as the program cap is $500 billion. These are outright purchases (permanent open market operations) where the Fed creates new money by crediting the selling primary dealer reserve account held at the Fed (http://www.newyorkfed.org/markets/po...cfm?showmore=1). These are not part of one of the Fed lending programs (Ex. TAF), nor are they temporary open market operations that will shortly be unwound. The Fed feels this is necessary due to a significant drop in foreign ownership. China has been a net seller of agency debt and agency mortgage-backed securities in recent months, although total US Dollar reserves held by the Chinese continue to increase.

Finally, there have been rumors that the Fed may shortly begin the outright purchase of longer dated US Treasury bonds. This would be the Federal Reserve monetizing the debt of the Treasury. The Fed has not monetized treasuries during this financial crisis (in fact, it has sold treasuries from its portfolio). It has merely accepted treasuries as collateral in its various lending facilities and in temporary open market operations. The outright purchases of mortgage-backed securities and treasuries adds these specific assets to the asset side of the Fed balance sheet, thus increasing bank reserves and the monetary base. As for the targeting of long term treasuries, 1) the Fed is under more pressure to keep a ceiling on long term interest rates and 2) will likely need to support large amounts of newly issued treasury debt in the near future. Its goal is to keep mortgage lending cheap and these programs would do just that, though in an artificial manner that devalues the currency once this money works its way into the economy. This pressure comes as there is evidence China is de-emphasizing long term US treasury debt in its US treasury holdings. While overall Chinese purchases of US treasuries continue to rise, the increases are coming at the short end of the yield curve. Meanwhile, China has recently been a net seller of longer dated treasury bonds as they fear a fall in the value of the long bond. This may force both the Fed and the banks to purchase longer dated treasuries (more purchases in the case of the banks) to cover the shortfall. Might the average maturity of outstanding US Treasury debt held by foreign official institutions be declining in the future? I think it will.


Reference statistical releases:
http://www.federalreserve.gov/releases/h41/Current/
http://www.federalreserve.gov/releases/h3/Current/
http://www.federalreserve.gov/releases/h6/Current/
http://www.federalreserve.gov/releas...1208assets.htm
http://www.newyorkfed.org/markets/mbs/
http://www.newyorkfed.org/markets/po...cfm?showmore=1
http://www.federalreserve.gov/releases/g20/Current/
http://www.federalreserve.gov/releases/h8/Current/
http://www.treasurydirect.gov/instit...ress/press.htm

Previous essay ... Interpreting Fed Policy
http://www.ronpaulforums.com/showthread.php?t=172641


Brian

[tremendoustie]

Great analysis Brian, thank you.

Two questions:

1: Why do you think the fed is offering interest on bank reserves, if they want the banks to loan money? Wouldn't this be a disincentive for lending?

2: What means could the fed use to "drain" reserves once lending picks up, especially since the banks are fundamentally insolvent? Are these loans called in and re-issued frequently? And if not, is it not true that the Fed would be unable to call the loans in until they mature?

And, in a separate matter, I'm interested in your thoughts on the monetary issue with China. Specifically, suppose we had a responsible government, which did not borrow at all, and did not increase M0, or only increased it proportional to true production. Also, suppose individuals as an aggregate in the US did not borrow excessively or deplete savings. Would it not then be impossible for China to manipulate currency values to promote exports to the U.S.?

There would be no U.S. treasuries to buy, and how would they buy dollars? Since there could not be more outgoing dollars from the U.S. than incoming, there could not be more goods incoming than outgoing.

While politicians complain about China's monetary policy, this would imply that the fault is really with the borrowing of the US government and the Fed's monetary irresponsibility. They may have sold us the crack, but we went looking for it, so to speak.

[gonegolfin]

Great analysis Brian, thank you.

Two questions:

1: Why do you think the fed is offering interest on bank reserves, if they want the banks to loan money? Wouldn't this be a disincentive for lending?

Thanks.

I discuss this in the previous article linked at the bottom of this essay.

http://www.ronpaulforums.com/showthread.php?t=172641

Yes it is a disincentive to lend. The Fed wants to recapitalize the banks while minimizing inflation. But I suspect they may pull the plug on paying interest on excess reserves once these reserves are needed to purchase treasury debt at auction.

2: What means could the fed use to "drain" reserves once lending picks up, especially since the banks are fundamentally insolvent? Are these loans called in and re-issued frequently? And if not, is it not true that the Fed would be unable to call the loans in until they mature?

Also in my previous article ... they could issue interest bearing debt (Fed bonds). They could also unwind the lending programs. And then there is the traditional method of simply selling treasuries. Of course they have less than $300 billion of treasuries left in their portfolio ... unless they unwind the TSLF (then it is just under $500 billion).

Any sale of Fed assets would drain reserves. However, only treasuries can be purchased and sold without a discount.

And, in a separate matter, I'm interested in your thoughts on the monetary issue with China. Specifically, suppose we had a responsible government, which did not borrow at all, and did not increase M0, or only increased it proportional to true production. Also, suppose individuals as an aggregate in the US did not borrow excessively or deplete savings. Would it not then be impossible for China to manipulate currency values to promote exports to the U.S.?

This scenario is not possible with our current monetary system. Since our monetary system is debt based, our economy relies on debt. Money supply could not be increased without debt. M0 would not exist without debt.

Brian

[tremendoustie]

Thanks.

I discuss this in the previous article linked at the bottom of this essay.

http://www.ronpaulforums.com/showthread.php?t=172641

Yes it is a disincentive to lend. The Fed wants to recapitalize the banks while minimizing inflation. But I suspect they may pull the plug on paying interest on excess reserves once these reserves are needed to purchase treasury debt at auction.

Yet, increased lending implies more of the monetary base becomes monetary supply, and increased price inflation, does it not? They cannot have their cake and eat it too -- either they must reduce the percentage they pay on reserves in order to encourage lending, or they can keep it high to minimize inflation.

They are saying that they want lending to occur, but they are making themselves the most attractive borrower of all, ensuring that little money at all is lent to the public. Is my understanding on this wrong?

It seems for the policy to match the rhetoric, they would want to reduce the percentage they pay now, in order to encourage lending to the general economy, and then increase it again once it picks up, in order to combat inflation.

Also in my previous article ... they could issue interest bearing debt (Fed bonds). They could also unwind the lending programs. And then there is the traditional method of simply selling treasuries. Of course they have less than $300 billion of treasuries left in their portfolio ... unless they unwind the TSLF (then it is just under $500 billion).

Any sale of Fed assets would drain reserves. However, only treasuries can be purchased and sold without a discount.

Yes, I could see that this would soak up liquidity. And, I suppose, assuming all treasuries were already sold, the interest on any Fed bond issues would be paid simply by issuing new money, or selling more debt?

Realistically, do you have any insight into how much debt the Government/Fed can really carry, before people start to lose confidence? I doubt anyone has a good handle on the answer to this question, but I am interested in your thoughts.

This scenario is not possible with our current monetary system. Since our monetary system is debt based, our economy relies on debt. Money supply could not be increased without debt. M0 would not exist without debt.

Good point, but, I am not saying there is zero debt, only that there is zero government debt, and the aggregate debt of the US populace is remaining steady.

Or, if you prefer, suppose we were on a non debt based monetary system.

The question is, do you agree with my assessment that China cannot manipulate trade unless we willingly accept increasing debt, or our government does, or we issue new currency? That is, without our complicity, China would not be able to affect trade balances simply by devaluing the yuan relative to the dollar?

The point is, I'm thinking that with free trade and responsible fiscal policy, under an austrian system, we need not fear antagonistic trade policies by other nations, like China. And, with bankrupcy protection, I doubt other countries would be as willing to fall all over themseves in order to issue debt to U.S. consumers individually, as they are to our government.

[gonegolfin]

Yet, increased lending implies more of the monetary base becomes monetary supply, and increased price inflation, does it not?

Correct. Lending or investment.

They cannot have their cake and eat it too -- either they must reduce the percentage they pay on reserves in order to encourage lending, or they can keep it high to minimize inflation.

As I said, I think it is probably a timing thing. They will unplug the drain when they are ready to encourage investment of these reserves.

The other thing to consider is that if the federal funds rate goes to zero, there is no interest being paid on excess reserves. The federal funds rate has been hovering around 0.20% in the last week.

They are saying that they want lending to occur, but they are making themselves the most attractive borrower of all, ensuring that little money at all is lent to the public. Is my understanding on this wrong?

No, their current tactic is certainly to exercise control over lending/investing of these reserves and influence the money supply. This is why I say in the lead paragraph that "the Fed and Treasury have taken over roles that should be held by the private sector. That is, the undue influence of the Fed and Treasury in these times requires investors to pay particular attention to their actions, whether they are up front and center or they require a bit of unearthing."

It seems for the policy to match the rhetoric, they would want to reduce the percentage they pay now, in order to encourage lending to the general economy, and then increase it again once it picks up, in order to combat inflation.

Yes ... if the Fed truly wanted massive lending now, they would not have introduced the various sterilization operations I have discussed in these essays. They want to recapitalize the banks and are very concerned about inflation. They also know that some big upcoming Treasury auctions need buyers.

Yes, I could see that this would soak up liquidity. And, I suppose, assuming all treasuries were already sold, the interest on any Fed bond issues would be paid simply by issuing new money, or selling more debt?

The Fed could execute a continuous cycle of 1) issuing Fed bonds (which would drain liquidity) and 2) purchasing treasuries (which would add reserves, but also add treasuries to the asset side of the balance sheet). This would keep the game going as the balance sheet could grow indefinitely (until confidence fails). Fed bonod interest payments would add to reserves but could be immediately sterilized.

Realistically, do you have any insight into how much debt the Government/Fed can really carry, before people start to lose confidence? I doubt anyone has a good handle on the answer to this question, but I am interested in your thoughts.

There are a lot of variables here. And by people, I assume you mean holders of the US Dollar, which includes foreign investors and official institutions.

We are not at a point where the debt is so large that the currency will soon be abandoned. We are not at all-time high debt levels as a percentage of GDP (as an example).

I am not concerned about hyperinflation at this point because increasing narrow money supply by a few trillion $ is not nearly enough to cause such a situation. But I do think we will be talking about painful inflation after we work our way through the current deflation (which may take a while). My current thoughts are somewhere between 15% and 40%. Some of this depends on how well the Fed executes. Some of it is simply baked into the cake.

Good point, but, I am not saying there is zero debt, only that there is zero government debt, and the aggregate debt of the US populace is remaining steady.

Or, if you prefer, suppose we were on a non debt based monetary system.

This would be the only way in the situation you posed.

The question is, do you agree with my assessment that China cannot manipulate trade unless we willingly accept increasing debt, or our government does, or we issue new currency? That is, without our complicity, China would not be able to affect trade balances simply by devaluing the yuan relative to the dollar?

Yes, they can. The Dollar would still have a value in international exchange. If it were a non-debt based currency, it would be the strongest currency in the world. But the Chinese could still affect the exchange value by buying or selling Yuan. US imports would be limited by competition for scarce Dollars.

Brian

[icon124]

I suspect that the Fed intends to encourage treasury investment (by the banks using these excess reserves) when it comes time to float more treasury debt. With the size of the stimulus package and other bailout provisions being discussed by our political leaders, this time will be soon in coming.

Encourage the banks, or outright force the banks to invest in treasuries? I'm thinking we will see the Fed forcing banks to use the injections to buy treasuries. For some reason I see the Fed saying something along the lines of "well we gave you the money to be solvent to begin with, so now you must return the favor by buying treasuries."

What's your take on this? Do you think banks with buy the treasuries on their own, or will the Fed make them do it?

Although I do see the Fed forcing banks to buy treasuries I do also see the banks participating because I'm sure they understand how harsh this inflation could be otherwise.

Finally, there have been rumors that the Fed may shortly begin the outright purchase of longer dated US Treasury bonds. This would be the Federal Reserve monetizing the debt of the Treasury.

Yeah I heard about this...When this happens there goes any form of free market capitalism we thought we had. This we be a down right sad day in America when the Fed directly begins purchasing treasuries. When are we going to get enough people to step up and stop this!? Haha sorry needed to rant on that one.

[gonegolfin]

Encourage the banks, or outright force the banks to invest in treasuries? I'm thinking we will see the Fed forcing banks to use the injections to buy treasuries. For some reason I see the Fed saying something along the lines of "well we gave you the money to be solvent to begin with, so now you must return the favor by buying treasuries."

What's your take on this? Do you think banks with buy the treasuries on their own, or will the Fed make them do it?

Yes, it could be either or a combination of. I wrote about such coercion in that last essay when discussing the sale of Fed bonds. The Fed could use the same tactics. That is, you either purchase X amount of treasuries, or we will stop rolling over the TAF and TSLF loans (as an example).

Quote from previous article ...
"But these proposed Fed bonds would be interest paying debt obligations that would certainly compete with Treasury securities. Who would buy these bonds? I agree with Mr. Rozeff in that only troubled banks (banks receiving help from the Fed) would purchase these securities. I also think it would also require some level of coercion. Such as ... you either buy these Fed bonds or we will not roll over your TAF loans."

Yeah I heard about this...When this happens there goes any form of free market capitalism we thought we had. This we be a down right sad day in America when the Fed directly begins purchasing treasuries. When are we going to get enough people to step up and stop this!? Haha sorry needed to rant on that one.

Just to be clear for others ... The Fed does not conduct outright purchases of treasuries often, but it is a normal part of operation in that this is how the Fed expands its balance sheet over time. However, in this case, this is not about normal balance sheet expansion. This is about injecting a substantial amount of new money into the banking system and supporting the long bond market (it is going to need help).

Brian

[tremendoustie]

Yes, they can. The Dollar would still have a value in international exchange. If it were a non-debt based currency, it would be the strongest currency in the world. But the Chinese could still affect the exchange value by buying or selling Yuan. US imports would be limited by competition for scarce Dollars.

Brian

I agree that they could affect the exchange rate by selling Yuan, which they could simply print. But, would this really affect the balance of trade?

That is, how could we import more goods than we export, if we do not have increasing debt/decreasing savings, or an increasing money supply? It seems to me that in this case, the only way to import one thing would be to sell something else overseas, of an equal value.

In this situation, the total value of currency coming into the nation must be at least equal to the amount leaving -- otherwise increased debt or savings depletion must occur. This would imply that the total value of goods leaving the country is at least equal to the amount incoming, would it not?

This would mean no trade defecit, no matter what happened to the Yuan.

[liberteebell]

Thank you for helping me understand what's going on.

Btw, is this your article?

http://acuf.org/issues/issue124/090126news.asp

[gonegolfin]

I agree that they could affect the exchange rate by selling Yuan, which they could simply print. But, would this really affect the balance of trade?

It would affect the value of the Yuan, which would affect trade.

That is, how could we import more goods than we export, if we do not have increasing debt/decreasing savings, or an increasing money supply? It seems to me that in this case, the only way to import one thing would be to sell something else overseas, of an equal value.

In this situation, the total value of currency coming into the nation must be at least equal to the amount leaving -- otherwise increased debt or savings depletion must occur. This would imply that the total value of goods leaving the country is at least equal to the amount incoming, would it not?

This would mean no trade defecit, no matter what happened to the Yuan.

Are you thinking of just the trade deficit when you should be thinking of the current account deficit? The trade deficit component of the current account deficit could be addressed by net investment inflows/outflows (invested savings) depending on which side is running the deficit.

Absent this, we could of course have a trade surplus with another nation that offsets the deficit with China.

Brian

[gonegolfin]

Thank you for helping me understand what's going on.

Btw, is this your article?

http://acuf.org/issues/issue124/090126news.asp

You are quite welcome.

No, it is not. My latest essay will be on Gary North's site again sometime Monday.

http://garynorth.com/

Brian

[tremendoustie]

It would affect the value of the Yuan, which would affect trade.


Are you thinking of just the trade deficit when you should be thinking of the current account deficit? The trade deficit component of the current account deficit could be addressed by net investment inflows/outflows (invested savings) depending on which side is running the deficit.

Good point.

However, if the Yuan were devalued, it would also be a disincentive for Chinese investments in the U.S. So, I don't think a devalued Yuan would imply an arrangement where consumables were imported to the U.S., and were balanced by foreign investment in the U.S, so as to lead to a trade deficit, but no current account deficit.

Absent this, we could of course have a trade surplus with another nation that offsets the deficit with China.

Brian

Certainly this is possible. However, it would not be damaging to U.S. industry, by my reckoning, as long as total trade were balanced.

I guess what I'm trying to say/get your opinion on is this: Suppose we were fiscally responsible, and did not have a policy of ever depleting savings or increasing debt, and did also not have inflationary monetary policy.

My thought is that no matter what the trade/monetary policies of other nations were, we would not have a current account deficit. Furthermore, there would be no reason to expect we would have a trade deficit. This would prevent the switch to a net consumer/service based economy, and the associated destruction of industry.

Popular economic thought says that trade policy must be reactionary, that other countries can undermine our economy simply by adjusting their own policies. What I am saying is that this idea may be wrong. The only reason they are able to affect us in this way is that our policies allow ourselves to become over indebted. With fiscal responsibility, I think we can ensure that we produce at least as much as we consume.

[gonegolfin]

Good point.

However, if the Yuan were devalued, it would also be a disincentive for Chinese investments in the U.S. So, I don't think a devalued Yuan would imply an arrangement where consumables were imported to the U.S., and were balanced by foreign investment in the U.S, so as to lead to a trade deficit, but no current account deficit.

I guess what I'm trying to say/get your opinion on is this: Suppose we were fiscally responsible, and did not have a policy of ever depleting savings or increasing debt, and did also not have inflationary monetary policy.

My thought is that no matter what the trade/monetary policies of other nations were, we would not have a current account deficit.

By saying we would "not have inflationary policy" above, I assume you do not mean that the money supply could not grow. This would not work.

That said, you may be right. Although, I do not believe that the current account would always be balanced in your scenario (not that you said it would be, just making a point). I think that it might be the case that it is either balanced or runs a surplus (that is, it would never be negative). It would not be negative because this would require foreign financing of domestic investment. It could be a surplus due to a growing economy and invested savings abroad.

Brian

[Arnaldo]

Dear Brian,

I have looked at the %change chart of m1.

Looking at 2001 it spikes up to +6% and then drops to -4%, is it that the cause of the inflationary bull market 2003-2007?

Or shall we look at the log scale in which case the magnitude of the actual increase is even more evident?

Which sign shall we look for to anticipate the inflationary spiral?

[tremendoustie]

By saying we would "not have inflationary policy" above, I assume you do not mean that the money supply could not grow. This would not work.

That said, you may be right. Although, I do not believe that the current account would always be balanced in your scenario (not that you said it would be, just making a point). I think that it might be the case that it is either balanced or runs a surplus (that is, it would never be negative). It would not be negative because this would require foreign financing of domestic investment. It could be a surplus due to a growing economy and invested savings abroad.

Brian

Agreed -- I think a current account surplus would tend to imply increasing U.S. savings in real terms, by my reckoning, which wasn't ruled out in my scenario.

It's interesting to note, given how politicians act like Chinese monetary manipulation or trade practices will destroy U.S. industry, and that it must be prevented by our application of political pressure to them or adoption of our own manipulative trade practices. If we just acted responsibly ourselves, we could ensure the value of our domestic consumption does not outstrip that of our domestic production.

I have another question for you, but I don't have time to write it up at the moment, hopefully I'll be able to catch you later.

[gonegolfin]

Dear Brian,

I have looked at the %change chart of m1.

Looking at 2001 it spikes up to +6% and then drops to -4%, is it that the cause of the inflationary bull market 2003-2007?

Or shall we look at the log scale in which case the magnitude of the actual increase is even more evident?

Which sign shall we look for to anticipate the inflationary spiral?

Early in the decade, mild deflationary forces were at play coming out of the bubble in the 90's. Bank money creation slowed. The cause of the inflationary bull market you mention was the Fed adding reserves to the system (fed funds rate dropped to 1%) which allowed for cheap lending. All of this cheap credit chased a variety of assets, mostly real estate. We are now paying for that mistake.

As for the signs of coming out of the current mild deflation, I want to see the money multiplier well above 1 (it is below 1) and I want to see real consistent growth in M1 and M2 (we are trending back down a bit now after the Holidays ... which is usual). I also want to see bank lending on an uptrend, not the real downtrend it is currently experiencing. I do not think that anything like this happens until the banks have more incentive to lend or invest ... such as a more profitable yield curve and the elimination of interest paid by the Fed on excess reserves.

I will be surprised to see 5% price inflation this year. I think that we are likely mired in mild deflation for some time (18 months to three years). But I continually watch the data and change my forecast if it is warranted.

Brian