Money market growth

Enrique Diaz-Alvarez enrique at anise.ee.cornell.edu
Tue Dec 1 10:53:35 PST 1998


Hi y'all,

I came across this explanation for the astounding growth in moeny market assets in October, which is all the more surprising since it took place at the same time money was flowing into the stock market and the savings rate (or a good proxy for it) went below zero for the first time since the 30's. In essence it says that this growth is caused by uncontrolled credit creation outside the banking system, which is not subjected to reserve limitations. I found this at a site for nutjob goldnuts, and anything they say is suspect to say the least. What other explanations are there? Where is the money coming from? Foreign inflows?

The complete article may be found at

http://www.gold-eagle.com/editorials_98/noland113098.html

[...] the doctrine that money and credit are

created almost exclusively through the "multiplier effect" of bank deposits

recirculating through the banking system with reserve requirements and

Federal Reserve governance controlling bank credit expansion. However,

and critically, this school views non-bank participants in this process as

merely financial intermediaries, transferring bank created money from

saver to borrower. With this in mind, such analysis focuses

overwhelmingly on bank reserves and the narrow definition of money, M1.

And with M1 actually contracting marginally over the past six months

and bank reserves with a year-over-year decline, it is completely lost

among these adherents as to how it is possible that the broader money

aggregates explode in an unprecedented and historic expansion.

Greenspan's Vigorous Partners - Fannie and Freddie

Let us provide an explanation. For our discussion we will focus on Fannie

Mae and Freddie Mac, companies whose balance sheets have ballooned to

almost $750 billion from about $170 billion at the end of 1990. Fannie and

Freddie rely extensively on the money markets for financing truly

staggering balance sheet growth, having accumulated short-term

liabilities approaching $400 billion. Indeed, as we wrote last month,

Freddie actually financed its entire record third quarter asset growth with

$37 billion of additional short-term debt. Basically, Freddie and Fannie

tap the money markets for funds used to acquire long-maturity financial

assets, mortgages. They borrow, creating money market liabilities, and use

proceeds ("money") to fund the purchase of mortgages originated

throughout the financial system.

Importantly, when Fannie and Freddie purchase mortgages this "money"

stays within the financial system where it largely recirculates back to

money market funds. This works much like the banking system "multiplier

effect" accept for one very significant exception: Money market funds are

not restrained by reserve requirements, hence providing a completely

unbridled credit creation mechanism. In regard to money funds and their

propensity of fostering uncontrolled credit growth, we note the traditional

caution of the Bundesbank, clearly recognizing the considerable risk

associated with credit creation extraneous to the banking system. Indeed,

with today's highly sophisticated financial infrastructure functioning

largely unsupervised and outside the banking industry, money

instantaneously "spins" through the system providing unlimited credit

creation.

-- Enrique Diaz-Alvarez Office # (607) 255 5034 Electrical Engineering Home # (607) 272 4808 112 Phillips Hall Fax # (607) 255 4565 Cornell University mailto:enrique at ee.cornell.edu Ithaca, NY 14853 http://peta.ee.cornell.edu/~enrique



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