QE3 and the Adjusted Monetary Base

The adjusted monetary base is actually down slightly right now from where it was when QE2 ended at the end of June of 2011.

You can view the shorter-term chart for the adjusted monetary base here:

You can view a 5-year chart here:

You can view a longer-term chart here:

You can also view the excess reserves held by commercial banks here:

While we will certainly keep an eye on the adjusted monetary base, I see no reason not to take the FOMC's word that the Fed will increase its holdings by approximately $40 billion each month.

Some analysts have mistakenly thought that the Fed's assets would increase by $85 billion per month.  But the FOMC statement said that its longer-term assets would increase by that much.  It will also decrease its holdings of shorter-term government debt.  This is part of a continuation of Operation Twist.  I have interpreted the FOMC's statement to mean that the net increase in holdings will be $40 billion per month.

It will be important to look at the excess reserves held by banks as QE3 develops.  The increase in reserves has almost identically mimicked the increase in the monetary base since the fall of 2008.  This has helped contain price inflation (along with the fear that goes with a bad economy).  If the excess reserves start to decrease, or even not go up as much as the monetary base, then price inflation is likely to get worse more quickly.

Just don't make the mistake to think that we cannot see price inflation even if the banks continue to pile up excess reserves.  Those reserves still represent money that is held by people and businesses.  While it is not being loaned out, it is still available for people to spend.

As of right now, the monetary base is just above the mark of $2,650,000,000,000.  We should expect to see it go up each month by about $40,000,000,000.

Since QE3 is open-ended, we don't know when it will stop growing.

The Fed was able to keep price inflation in check for the last 4 years, despite a tripling of the monetary base.  This was the probably the worst recession since the Great Depression ended.  It was a collapsing of the housing bubble.  We have seen high unemployment and great fear.  We have seen excess reserves piling up.  We have seen consumers cut back.  All of this has helped the Fed in keeping price inflation down.

I don't expect for this to continue.  Something will have to give.  If the Fed keeps going for a while with QE3, I am guessing this will be enough to prevent the economy from falling back into a deep recession, at least for now.  Instead, I think we will see higher price inflation before we see another deep recession.

Of course, nobody can know for sure.  We don't know how long the Fed will keep up the monetary inflation.  We don't know what will happen with velocity, which is the speed at which people spend their money.  One thing to be cognizant of, is the fact that velocity can pick up rather quickly.  If people perceive that their dollars are losing value too quickly, they will try to get rid of them in return for hard assets.  This, in itself, actually perpetuates the higher velocity.

So while it is impossible to know for sure when serious price inflation (double digit) will hit, just be aware that it can happen rather quickly.  Eventually, the Fed will have to choose between saving the dollar from hyperinflation or allowing a deep recession/ depression.  Hopefully it will choose the latter.