From Calafia Beach Pundit:
As reported yesterday by Jeff Cox of CNBC, the Fed is likely on the verge of making an important policy change (HT: Calculated Risk). Within the next several months, the Fed is likely to announce the tapering of QE. That's not a big surprise, but this time there is an interesting twist: in order to offset the risk that tapering might cause interest rates to move higher—which could slow the still-weak housing market and the still-weak economy—the Fed will also announce a lowering of the unemployment rate threshold that would prompt them to begin raising interest rates. By doing this the Fed would be removing some of the unwinding risk that continued tapering creates, while at the same time keeping bond yields from increasing, since a lower unemployment rate threshold would significantly extend the period during which the Fed would keep short-term interest at or near zero.
The official justification for this move would be to strengthen the economy. But for those of us who believe that monetary policy has little or no ability to create economic growth, the real reason the Fed would make this move is to aggressively weaken the demand for cash and cash equivalents (e.g., currency, T-bills, bank savings accounts, and bank reserves). If the Fed succeeds in convincing the world that cash and cash equivalents will pay next to nothing for the next few years (i.e., the time it would take for the unemployment rate to fall to the Fed's new threshold), then the world's demand for that cash is most likely going to decline.
As the chart above shows, there's an awful lot of "cash" out there that pays almost nothing: over $7 trillion of bank savings deposits, $0.7 trillion of retail money market funds, $0.6 trillion of small-denomination time deposits, and $1.4 trillion in checking accounts. And let's not forget the $2.5 trillion of bank reserves, the vast majority of which are held as "excess reserves," that the nation's banks are apparently quite happy to hold and which pay all of 0.25%.
The M2 measure of the money supply is arguably the best measure of the amount of readily-spendable cash in the economy. As the chart above shows, the ratio of M2 to nominal GDP is at record-setting levels. That means that the public's demand for "cash" has never been stronger. Households and businesses have never before held such a large proportion of their annual income in cash. That's remarkable on its own, but it's even more remarkable considering that the yield on all that "cash" has never been so low for so long (T-bill yields have been hugging zero for the past 5 years). It's a fact that the world's appetite for "cash" has never been so voracious....MORE
