Tuesday, October 22, 2013

United States Housing Index Compared with Several Measurements

Nick Edmonds has a post that I found very interesting.

UK Housing a Look at some Ratios

I decided to take a look at United States housing through the lens of Government Provided Money Supply.

The Federal Reserve provides three measures of money supply, M1, M2, and MZM.  So far as I know, all three are crafted to aid the Federal Reserve in it's job of managing the economy.  There is no simple scaling factor that relates these three measures, making them difficult to use for macroeconomic analysis. 

On-the-other-hand, the concept of Government Provided Money Supply provides a common reference standard for macroeconomic purpose.  The components are recognized as either money supply or near-money, depending upon the reader's perception of "moneyness".  Step-changes in these components are accepted indications that step-change purchase events have occurred or will occur.  Bank loans is one component of Government Provided Money Supply that conventional wisdom would accept as the best measure of house pricing.

I recognize that calling Government Debt "money supply" is unconventional. Calling bank loans "money supply" is also unconventional but a little more acceptable; and it is in keeping with the MMT "loans create deposits" slogan.  

We will use data from the Federal Reserve FRED series to plot data series and compare trends.

Figure 1.  Three components of Government Provided Money Supply.  The top thin line is Government Debt held by the public.  The diamond line is Total Bank Loans reported as FRED series TOTLL.  The bottom box line is bank deposits less bank loans.  It can be considered as backing for bank loans in excess of the deposit created by the loan.  The bottom thin line is Government Debt held by the Federal Reserve. It is included only as reference as to scale.  All the components are divided by GDP to provide relief from the inflation caused distortion which magnifies the effect of current data.

Figure 1 is a comparison of Government Provided Money Supply components. The important line in Figure 1 is the top dark line which is bank loans reported as series TOTLL.  This line will be the base line of comparison in several of the following graphs.  The bottom dark line in Figure 1 is total bank deposits less total bank loans.  It is left as a reader exercise to use bank deposits as a money supply standard.

Figure 2 compares house prices with bank loans.  All Transactions House Prices are reported as an index of 100 based on 1980.  Bank loans are scaled to 100 to create an index by simply applying the proper factor based on 1980's value.  The result is two lines reflecting the relative change in value between data points.


Figure 2.  Compare bank loans and house prices.  The heavy line is bank loans.

The most interesting revelation from Figure 2 is that the growth rate of bank loans is much greater than the growth rate of house prices.  I had some expectation that the two lines might be parallel but they are certainly not.  Money supply, whether measured by the bank loan component or by Government Debt is certainly not driving house prices as the sole factor.  Other factors in the United States that influence house prices would include large tracts of undeveloped land, great improvement in tools used to build houses, competing uses of disposable income such as cars, and government policy.

Figure 3 compares house prices with personal income.  Similar to Figure 2, personal income is indexed to 1980 to provide a relative comparison with house prices.  Here we see that house prices have not increased as fast as has personal income.  This observation would reinforce the notion that competing uses for personal income is impacting the share of income spent on residential property.
Figure 3.  Personal income compared to house prices.  Personal income is the top thin line.  House prices are the lower dark line.
Figure 4 will be the final figure.  Here we compare personal income with bank loans.  Using the same indexing technique used in previous figures, we can see that bank loans have increased faster than personal income.  Again, I had an expectation that personal income might increase parallel to bank loans, which would be parallel to the increased money supply. 


Figure 4.  Personal income compared to bank loans.  The lower thin line is personal income.  The upper heavy line is bank loans.
Not shown here, when personal income is indexed to money supply measure M2 using the 1980 index point, the match is MUCH better than we see in Figure2 with bank loans.

The failure of personal income to increase at the rate of bank loan increase indicates that additional factors are in play.  One possibility is that imports are being purchased with borrowed money.  Stated another way, borrowing is employing foreign workers whose income is not reported, not United States workers with reported income.

Another possibility is that borrowed money is financing increased valuation of existing fixed assets.  

Yet another possibility is that government spending is becoming a very large part of national income.  Government spending would not be expected to follow bank lending closely.

Perhaps all possibilities are at work.

I will close the post with a word of caution: 
Inflation over the period of record has skewed data in a logarithmic fashion.  This skewing makes indexing very sensitive to the date of reference.  The general trend between lines remains valid but be very careful in how exact differences are described.

Sunday, October 6, 2013

Government Debt is NOT Money Supply?

Blogsphere frequently contains discussion of money and money supply, with the discussion then continuing into issues of bank deposits and national debt.  The common thread between these subjects is "the nature of loans".  This common thread is ill perceived, leading to chaotic discussion, with ultimate division into schools of thought, never to agree.

Before you jump to the next blog, please understand that a loan is more than an agreement that you understand well.  It has a life of it's own that needs to be built into models of the economy.

It is very common practice for customers to get loans.  Most common are loans for cars and loans for houses. If you have made a loan, you know all about loans. Right?  Well, did you know that the lender often sells that loan?  Did you know that the loan may be sold many times before you finally pay it off?  Did you consider that the loan had a life span?

Life span of a loan is a convenient way of economically describing a loan. A life has a beginning, a period of existence, and an end.  A loan can be viewed as having these three properties of continuum.  We will examine these properties in order.

Economist like tight definitions so here we will make some assumptions:

1.  The loan is denominated in money.
2.  The loan has a physical component that can could include a paper or electronic record.

A continuum has a beginning.  The beginning of a loan is agreement between two or more parties to trade money for action or property.  This action implies that:

1.  The lender has money to loan.  Large amounts of money are likely to take a long time to accumulate so the lender of large amounts of money must have a low propensity to spend money, allowing him to accumulate.   (Alternatively, the lender has a very large income, allowing him money flows far in excess of needs for daily living.)

2.  The borrower has a project or purchase in mind for immediate action.

3.  The borrower makes a commitment to return the money in the future.  This implies a time contract.  The initial value of the contract would be at least the value of the loan.

Following loan completion, we would expect several economic indicators to change:

1.  If a loan from a bank, bank deposits would rise in total.

2.  If a loan to government, money supply measures which included Federal Debt would rise.

3.  Unemployment would fall as the loaned money was used to complete a project or workers toiled to replace reduced inventory.

4.  If the loan was a continuation of a pattern (annual loans for equal amounts), unemployment would not change.

During the interval between loan beginning and loan close, the loan will exist as property. The borrower has an obligation that will be valuable when the money is returned. This results in an opportunity for trade between lenders, one who wants to sell an existing loan and another who wants to loan funds in waiting.  This sort of trade is ubiquitous.

Finally, at the end of the loan period, the money on loan is expected to be returned. This will result in a reversal of the economic indicators affected at loan beginning.

Expectation-of-economic-condition-reversal is a very important consideration.  It makes obvious that the use of loans by government to increase employment is doomed to short term success. A single step increase in employment purchased by loan funds can only be sustained by a similar loan the following period.  A second step increase in employment can only be purchased by an additional loan added to the first step loan, forcing subsequent period loans to be each higher.
A return to no-new-loan conditions by government would result in a two step decrease in employment, reversing the stimulus of the earlier loans.

With this background, we are ready to make a leap to discuss the subject of the post title, "Government Debt is NOT Money Supply?" .

We will begin the second half of this post by assuming that:

1.  The Federal Government pays employees with Federal Reserve Notes.

2.  The Federal Government gets the Federal Reserve Notes from the Federal Reserve in exchange for a contract to return the notes after a period.  This constitutes a loan from the Federal Reserve to the Federal Government, which will be evidenced by Federal Debt.

3.  Once the initial Federal Reserve Notes are issued to employees, owners of the notes can use Federal Reserve Notes to purchase Federal Debt.

Remembering our earlier discussion of loans, the Federal Reserve is the lender, the Federal Government the borrower.  The property borrowed is the Federal Reserve Notes.  The evidence of debt is the contract named Federal Debt.

Federal Reserve Notes are the money we carry in our wallets. Our bank deposits are denominated in Federal Reserve Notes.  It is very helpful to know how much money is available in the economy but it is very widely distributed, making it difficult to count.  On the other hand, if we recognize that all Federal Reserve Notes first come from the government (otherwise they would be counterfeit), then it is easy to equate Federal Reserve Notes with Federal Debt and know what the money supply is.

This seems simple but there is no-where near as many Federal Reserve Notes as there is Federal Debt.  Not close.  Why not and where might the difference lay?

The Federal Reserve is the first place to look.  The Federal Reserve has no money of its own to use for anything.  It can only print Federal Reserve Notes.  Federal Reserve Notes are used to purchase Federal Debt and, more recently, Mortgage Backed Securities.  We then can add the Federal Debt and Mortgage Backed Securities total of the Federal Reserve to know how many Federal Reserve Notes are in supply?  No, there is a way that the supply of Federal Reserve Notes is reduced relative to  Federal Debt.

The Federal Government, having no money of its own, gets money from the Federal Reserve first, then from the public once the public has money to spend. The non-taxed spending by the Federal Government mostly comes from loans sold to the public.  This borrowing uses the same Federal Reserve Notes time after time in the form of roll-over loans.  The number of Federal Reserve Notes does not change greatly, but the total amount of Federal Debt increases annually.

From the standpoint of the public, the amount of money available increases as fast as the Federal Debt increases.

Is it correct to say that the money is invested in Federal Debt so that the money is not available?  Yes and No.  Yes, the money is not available for a short time.  No, the money is available in entirety if we are willing to wait to the end of the debt period.  Further, from our discussion on loans, we know the money is available at anytime if a trade of contract for money can be made.

To this blogger, the knowledge that Federal Debt will be available as Federal Reserve Notes (money) at debt-term-end, is convincing argument that Federal Debt is an excellent measure of money supply.  Knowledge that Federal Debt is convertible to money upon very short notice is a reinforcing argument.  This readily available measure of money supply should be used more often in "money supply" context.

(Bank loans also add to money supply. Further discussion on this topic can be found at Government Provided Money Supply.)