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It's Only Money
Most people think of "cash" as folding green, jingle in the pocket, whatever you've got on you or in the envelope in the sock drawer.
Investment types treat cash as a contemptible non-entity. Money market funds are not investments, they say; just parking places for money not yet invested. Ditto for Treasury bills, CD's -- anything so short term as to pay a return not much ahead of inflation. We all know what will happen to us if we fall behind inflation.
Cash is liquid, above all else. The credit card commercial should say: "Cash. Don't leave home without it." Spends easily, instantly, no arguments, no service charges. While it's true that nobody will pay you much to hold it for you, you can get it back whenever you want it. There are no early withdrawal penalties, nor the sinking sensation of owning a 7%-paying bond which just lost 10% of its value.
Despite its low return, there is a lot of cash lying around.
"M-1" is an economist's most basic definition of cash: currency held by the public and balances in checking accounts. Total M-1 as of last week: a hair over one trillion dollars.
"M-2" is the more thorough accounting of cash: the sum of everything in M-1 plus savings accounts and money market funds. Total M-2 as of April: about four trillion dollars. Some real money, there: almost enough to pay off the national debt in one whack.
Cash is the Fed's game. Alan Greenspan is the Tiger Woods of cash. The Fed is not allowed to play any other games: not stocks, not bonds, not mortgages, not real estate. The Fed must achieve its objective (a stable currency, to the extent that politicians can stand the discomfort) solely by regulating the cost and supply of cash.
The term "tighten" refers to the Fed's ability to limit credit, which is accomplished by squeezing bank reserves. The Fed's current effort to slow the economy actually began in January: since then, bank reserves have fallen at a 20% annual clip.
This credit clamp used to be the Fed's great, irresistible power to slow the economy, back in the days before international electronic money. Now, the electrons tend to leak around the Fed's best efforts to strangle.
Today, the Fed has only one absolute power: it can change the cost of cash. Just cash. When the press says the Fed has tightened, it means that the Fed has raised one interest rate: the cost of overnight cash traded between banks (the "Fed funds" rate).
There are odd and unpredictable side effects when the Fed changes the cost of cash. The flip side of cost is value, and investors have greater relative interest in holding costlier cash. Relative to what? Inflation, for one thing; and for another, what else you might do with the cash.
In 1990, the inflation rate was 3.00%, and because an easy Fed was trying to engineer a recovery from recession, cash paid the same, meager 3.00%. It was silly to hold cash. Most investors preferred stock market risks to guaranteed zero.
By last year, cash had recovered to pay 5.25%, which beat inflation at 2.50%, but a net 2.75% real return was shabby compared to the stock market's 27% payout (one decimal over the cuckoo's nest).
Just when you think the "fully invested" Gucci Gulch guys are right in their contempt for cash, the S&P 500 chart looks like the Matterhorn, and your index fund isn't worth any more than it was at Christmas. Say, what do you suppose it will be worth next Christmas?
You're a buy-and-hold type, right? The S&P could be in for a little 10% oops-a-daisy, but it was bound to happen sometime. Cash is up to 5.50% now, going to 6.00% (did somebody say 7.00%?) by Labor Day. Five-and-a-half guaranteedÉ going higher.
Last week, money market fund deposits grew by $10.5 billion, a 92.4% annual growth rate. The Fed didn't mean to do it. Honest. "Irrational exuberance" was just an observation, not a threat. Market psychology is a funny thing.
Ah, well. It's only cash.
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