Does Wealth Equal Money?

Economists who adhere to Milton Friedman’s concepts say that inflation keys off the money supply, although the number-keepers define inflation in terms of the prices of goods and services. So pervasive is the Friedman idea that lots of people now say the dollar will sink and inflation will reign because the government has been “printing” so much money and is planning to “print” even more - they equate the huge Federal deficits with an increase in the money supply. (I put “print” in quotes because most of the money is not cash - it’s accounts at banks that exist in the form of computer digits.)

But what if the money supply is more than M3 or M2, which measure institutional accounts where people and companies keep their “money”? What if the money supply also includes the net value (after debt) of people’s homes and their stock portfolios and the market value of privately owned businesses? In other words, what if wealth = money?

The wealth supply has been drying up over the past six to twelve months at a huge clip. Many trillions of dollars in the U.S. alone has disappeared - and a lot more than that in global terms. Federal deficits - both present and projected -are minor in comparison with the loss of wealth. Thus in this sense there are fewer dollars around compared with GNP. Therefore, the value of the dollar should be rising. And guess what? This what it has started to do. The U.S. dollar index is up about 9% since early September, 2008.

Does money = wealth? Well, we’ve been using houses like we use bank accounts and we sometimes use stock certificates in the same way. Charities are happy to accept stock certificates - so are many mutual funds that will create an account in exchange for stock. Banks will lend against either one, creating accounts which are certainly part of the money supply in anyone’s measure. Private companies also use their net worth to create new bank accounts when they see an investment opportunity. So it seems very likely to me that we must include these assets - normally called “wealth” rather than “money” - in the money supply.

And if that’s the case, then the money supply has been very much in decline over the recent past and is likely still declining. Therefore it is not surprising to see the dollar strengthening as equity values and housing prices continue to decline. And since both car loans and commercial loans are likely to increase markedly over the next year thus destroying a lot more wealth in the banking system, money supply is likely to continue to decline regardless of “huge” Federal deficits in the next few years.

If declining money supply means fewer dollars available compared with demand for them, the dollar may well continue to strengthen as the U.S. economy continues to suffer. A strong dollar also implies weak commodity prices (as denominated in dollars), including oil and perhaps gold which is also looking weak lately.

Of course, the counter-argument is that foreign dollar holders may want to sell them in view of U.S. budget deficits. My guess is that foreign dollar holders don’t have much alternative. Name a strong economy with a fiscal surplus and a liquid currency. I don’t know any such animal. Moreover, if the dollar does continue to strengthen, that will also give foreign holders the confidence to continue holding dollars.

This point of view was circulating in my mind when I read an analysis by Hoisington Investment Mgt. Co. forwarded by John Mauldin. It stated the following:

The late Nobel Laureate, Milton Friedman, noted in his 1963 book, Monetary History of the United States (coauthored with Anna Swartz), that the money stock decreased by a massive 31% in the Great Depression. The turnover of that money, called velocity, fell 21%. Nominal GDP equals money multiplied by velocity. Consequently, from 1929 to 1933 the breakdown of both measures resulted in a contraction in nominal GDP of approximately 50%. However, Friedman postulated that if the Fed had not let money shrink, velocity would have been steady and the Great Depression would have been averted, i.e., nominal GDP would not have collapsed.

If you consider equity and housing values as another component of “money”, how much more dramatic than the quoted decline of 31% was that of the Great Depression? I can’t quantify the decline to date in either traditional money supply or total wealth. But it has to be huge.

American banks include trillions of dollars of assets on their books that are presently known to be toxic (collateralized debt obligations - CDO’s) and even more loans based on cars and commercial real estate that are expected to become toxic in the next year or so. These assets are very much part of the money supply. Their decline in value and their lack of liquidity are a major reason so many banks are not making new loans. They are why Krugman and others are saying that many banks are worthless and need to be recognized as such, liquidated, and consolidated and not “bailed out” by federal cash.

John Mauldin seems to be in substantial agreement with these ideas. In his 1/17/09 letter he wrote the following:

We got the Consumer Price Index numbers today, and they tell a tale of deflation. On an annualized basis, the CPI for the last three months was a negative -12.7%! Even core CPI, which is without food and energy, was a minus 0.3%. The CPI for 2008 was just 0.1% for the whole year. This was the smallest calendar-year increase since 1954, and it’s down from 4.1% for 2007. (To see the whole release and data, you can go to www.bls.gov.)

As I have been pounding the table about, a credit crisis and imploding balance sheets, a housing crisis, and a massive earnings shortfall that yields a relentless stock market drop are all independently deflationary. The combined forces are massively so. To think that a mere trillion or so dollars in stimulus will be enough to reflate the US and the world economies is simply not realistic.

A liquidity trap is a situation in monetary economics in which a country’s nominal interest rate has been lowered nearly or equal to zero to avoid a recession, but the liquidity in the market created by these low interest rates does not stimulate the economy. In these situations, borrowers prefer to keep assets in short-term cash bank accounts rather than making long-term investments. This makes a recession even more severe, and can contribute to deflation. (Wikipedia)

He said it better than I. I just had to say it in my own words to feel like I understand it. In either case the conclusion has to be the same: one should be very careful about owning stocks. And if I’m right about the dollar actually getting scarce despite huge federal deficits and thus leading to dollar strength, then oil and most commodities - and therefore oil stocks - will not fare any better than the average stock, perhaps worse.

Mexico

Incidentally, my favorite short is the Mexican peso. Mexico has been holding interest rates extraordinarily high for many months which has kept the decline in the peso to only the 30% +/- that occurred in September and October last year. Mexico announced last Thursday that its weak economy requires it to reduce interest rates. Have you ever seen only one interest rate reduction? No, they come in waves, and I suspect this is the first of many to come for Mexico.

As I’ve written so often, Mexico is dependent on oil exports to support over 40% of its federal budget. It cleverly fixed its oil export prices at $75 through the fall of 2009 by hedging but that will run out soon enough. More importantly, their production is falling, oil exports are falling even faster, and Mexico could become an oil importer within five years. Add to all that a major drug war and endemic political corruption in Mexico and you get a very sick and potentially dangerous country.

I think Mexico is a major debacle in the making. And if Mexico gets pneumonia it will be hard for the U.S. not to catch some part of the bug.

Comments

[copperpenny:]

Thanks for a stimulating point of view.

Jan 20 06:42 PM

[Steven Hansen:]

i read the John Mauldin newsletter and i think you got the point across better. i for one believe wealth = money. the tens of trillions of dollars of wealth destroyed worldwide combined with the trillions of dollars of additional government debt (future money) has put money in a pretty deep canyon with steep sides.

Jan 20 09:17 PM

[Jim Kingsdale:]

In para. 5 I said car and commercial loans will increase. I meant to say defaults in car and commercial loans will increase. Sorry.

Jan 21 01:15 AM

[Conan the B...:]

Money may not equal wealth, but it is much better to have it than Not.

One of my favorite commentators(me), NOWHEREMAN listed his predictions for 2009 in an Article for "2009 predictions" on January 2, 2009 at 2 AM CDT.

Less than 3 weeks later All but one are up at least 50%, The one is up almost 200%.

Of the "safe" selections listed one is down 10%, the other two are up on average 20% excluding monthly tax free dividends of more than 10%.

Oil dropped and the dollar rose. But I have missed on gold so far.

But as the Dollar continues to climb and risk aversion continues to pervade the Economies of the World, Gold which is the "Last Man Standing" will succumb to the unwinding of all things leveraged.

"Blood in the Streets" does not equate to calling for Market Bottoms by Both Bulls and Bears. Blood in the Streets means "I will never Invest again". An aversion to stocks in general. We are not there yet.

FDR did not push his economic agenda for two months prior to taking office. Everyone was on the same page during the Great D. Not this time. There is no unity.

Our New proposed Secretary of the Treasury is the man who helped push Lehman into bankruptcy and is a proven Tax evader...what a great Change.

I've looked at hundreds of comments in the last few days, nothing has changed. Everyone blames everyone else for the Nation's problems.

It is the same "foxhole" but everyone still wants a hatchet to be buried into everyone else's back.

No one seems to Really believe the Nation is in a Crisis.
Watch the "new" unity in Congress evolve.

A day's bounce is likely but China is going to Report 4th quarter GDP in a couple of days, it is expected to come in at 6.8%. What if China, the Savior of the West, has a smaller rise, say 6%, what will that do to stock markets around the World?

Jan 21 01:30 AM

[Conan the B...:]

JK: Got one for you, an infrastructure play posing as a refiner. Alon energy(ALJ), Israeli owned, has had refinery problems (fires) and the associated costs with bringing them back on line but they appear to have that segment under control with the Bonus that most are Heavy/sour refineries.

ALJ bought a company called Giant Industries a few years back. I knew of it when it was a standalone.

You know the Drill, you have to do your own DD.

PS Finally bought more ZNNMF at $1.899, Looking forward to Eestors patent description.

Jan 21 01:45 AM

[fran:]

wealth is a properly selected and managed set of assets which have a market. in answering this, i refer back to the origins of men's tendency to barter in order to survive. thus the invention of markets and "money" to make the process more efficient. if "it" can be traded and you possess/control it, "it" is wealth. but wealth could be good health and friendship, also.

eyes of the holder or beholder?

Jan 21 09:47 AM

[fatpitch2:]

Jim:

Any thoughts on the "net" effect on interest rates for LT treasuries?

I do agree that we have vaporized far more "virtual" dollars than the puny stimulus levels can (currently) overcome... but I do expect our government to keep trying harder and harder....

Here we are at what... ~2.25% which is what a 200 year low, and implies that buyers do not expect any inflationary pressures for 10+ years?

This in a bond environment where the government is ever rolling over existing debt and piling on new debt at a rate in excess of $1T+ per year for the next several years?

Thanks!
Jim

Jan 21 10:33 AM

[Paul Killinger:]

Very well sated, sir.

We'll have to wait to see how this all pans out. Right now everyone is simply trying to regain their footing.

But if printing money alone were a good thing, the Weimar Republic would have been the richest society in the history of the world. As we know, it didn't turn out that way.

Jan 21 12:01 PM

[Obama is Bu...:]

Jim, so if you want to argue that wealth=money, and collapsing wealth is equivalent to a collapsing money supply (aka deflation)... I have to ask the very obvious question:

When "wealth" was increasing 15-20% per year (housing notably) from 2001-2006, did you advocate that Fed Funds should be increased to match that "inflation"? Can you provide a link to an article where you make this argument?

I have asked this question of all the deflation advocates -- and not one has replied.

If you want to argue that wealth = money, then it should also hold when times are good -- otherwise, you are simply arguing for keeping rates perpetually too low

Please give us the link to the article in which you argued for 15-20% Fed Funds during the boom

Jan 26 02:10 PM