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Advanced Thought Leadership for Your Money®

The Money Supply Logjam

Fall 2014 Edition

Tight Money: Why the Fed Isn't To Blame

Aaron Kolkman, CFP®, AAMS®

Troy Noor, CFP®, CFA

The relationship between supply and demand dictates that money supply can devalue a currency. As such, the Fed's monetary policy decisions post-2008 to pursue Quantitative Easing (QE) has increased the money supply, albeit not by "printing money" but by buying Treasury holdings in the open market. Unfortunately, this increased money supply is "caught in the system" not due to bankers' unwillingness to lend, rather because current regulatory policy has constrained credit decisions through increased borrower qualifications or slower underwriting (or both). In short, the Fed needed partnership from Congress and has received very little. Although Congress is not populated by economists, it has failed to hear former Fed Chairman Dr. Ben Bernanke's repeated calls for a reduction in regulatory burdens on lending institutions.

Devaluing a currency means that goods and services valued in that currency require a larger amount of money to purchase. This price inflation is a common fear in many circles, and therefore is carefully monitored in both public and private circles, as well as discussed often in the media. While it's true that price inflation can result from excess money supply, rampant inflation is unlikely unless Congress significantly lifts new banking regulations brought about by the 2010 Wall Street Reform Act (aka "Dodd-Frank"). Therefore, the Fed's decision to increase money supply will only translate to price inflation if Congress makes moves of its own. Of course, if banking regulations lessen too quickly, real and prolonged inflation can quickly result. Therefore a moderate and gradual approach is recommended.

Importantly, the Fed's Federal Open Market Committee (FOMC) decisions to pursue QE programs affects long-term interest rates (managing rates lower by increasing bond prices - as QE requires the Fed to buy-up Treasury bonds and thereby attain its objective of increasing cash in the system), not short-term interest rates. Of additional interest, then, in the money supply discussion is the near-zero interest rate policy pursued by the Fed in parallel fashion with QE programs. To summarize, low short-term interest rates have coupled with QE to squeeze bankers' margins, and even forced some bankers to the Fed's discount windows in search of yield on its own capital (versus lending it at all). The result? More excess money supply in banks directly resulting from Fed policy decisions with the same post-2008 regulatory burden from Congress to lend it.

Clearly, Congressional overreaction to post-2008 and now under-reaction to the Fed's requests for partnership mean low rates, low inflation, and low economic growth in the near-term, forcing equity prices higher (especially as dividend yields remain attractive) as existing capital seeks opportunity.

For additional information, contact Troy Noor at: (877) 664-2583 or troy@blvdwealth.com.

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