M3's False Signal: Deflation Scare Doesn't Mean Deflation

Steve Saville has a very nice piece this morning on the M3 money supply and its 'false signal' juxtaposed against the story being told by the more accurate True Money Supply [TMS].

The chart (courtesy of nowandfutures.com) shows the alarming drop off in year over year M3. Can you say 'deflation scare, here we come'?

M3 and TMS usually trend in the same direction, but on those occasions when they diverge in a big way -- as they did during 2006-2008 and also during the early 1990s -- we can safely assume that TMS is providing the more correct information about what's happening on the monetary inflation front. The reason is that M3 contains Money Market Funds (MMFs) and Time Deposits (TDs), neither of which are money*.

We are re-visiting this issue now because another big divergence between M3 and TMS is currently brewing, but whereas last year's divergence encompassed rapid M3 growth in parallel with slow TMS growth the latest divergence encompasses the opposite.

Key word: Scare. Now of course, first we will need to work our way through the summer party and some of the targets that have been dialed in (by NFTRH at least) since April or so. Yes, I have had to abandon the bullish view of a short term decline to a major inverted head & shoulders on the SPX (and its ultimate target above 1200) in favor of something more dangerous, a bull party summer blow off.

But there is a good chance that people taking the market higher now care not a whit about M3, TMS or anything other than a good play in which to offload the latest trade. I notice an increasing volume of come-lately contrarians out there now, bullish now that the market has given them permission to take such a daring stance, nearly 300 SPX points higher than when it was appropriate.

The world keeps turning, herds become compelled to look that way [M3] when they should be looking this way [TMS] and the few will profit from this through clarity and patience. It's the way markets work.

Separately, Saville also states the following about Japan's 'bridges to nowhere' policies that the US is now following. As I have been saying, massive spending into non-productive ends will only prolong the problems. Sad but true. Beyond Japan, take a look at our own sad history of the 1930's.

Rather than attempting to 'solve' its problems by promoting rapid monetary inflation, Japan's Government has relentlessly tried to generate sustainable growth via massive debt-financed spending on public works. This strategy has drained much-needed capital from the private sector and consumed it in non-productive ways, such as in the building of bridges to nowhere. As a consequence, what would probably have been a severe 2-3 year contraction has been transformed into a seemingly endless slump that is now into its 19th year.

Comments

[yellowhoard:]

Wow!

Breathtaking chart.

Time to take profits.

Jul 21 08:32 AM

[Mayer Amsch...:]

Didn't we already have the deflation scare? I guess we need another one to complete the third leg of the "W".

Jul 21 09:22 AM

[Gary Tanashian:]

That would be my thesis. Watch the dollar. Uncle Buck had better get his act together or the deflation scare scenario will be kaput.


On Jul 21 09:22 AM Mayer Amschel Rothschild wrote:

> Didn't we already have the deflation scare? I guess we need another
> one to complete the third leg of the "W".

Jul 21 10:28 AM

[Moon Kil Woong:]

Japan didn't build bridges to nowhere, that was Alaska. Japan tried to build a entire city in te ocean than no one lives in and remains uncomplete to this day.

As yellowhoard pointed out, thanks for the chart. I also generally agree with the Gary Tanashian's conclusion so thanks for the article too.

Jul 22 04:16 AM

[flow5:]

Steve Saville is ignorant. CB time/savings deposits, unlike savings-investment accounts in the “thrifts”, bear a direct, virtually one-to-one, unvarying relationship, to transactions accounts. As TDs grow, TRs shrink, pari passu, and vice versa. The fact that currency may supply an intermediary step (i.e., TRs to currency to TDs, and vice versa) does not invalidate the above statement, etc., etc.

If the “store of purchasing power” attribute of money, when applied to a given asset, is to have significant meaning, it ought to be defined in terms which are applicable to the whole economy. That is, no asset really has a “monetary store of purchasing power” quality unless there can be a net conversion of that asset into money, ceteris peribus. In other words it must be possible to effect this conversion without necessitating that any present money holder reduce/liquidate his holdings/assets.

Any other interpretation becomes mired in a futile discussion of relative degrees of confidence and liquidity. But much more than monetary liquidity for the individual holder is necessary if an asset can be said to have the “store of purchasing power” quality; it must be simultaneously monetarily liquid for society as a whole.

Jul 22 12:13 PM

[Gregman2:]

You seem to be advocating rapid monetary inflation qua expansionary TMS (versus debt financing for capital projects). Shouldn't you also consider a liquidationist approach as a comparison? The fact is, wealth is overly concentrated and not circulating, and there's too much personal debt in the system.

Jul 22 12:45 PM

[Chancer:]

Vanguard told me that their Tips fund earned zero this year because we are in deflation.

Jul 22 02:30 PM

[flow5:]

Money should be defined in terms of its means-of-payment attributes. The present array of interest-bearing checking accounts has confused the distinction between means-of-payment accounts and savings-investment accounts and created a dilemma as to what portion, if any, of this interest-bearning accounts should be considered as savings. This delemma is resolved if transactions velocity is taken into account; i.e., the M's are analyzed in terms of monetary flows (MVt).

From the standpoint of monetary authorities, charged with the responsibility of regulating the money supply, none of the definitions makes sense. The definitions include numerous items over which the FED has little or no control, including many the FED need not and should not control. The definitions also assume there are numerous degrees of "moneyness", thus confusing liqudity with money (money is the "yardstick" by which the liquidity of all other assets is measure). The definitions also ignore the fact that some liquid assets have direct one-to-one relationship to the volume of demand deposits (DD's), while others affect only the velocity of DD's. The former requires direct regulation, the latter simply is important data for the jFED to use in regulating the money supply.

In defining the money supply, a distinction should be made between the public and the monetary authorities. From the public viewpoint currency and checkable deposits, credit cards, traveler's checks, ATS accounts, etc. serve directly or indirectly as money. From the monetary authority's point of view, money has to be confined to assets that constitute means-of-payment and are controllable. Currency is not such an asset, Fortunately it is an asset the FED does not, should not, and cannot control. There is no inflationary bias in an expansion of currency, and the deflationary bias resulting from its growth, can, and is, offset through the expansion of Reserve Bank Credit.

Jul 23 07:24 PM

[flow5:]

The source of ALL TIME/savings deposits within the commercial banking system, are demand/transaction deposits - directly or indirectly through currency or their undivided profits accounts.

Money flowing "to" the intermediaries (non-banks) actually never leaves the com. banking system as anybody who has applied double-entry bookkeeping on a national scale should know.

The growth of the intermediaries/non-banks cannot be at the expense of the com. banks. And why should the banks pay for something they already have? I.e., interest on time deposits.

Jul 23 07:29 PM