The M1 Money Multiplier

Nick, aka. The Modern Mystic, has posted an interesting video (all 20 minutes of it…) on an observation that Denninger made at the end of last year. It concerns a series published by the St. Louis Fed, called MULT, M1 Money Multiplier. In simple terms it is related to money creation, and indicates to what extent the banks are loaning out money that they have on deposit from the Federal Reserve.

When the Fed prints money (quantitive easing) it is trying to rebalance the money supply to reflect the amount of money that the banks have lent out. This in turn enables (in normal times) the banks to extent further credit. Money is just debt, therefore by borrowing money from the Fed the banks actively create money… bit of a headfuck, but that’s seemingly how it works.

The degree to which the banks lends out the money (debt) that they get from the Fed determines the money multiplier. In times where the banks loans are performing well they can extend more credit, which in turn creates more money. When the times are bad, they can still extent credit, but more cautiously, and that also creates more money.

However, there are limits to this ponzi scheme. Banks are governed by a set of regulations that stipulate that they must have a certain ‘capital adequacy’, which is to say, they must maintain a ratio between the money that they have on hand (assets) and the money that they have lent out (debt). This is all complicated by layers and layers of further accounting rules… but in general terms it’s true.

Without having looked into how the M1 Money Multiplier is calculated, i would guess that it’s actually a fairly direct measure of the banks ability to lend out the money the Fed is printing, in relation to their need to pay down debt.

As Nick notes, now that the multiplier is down below one nothing is working as it should. The Fed prints up money with the expectation that an increase in the money supply will improve the situation, but the banks simply use the extra cash to pay down existing debts. As the money supply then continues to fall, the banks have more and more bad debts to pay off, and the downwards spiral continues to tighten.

There is a lot of assuming in this argument, but it does correlate quite well with what is actually happening. The Fed is printing money, but very little is happening in the credit markets. The governments are trying to jawbone the banks into extending credit, but the banks are resisting. With so much of their existing debt going bad, there are between a rock (capital adequacy regulations) and a hard place (falling money supply).

If this indeed what is happening in the system, the Fed (and the Bank of England) is basically wasting it’s time trying to stuff money into the banks, and would be better off wiping out their debt in the bankruptcy counts.

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2 thoughts on “The M1 Money Multiplier

  1. I read somewhere (can’t remember so don’t ask) that Japans real debts if all the ‘hidden debt’ inherent in the Japanese banking system is taken into account (Ministry of finance budget manipulations, Zaito loans to bankrupt agencies, unfunded pension liabilities etc) could be as high as $11 Trillion US about 250% of Japans GDP.
    And this was before the recent ‘problems’ in the world money markets.
    Now, where did I put that book on sustainable organic farming for beginners again??

  2. Don’t think there is much doubt that Japan is broke. There is always some talk about how Japan has borrowed from it’s own people (by treating things like the Post Office like a slush fund) but the reality is that broke is broke.

    As noted previously, anyone of our age who thinks that any western style democratically governed country is going to provide for them in their old age needs their head examining.

    It seems more likely that the US and UK will hit the rocks before Japan… if only because the Japanese are well versed in the art of ignoring reality. Which isn’t to say that i’m not worried; my efforts to get cash out of the bank and into something tangible are increasing…

Wise words...

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