Ambrose Evans-Pritchard has a bold headline US Money Supply Plunges at 1930s Pace that is sure to provide much referential action for the UK Telegraph.
I like to read AEP, but have to admit that he is given to sensationalism on occasion. That is because it sells papers, and also draws blog clicks, as posters on the web are wont to emulate that style as well. Fear sells.
But there were some disturbing elements to this particular piece in addition to its florid headline.
The US stopped publishing M3 several years ago. At the time I was not happy about this, and complained quite a bit.
Several enterprising fellows, including my friend Bart over at Now and Futures, as well as John Williams at Shadowstats.com, have been attempting to extrapolate the M3 figures, and doing a fine job given what they have to work with.
I cannot tell what source for M3 that AEP is using since he does not cite the source of his alarming, screaming headline information.
Here is a quick review of the components of the Monetary Supply figures including M3 for your review. You may also wish to refresh your knowledge here: Money Supply a Primer.
The chief component that is ‘missing’ these days which must be estimated is “eurodollars,” which as you may recall are US dollars being held overseas. You know, those dollars that Bernanke has been sending over to Europe en masse lately through the swaplines.
The fellows can estimate this, but the reporting of eurodollars lags by a quarter or more, the only reliable source of information being the forex commercial banking reports from BIS.
I would very much like to have M3 back, but in particular I would like the Fed to be releasing a more accurate and contemporary measure of Eurodollars, the dollar overhang overseas, particularly in light of the huge swings in the DX index, and its almost undeniable relationship to the recent dollar short squeezes on the European banks.
But alas, we do not have this, so we can only estimate M3, particularly the eurodollar component.
But the good news is that we still have both M2 and MZM.
Here are the most recent figures for MZM and M2 from the St. Louis Fed, expressed as a per cent of change YoY, not adjusted for seasonality. For good measure I have added GDP and PPI Finished Consumer Goods in the mix.
MZM is the broadest measure of liquidity, and is very much a creature of the Adjusted Monetary Base. As one can see from the chart, the Fed, using their various policy tools, jams the short term money supply higher in response to a lagging economy, and the broader measures like M2 tend to follow with a lag.
The Fed then backs off, and waits to see the effect of their actions, as well as any accompanying fiscal programs, on the real economy as measured by GDP, with an eye on inflation. In this case I am using PPI, but I do greatly prefer John Williams’ unadulterated CPI measure. Unfortunately I do not have it handy in the right format for this study. But PPI will suffice.
Now, looking at this chart, it appears that the Fed is following their usual gameplan. The excess reserves that the banks are holding, at least indirectly in response to the balance sheet expansion and interest rate payments on their own deposits by the Fed, are enormous and unprecedented. If the Fed were to start pulling some levers to motivate those reserves into the real economy through loans, the impact could be dramatic. The Fed will do this if their fear of inflation begins to be overcome by their fear of deflation.
Right now it appears to me that they are overly preoccupied with the status of the biggest of the banks and their asset quality problems an under stimulating the real economy. I think this will be regarded as a policy error as were the actions of the Federal Reserve in 1932 wherein the Fed overreacted to a spike in CPI and tightened prematurely.
I am not saying what MUST or WILL happen. I am not arguing from theory. I am just attempting to demonstrate what is happening now based on the data. And right now Ben is indeed printing money, and figuratively dropping it from helicopters. The problem is that the helicopters are hovering over Wall and Broad Streets, and not Main Street.
If you want to know the theory, in a perfectly fiat system (no external standard constraint) deflation and inflation are always the outcome of policy decisions amongst a number of variables and competing interests. Period. Anyone who does not understand this does not understand money.
Once the US relaxed its adherence to the gold standard by devaluing the dollar, deflation became a moot point. What was not handled well was the continuing lack of aggregate demand because of the resistance of the Republicans in Congress to jobs creation, and the overturning of most of the New Deal initiatives by the US Supreme Court.
I am not saying what the ‘right thing’ to do is. But what I am attempting to get across is that one way or the other, excess financial sector debt is going to be liquidated, either through default, or through inflation, or through a mixture of higher taxes and sluggish growth with a disparity of income that increasingly resembles 19th century serfdom.
At some point this dynamic is going to become less ‘economic’ and more political and the equilibrium will be reached. A good leading example of this is in Iceland.
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