Pro Perspectives 6/22/20

June 22, 2020

Tomorrow will mark three-full-months since the Fed responded to the nationwide stay-at-home orders, with the nuclear option of central bank interventions

No coincidence, over the past three months, we’ve seen some huge runups in the prices of stocks and commodities (asset prices). 

The Fed has expanded the balance sheet now from $4 trillion to over $7 trillion.  And with the facilities they've already announced, that number will likely go to north of $10 trillion.   

So, how much of that money is already sitting in the hands of people?  

Let's take a look at M2 money supply.  This is financial assets held by households, including savings, bank deposits and money sitting in retail money market funds.    

As you can see in the chart, the M2 money supply has ALREADY grown by close to $3 trillion since the onset of the health and economic crisis in the U.S. 

And this money will multiply! 

Let's take a look back at the Global Financial Crisis response, where the Fed expanded the balance sheet from $870 billion to $4.5 trillion.  The money supply grew from $7.4 trillion to almost $14 trillion.  It nearly doubled. 

If the money supply doubled this time, we'd be looking at over $15 trillion of new money circulating in the economy. 

Aligning with that, remember one of the most aggressive moves made by the Fed, in this recent response, was the elimination of the reserve requirement for banks.  They went from 10% to zero.  

This move to a "zero" reserve requirement, incentivizes, if not mandates banks to make loans.  What  does this do to the supply of money?  At a zero reserve requirement ratio, the stock of money could increase infinitely.

With that in mind, as we discussed last week, if the very pessimistic forecasts hit for the first half of the year, we're talking about a $275 billion loss in economic output for Q1 and a $2 trillion loss in economic output for Q2.  That's a sum of $2.275 trillion.  Clearly, there is a lot of excess money in the response. 

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