First, that is not the argument. Second, you are incorrect. The argument was whether or not the federal reserve controlled the supply of short term money. They do, every economists says they do, and I will defer arguing any idiotic contention to the contrary.
Imagine an economy with 200 people. 1/2 of the folks have Picassos valued at $.5M per copy and $.5M in near term cash holdings. The other 100 have each $1M in near term cash holdings. Now the 1/2 could liquidate their art collection, assuming willing buyers. Each of the 100 Picassos could sell at $.5M. At the end of the day, total cash holdings are unchanged, assuming there is a willing buyer for each. Imagine, a panic in Picassos where everyone is a seller and no one a buyer. The the Picassos suddenly become worthless. Of course at some price $.01 on the dollar, say, some smart guy will step in and buy all the Picassos. But regardless, at the beginning and at the end, whether you liquidate no Picassos or all the Picassos total cash holdings are unchanged. Individual holdings change all over.
There is an enormous difference between assets that are not regarded as near term money equivalents and near term money equivalents.
The same $1 million can serve to liquidate any amount of stock, just by using it over and over.
First, this is irrelevant to the creation of near term money equivalents. Second, this is wrong. $1M cash cannot liquidate more than $1M in stock. If the seller of the original $1M in stocks uses his cash to purchase another $1M shares of stock then there has been no net liquidation, which is the point that panics Bernanke. So long as there is only swapping of financial or real estate holdings at near peak market valuations everything is ok. The panic comes when there is an attempt to create NET liquidation in favor of short term cash. What the FED attempts to do is to create so much short term cash that there is little desire to hold short term cash and folks are willing to hold financial assets instead. It takes a lot because you cannot liquidate much of a highly leveraged asset without sucking all the cash out of the economy.
Once someone sells a stock, what do they want to hold instead? If it is a dollar balance at a bank, then it will increase the demand for dollars, which would raise the value of dollars (cause deflation) if the quantity of them were fixed. Since the quantity of them isn't fixed, it doesn't do that either, it just prompts the Fed to ease a little to accomodate the higher demand for held dollar balances..
First, increasing demand for dollars does not change the supply of cash $. The quantity of them isn't fixed ONLY because the FED expands reserves to make more of them. It is the whole point of central banking. Really. It is what central banks do and it is why we have them.
MZM is much broader than the items the Fed directly controls. M1 closely, M2 loosely, yes. MZM, no.
I would agree with the Austrians that what counts is M0, but the Fed thinks that anything in MZM is really money, and their recent actions show their willingness to use anthing in MZM as money, so it is for these purposes money. Since the regulators of our currency think it is money and will treat it as money in the creation of bank reserves, and they created an extra $2T of this kind of money in the last year or so, I will concede the argument to the FED.
Me I am against this kind of funny money accounting as the kind of flimflammery that got us into this mess, but if you disagree run your argument with the FED, not with me.
As the saying goes, "OK, pick one". But indeed, you alleged above that the Fed created new short term money to let someone cash out of their mutual fund. But I'll move on to the second and overlook the dodge on the first.
"The argument was whether or not the federal reserve controlled the supply of short term money."
They try to, but in the long run they don't much manage to, I'd say. Money creation, like all credit, is endogenous. When regulators control one sort, private financiers invent new structures and substitutes to economize on whatever the regulators have controlled, get it to stretch farther, and use new money substitutes instead. Which will be accepted and thereby become money, in economic fact, whatever legalisms attempt to maintain.
"regardless, at the beginning and at the end, whether you liquidate no Picassos or all the Picassos total cash holdings are unchanged."
I believe I already said that, stock for picassos. (He's dreck, by the way. But that's a quibble).
"There is an enormous difference between assets that are not regarded as near term money equivalents and near term money equivalents."
Actually, I can't see any in anything you've said so far, since yes the money is constant in trade in existing assets, but then so are the existing assets. Same number of picassos, or shares, as well as the same number of dollars. Ah, but, you will say, money equivalents, more *are* made. And I'll agree, and then point out that people are scribbling on their napkins all over, and some of them are making new picassos thereby, and others new shares of stock, and others new promissary notes or credit card receipts. All assets can be increased in quantity, by processes disjoint from trade in existing assets.
"$1M cash cannot liquidate more than $1M in stock."
Sure it can.
"If the seller of the original $1M in stocks uses his cash to purchase another $1M shares of stock"
Ah but he didn't, be bought a great big boat he is sailing to Bermuda. Or a Florida condo. Or overpriced dreck signed by some Pablo or other. He has still liquidated his stock, and passed his dollars or dollar equivalents on. Just as any number of shares of Exxon can be swapped for shares of Microsoft with the same dollars, any number of boats or dreck or condos can be swapped for shares of Exxon, using the same dollars as medium of exchange, between. The only thing you can say, is more people can't hold dollars than there are dollars - but since, when lots more people want to hold more dollars, scribblers are not wanting to scribble away and meet their demand, even that isn't saying very much.
"which is the point that panics Bernanke."
Hardly.
"The panic comes when there is an attempt to create NET liquidation in favor of short term cash."
Nope, the Fed can readily accomodate any such demand, and it does. Not that panic changes the amount of stock in the world, it doesn't - nor do panickers sell stock to the tooth fairy, they sell it to other men willing to part with cash because they think the prices attractive. But a simple net increase in the demand to hold dollar balances, due say to a desire to be better placed to meet exigent demands from worried creditors, the Fed can and does meet, by providing extra funds to the banks allowing them to carry larger balance sheets etc. Or these days by just letting them hold asset classes they are willing to carry smaller risk reserves against. Or by arranging for other institutions to do likewise e.g. the Home Loan Banks running up their debts as fast as commercial paper runs down.
"create so much short term cash that there is little desire to hold short term cash"
Nah, it just accomodates demand and refuses to let cash go "on special" due to deflationary demand shocks to the level of desired money balances. If it were a matter of incentives, a spread between T-bills and LIBOR of 1.5% would more than suffice. Instead it is a matter of Basel II standards and risk adjusted asset measurements, so holding the T-bill frees up a dollar to carry 10 times as much in paper that actually pays something.
"you cannot liquidate much of a highly leveraged asset without sucking all the cash out of the economy."
You can't suck all the cash out of the economy with transactions that leave the number of dollars unchanged, such as trade in existing assets. No, the deflation issue is, do the banks and only the banks, deliberately run off assets and repay liabilities, both, to reduce their total balance sheets and bring their risks back into line with desired ratios to capital?
If the banks do that, then bank debt outstanding declines, and financial claims outstanding, running in favor of the bank, also decline. The rest of the world owes its banks less. But banks also owe the rest of the world, less. And what banks owe the rest of the world, that's the money supply. But the issue is not, does that figure rise to huge enough amounts that people don't want to hold it. No, it is, does it decline absolutely, and rapidly?
That, the Fed deliberately prevents. Because it would put short term money "on special". Instead, it intends for discounted and temporary transfer of any sound asset to be a perfectly acceptable substitute for short term money - and that makes its specialness decidedly less important.
"First, increasing demand for dollars does not change the supply of cash $"
True, but it will raise the exchange value of an unchanged quantity of them. If, instead, the supply of dollars rises when demand for them rises sharply, then the exchange value of dollars against other assets will not spike, as panic demand for holding dollar balances, hits. And that is precisely the reason for the lender of last resort function of the Fed. The supply is deliberately made elastic to meet and match any panic demand, so the panic demand cannot raise the exchange value of the demanded item.
Your mistake, is in seeing the "delation" I referred to in my post, as necessarily referring to a *quantity* of anything. It isn't. Deflation is falling *prices*, not a falling quantity of dollars. Falling prices of everything, is simply an increase in the exchange value of money. Deflation is caused in the first instance, by a sharp, panic increase in the demand for money balances, compared to all other assets.
If that panic increase is allowed to increase the exchange value of money, it makes all existing debts contracted in money terms, that much more difficult to repay, at the new prevailing prices. And this is a positive feedback process that spreads bankruptcy. The Fed deliberately interrupts its course, by accomodating the heightened demand for money balances, until the market understands that money cannot go "on special".
The exchange value of money will not be allowed to rise. Its quantity will move instead. This being realized, the panic ebbs, all who wanted to get into money have done so, no bankruptcies caused purely by a scramble and increased weight of nominal claims, occurs. All real adjustments are still required, but no one is going to fail merely because the weight of their dollar debts it artificially increased 30% or more, by a passing panic. Been there, done that, everyone from Friedman left knows it is idiocy. It isn't going to happen again.
"The quantity of them isn't fixed ONLY because the FED expands reserves to make more of them."
Um, yes the Fed does so allow, and yes that is the point in a panic, but I still have to dispute the "only". In fact, the Fed acts as a regulator throughout, limiting the banks' ability to make new money. If the Fed weren't there, any private bank that liked could act the same way, if brave enough. Before it was, some did. Private banks didn't need Fed reserves to expand the money supply. They didn't need Fed reserves at all. They expanded the money supply whenever they felt like it. Solely governed by their own prudence in the level of debt they could get to pass, without distrust of their own ability to pay.
So, yes, the Fed is deliberately *allowing* the money supply to expand to accomodate a sudden panic demand for money balances. Which, frankly, is just counteracting the bank's own desire to force a cash flow in their favor to run off assets and fund writeoffs of bad debts, in favor of deadbeats who will never repay. With precious little net movement in the narrower money supply, but, sure, any panic demand for more money balances, met, without dollars ever going "on special".
"It is the whole point of central banking."
Actually, we have them to restrain private banks from creating too much money in boom times, by requiring reserves. And to accomodate sudden increases in demand for money in bust times, to lending freely when others pull back.
"what counts is M0"
A silly and antiquated idea, but fine, it simply isn't moving at all. M1 today is the same as it was in March of 2005, 3 years ago, literally the same. Currency is 3.3% higher than 2 years ago, but then the Fed accomodates any consumer preference for notes rather than deposits, so M1 is the nearest relevant measure.
The Fed isn't increasing the money supply it closely controls. It understands perfectly that the banks make use of fuzzier money substitutes, preferring the least regulated forms farthest from M1, precisely because they involve the least regulatory straightjacketing.
The reason it doesn't care, is in practice the reserve requirements do not "bite" first, and haven't for some time. The Fed moves reserves to meet banking conditions, not the other way around. What bites first for commercial banks are the Basel capital requirements, and not the Fed reserves-on-deposit requirements.
Banks limit their balance sheet growth to the amount they can carry while receiving a "well capitalized" grade from their regulators, under Basel II. They regard any slip below that level as a commercial liability likely to result in credit downgrades and higher costs of capital, and a consequent fall in competitiveness against one another. When one has such a correction to make, it simply grows slower than its rivals and loses market share.
When most or all need to do so at once, on the other hand, the Fed and its seconds step forward to lend, countercyclically.
All, exactly as designed and intended from the founding of the Fed. Frankly, the worst one can say about this cycle is that the Fed raised rates a bit too slowly after the boom got going, and was consequently about a year late. It broke the real estate fever exactly as it had to do, and now it is dutifully (and in my opinion, quite expertly) policing up everybody's over-done boom-time mess.
"I am against this kind of funny money accounting"
Nothing funny-money about it. If you don't think you are benefitted by using bank debts as money, try getting through the day paying for everything with blueberry scones. If you voluntarily use bank debt money, you are acknowledging by your actions that doing so benefits you. You then haggle over the deal anyway, even though you know the gains from the trade are beneficial to you, on the whole. Which is mere griping.