By December, the most recent month for which statistics are available, the U.S. dollar Fiat Money Quantity (FMQ) had grown to $12.48 trillion. This is $5.05 trillion more than if it had grown in line with the established average monthly growth rate from 1960 to the month before the Lehman Crisis.
By this measure of currency inflation, since August 2009 inflation is now 68% above trend. This is illustrated in Chart 1 below.
FMQ measures the difference between currency, measured by cash and deposits, and sound money by retracing the evolution of currency from gold and fully-backed gold substitutes. It is therefore fundamentally different from conventional measures of money supply, which compare changes in themselves over time. Instead it is a comparison between sound and unsound money.
Estimating monetary tightness
Since January 2013 quantitative easing (QE) of $85 billion has been the principal driving force behind FMQ, at double the rate of the increase in bank reserves held at the Fed with respect to purchases of Treasuries from the primary dealers. This is because the Fed buys them from primary dealers, crediting their banks with reserves on its own balance sheet, and the primary dealers are in turn credited with deposits at their banks. Alternatively when the Fed buys mortgage assets this can also be regarded as creating deposits at both the Fed and at the banks, though there may be some timing differences involved between when banks first acquire and then subsequently sell their own assets to the Fed.
The approximate effect of QE on overall liquidity is therefore captured by taking twice the monthly QE and then subtracting the increase in FMQ, so we can estimate how dependent markets have become on QE. Note that QE is not the only determinant of monetary liquidity. The result is shown in the next chart.