Money Supply Indicator Supports Deflation Argument

The chart below plots three widely used indicators of the US money supply: TMS, MZM and M2.

M3 was widely used, although the Fed stopped publishing M3 around the time Bernanke got in. ShadowStats attempts to recalculate it.

Defining those terms:

TMS is the currency component of M1, total checkable deposits, savings deposits, U.S. government demand deposits and note balances, demand deposits due to foreign commercial banks, and demand deposits due to foreign official institutions.

M2 is defined as total cash in circulation (outside banks) and balances in the domestic currency on accounts of resident non-financial organizations and individuals.

MZM is equal to M2 less time deposits, plus all money market funds. It measures the supply of financial assets redeemable at par on demand.

M3 is M2 + all other CDs (large time deposits, institutional money market mutual fund balances), deposits of eurodollars and repurchase agreements.

There is no end to the debate as to which money supply indicator is best. Some commentary:

• The Mystery of the Money Supply Definition (pdf)
• Mish's Global Economic Trend Analysis: Money Supply and Recessions 
• On the Money Supply definition Issue - Mises Economics Blog

While I didn't always think so, I recently changed my mind and now favor MZM as the most meaningful indicator.

Of the indicators noted above, only MZM has declined in the latest calculation. In any event, the conditions we're seeing now -- strong demand for US Treasuries, rising US dollar, declining global equities markets -- are indicative of a deflationary environment. Traders can play it accordingly, though I personally still think we will see a resumption of an inflationary environment within 36 months.

Disclosure: I am short USDJPY.

Comments

[flow5:]

No money supply figure standing alone is adequate as a "guide post" to monetary policy. & the money supply is unknown & unknowable.

2008 Oct 29 12:21 PM

[John Lounsbury:]

Simit - - -

You are very close to my own assessment. However, since all the complexities of our current financial structure (or lack of structure) are not understood, I feel these assessments are more guess work than analysis.
Nonetheless, you should keep on trying to make sense out of where we are and where we may be heading. Eventually, there will be good quantitative work and you may contribute to it.

2008 Oct 29 01:08 PM

[doubleguns:]

Simit, I am curious if you consider gold and silver eagles as money too. They are redemable as cash but hold a much larger value as a precious metal. The government controls the creation of them and thus should know how much of this money they have issued into the market.

2008 Oct 29 01:23 PM

[Simit Patel:]

@doubleguns, yes, i would think gold and silver eagles would be factored in if we use MZM as our money supply indicator, as they are redeemable by cash. i believe, however, we are seeing price suppression in the metals market, and thus these coins are not being given their fair value when redeemed for cash. to the extent we are seeing this type of price suppression MZM is probably less deflationary than it seems.

2008 Oct 29 04:40 PM