A Volcker Pan Recession

Once Paul Volcker took over in ’79, he acted on the belated realization, seeking to get the Great Inflation under control by restricting, well, something that seems like money.

All the Fed had by that point was bank reserves, so they gave it a go. Late in 1979, authorities restricted bank reserves with kind of an expectation, more like pure hope more costly reserves would constrict depository money.

And if they did, that would limit bank credit and then money flowing into the real economy thereby choking off inflation.

In fact, none of it made a difference; there was never a correlation between bank reserves and money of any stripe. Even using the by-then long outdated Ms, even M3, you can clearly see that, nope, bank reserves and money growth had no relationship whatsoever.

The dip in M3 late in ’79 (circled below) is actually a contrary move, too, because M3 growth slowed right when the FOMC was adding back more reserves via RPs during its fed funds panic.

And then once they went forward reducing reserves, M3 then accelerated.

So, years after this period, the gaslighters in Economics decided that it hadn’t been bank reserves, per se, which caused the early 80s recessions and an end to the Great Inflation, rather it must have been the accidental impact of rising (real) interest rates holding back bank reserves had caused.

By constraining them and driving up the fed funds rate, rates were suddenly thought the magic cure.

What else were they going to do? Honestly examine the eurodollar? Tell the public?

This wasn’t strictly an America or even dollar evolution. Banking and money in more general terms, a fact we can observe both in the Volcker Myth as well as its opposite end.

What’s the opposite of early eighties FOMC bank reserve restraint? Twenty-first century Japanese QE which massively expands the level of same.

No need to belabor this point too much, but, like Volcker’s mess, in Japan over the past two decades once again we see no correlation whatsoever between bank reserves and at least credit growth (I didn’t have time to produce the yen Ms here, but they show the same).

As Emil Kalinowski reminds us, it’s just past the anniversary of Haruhiko Kuroda’s bizarre yet appropriate Peter Pan confession.

I trust that many of you are familiar with the story of Peter Pan, in which it says, ‘The moment you doubt whether you can fly, you cease forever to be able to do it.’ Yes, what we need is a positive attitude and conviction.

In other words, ever since the Volcker Myth, bank reserves aren’t actually money but if you believe they are the whole economy can fly.