Thursday, January 7, 2010

Follow the Money -- Into a Double-Dip

Something we first noted six months ago, links below.
From Barron's Up and Down Wall Street column:

Shrinking real money supply is likely to nip any recovery in the bud.

ONE OF THE IRONIES OF MONETARY POLICY as it is currently practiced is that it has little to do with money.

While lip service may be paid to something called the money supply, the Federal Reserve and its cohorts actually fiddle with interest rates in attempt to set the economy on a blissful course of full employment and stable prices.

But money still matters, even if policy-makers ignore it.

Indeed, four years ago the Fed ended tracking the broadest measure of the money stock, known as M3. To fill that gap, John Williams Shadow Government Statistics ( estimates M3 from published sources as part of his mission to strip away the obfuscation prevalent in many government economic statistics.

The Fed still publishes the narrow measure of money, M1, consisting of currency and checking deposits; M2, which adds consumer savings and money-market accounts, and MZM, or Money of Zero Maturity, which includes M1 plus other accounts with check-writing privileges, such as money-market funds.

But M3, which takes in savings and institutional deposits, arguably is a superior measure of the liquidity in the economy. During the credit bubble from mid-2005 to the beginning of 2008 (just when the Fed stopped publishing M3 data), the broad money measure soared, attesting to the gusher of liquidity evident to all. The official M's failed to reflect the massive liquidity expansion during that time.

Now, Williams writes, SGS' estimate of M3 is signaling the opposite; it is shrinking in real terms, that is, after adjusting for inflation. That's happened only four times before last November, and each time it signaled either the onset of a major recession or a sharp deterioration in a contraction already underway.

"Not all economic downturns are triggered by liquidity crises, but all liquidity crises trigger or intensify economic downturns," he asserts.

The notion of a tightness in the money supply seems to fly in the face of all the "money printing" by the Fed since the intensification of the credit crisis in the fall of 2008. But what the Fed supplies is the monetary equivalent of crude oil to the economy, which actually runs on the refined product analogous to gasoline -- money and credit supplied by the banks. And it is those banking "refineries" whose output has been lagging, resulting in a now-shrinking broad money supply.

Based on currently available data, SGS estimates real M3 in December is down 3.2% from a year earlier. Before adjusting for inflation, nominal M3 is down about 0.7%, only the second year-over-year decline since modern reporting of the aggregate began in 1959....MORE

*Prior posts:

Pulling the Plug on the Market: M2 Money Supply Now Declining

Commentary: The Fed is now quietly taking money out of the system