Investors Should Beware Money Destruction
Posted August 15, 2023
This week Macro Watch examines the liabilities of five large central banks to explain how central banks create Money to pay for the assets they acquire, as well as how they destroy Money when they dispose of those assets, as many of them are doing now.
It is important to have a clear understanding of how Central Banks create Money – and how they destroy it – because Money Creation tends to cause asset prices to rise, and Money Destruction tends to cause asset prices to fall.
This video shows that the Federal Reserve, the European Central Bank and the Bank Of England are all now destroying Money; while the Bank Of Japan has nearly stopped creating additional Money; and the People’s Bank Of China is creating new Money at a much slower pace than in the past.
The takeaway is that Global Liquidity is tightening, which suggests that asset prices are likely to come under increasing downward pressure during the rest of this year.
The video also explains why Base Money (i.e., the Monetary Base), as it is traditionally defined, should be ignored since it no longer provides an accurate picture of the amount of Liquidity in the financial system. A revised definition of Base Money is provided that does reflect the true level of system-wide Liquidity.
For all the details, Macro Watch subscribers can log in and watch this video now. It is 26 minutes long and contains 53 slides that can be downloaded.
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I’m very much a novice when it comes to macro economics but I’m trying to understand how liquidity is tightening in the US when M2 money supply has increased by ~$200 Billion over the last 6 months. Is deficit spending essentially creating money faster then the fed is destroying it?
Hi Eric,
Thank you for your comment/question.
The answer is that M2 no longer adequately measures Liquidity in the US because it does not incorporate the money that has accumulated on the liabilities side of the Fed’s balance sheet as “Reverse Repurchase Agreements, Others”.
This was explained in a recent Macro Watch video called “Liquidity Is Tightening. Watch Out!” Here’s a link to the blog that describes that video:
https://richardduncaneconomics.com/liquiditys-tightening/
According to the St Louis Fed, M2 is up $90 billion from its low on May 1st. But Reverse Repos, Others are down $561 billion.
In addition to that, the money locked away in the Treasury General account has increased by $450 billion since the end of May. That has also drained liquidity.
If this is really a subject that interests you, please consider subscribing to Macro Watch.
With kind regards,
Richard