Friday, May 6, 2011

Cash is King

Scott Grannis of Calafia Beach Pundit points to the recent surge in the money supply as defined by M1, which consists of very liquid money (i.e. cash, checking, etc...) and notes that something seems different this time.

As this next chart shows, the growth rate of currency since mid-2010 is no longer correlating to dollar strength. In fact, currency demand has surged as the dollar has fallen. If currency demand were rising because the dollar is considered to be a safe haven during a time of crisis, why is the value of the dollar falling, and even hitting new all-time lows?
He shows the relationship in the following chart.

While he notes that M2 has not shown nearly the same growth as M1, in digging into the data this appears to be the key. The punchline is that M1 does not appear to be rising due to demand for currency (in the flight to quality nature as past periods, such as during the financial crisis), but instead appears to be rising due to the lack of demand for a few components that make up the M2 money supply (and not M1).

These two components are time deposits and money market accounts, which historically have compensated investors with a premium, at the expense of liquidity. In today's low rate environment, investors simply aren't being compensated enough to give up the liquidity.

The chart below shows these four categories (note that savings accounts, which are much more similar to checking accounts these days, is not shown and has risen substantially over this time).

Source: Federal Reserve


  1. It is a kind of complex process dues to many moving parts but in short QE is pumping up demand deposits.

  2. Currency is one component of m1. Currency is growing at an unusually fast rate. This has little to do with the other components of m1, and likely has a lot to do with foreign demand for dollars, since well over half of currency is held outside our borders. The question I raised is why is currency in strong demand when the dollar isn't?