...And That's Making It Hard For Banks To Resume Lending

Whatever its cause, the cash explosion seems to be complicating the conduct of monetary policy. For one thing, it may explain why the federal funds rate--the overnight cost of money to banks that must borrow from each other to meet reserve requirements--actually hit 10% several times in late January, even as the Federal Reserve Board was trying to lower it to 6 3/4%.

Says Lacy Hunt of the Hongkong Bank group: "Currency on hand is counted as reserves, and banks that were caught short by a smaller-than-expected return flow of cash would have had to borrow more funds to fulfill reserve requirements. That demand may have pushed up the funds rate."

More important, the currency surge implies that the recent pickup in the M2 money supply isn't promoting the expansion of credit use the Fed is seeking. Some 89% of the rise in M2 so far this year reflects growth of currency in circulation and inflows to money-market funds. But cash in the hands of the public and money-market funds are outside the banking system and thus can't alleviate the banks' funding problems or increase their willingness to make loans.

"Until sustained M2 growth spreads to components like small CDs, money-market deposit accounts, and demand deposits," says Bruce Steinberg of Merrill Lynch & Co., "the threat of a credit crunch will haunt the economy."