Money Supply Growth? It's Much Worse Than That!

Early last week, my pal Larry Kudlow showed a chart of M1. His purpose was to demonstrate that the growth of the money supply was modest, therefore future inflation expectations would/should subside. Hence, this would leave the Fed free to slash rates much further.

The unspoken subtext was this was needed to bail out a weakening economy and an increasingly volatile stock market.

If you want to prove that the Fed has been stingy, M1 is the wrong data point to use -- it paints a misleading portrait of money supply, as the nearby chart reveals. The Fed, as we have seen, has been doing their work not via the printing press, but rather through the Repo Credit market, with near daily repos, along with a little help from their Euro-buddies (who just injected half a trillion dollars of short term notes into their system).

M1 is merely physical currency, plus demand accounts. What you really need to see is M3, which includes eurodollars and repurchase agreements (hey, what do you know! The Fed no longer reports M3. What an astounding coincidence!).

Forget the printed dollars and focus on the rapid creation of credit by the Fed -- not actual paper dollars for the metaphorical helicopter drop, but actual credit -- and we discover an even uglier truth: The Adjusted Monetary Base (See St. Louis Fed chart below) is collapsing EVEN AS MZM GROWTH IS MOVING TO NEW HIGHS. As Bill King points out, this means that "Capital is now being destroyed faster than credit can grow."

Net net, all these liquidity injections are merely moderating the collapsing credit facilities, and not actually injecting much in the way of credit into the economy.

Credit Collapsing Faster than it can be created:

Courtesy of St Louis Federal Reserve Bank

Signs of economic weakness abound, despite the massive injections of credit and liquidity.

Deep down inside, I suspect Larry realizes that much of the "boom" from 2002 til '07 was driven by the absurdly cheap money -- and not tax cuts, as has been argued by many on his show. Just about everything from share buybacks to M&A to private equity bids to the Housing boom and MEW driven consumer spending to weak dollar led export boom were functions of ultra-low rates. Now that cycle has ended, and we are seeing the repercussions of the irresponsible policies of Alan Greenspan.

Time and time again we observe that *TANSTAAFL . . .

UPDATE: Here's the requested shadow Fed M3 chart:

Sources:

*TANSTAAFL: "There Ain't No Such Thing As A Free Lunch"

Monetary Trends (pdf file)
Research Division, Federal Reserve Bank of St. Louis
JANUARY 2008
http://research.stlouisfed.org/publications/mt/20080101/mtpub.pdf

Comments

[flow5:]

Since the DIDMCA the money supply has become unknown & unknowable.

Even so, what went for M2 went for M3. And M2 erroneously includes MMFs in its definition. MMFs are the customer's of the commercial banks. They are financial intermediaries.

Monetary savings are never transferred from the commercial banks to the intermediaries; rather are monetary savings always transferred through the intermediaries. Whether the public saves or dis-saves, chooses to hold their savings in the commercial banks or to transfer them to intermediary institutions will not, per se, alter the total assets or liabilities of the commercial banks; nor alter the forms of these assets or liabilities.

Financial intermediaries (MMFs) lend existing money which has been saved, and all of these savings originate outside the intermediaries. The utilization of loan-funds or activation of monetary savings by these financial intermediaries is captured thru the velocity of their deposits (bank debits/withdrawls), not thru the volume of their demand deposits.

I.e., from the standpoint of the economy, MMF deposits never leave the CB system. And the growth of the MMFs is prima facie evidence that existing funds/savings have already been spent/invested (transferred) by their owners/savers to borrowers. I.e., this represents a double counting.

Even now, M3 is meaningless as is the monetary base [sic]. Monetary flows (MVt) are rising.

2007 Dec 23 02:49 PM

[flow5:]

When did Kudlow "get religion"?

2007 Dec 23 03:10 PM

[flow5:]

When did Kudlow get religion?

2007 Dec 23 03:10 PM

[EL-GRECO:]

so, presumably the gentleman who wrote this article has fully sold his us dollars, us treasuries, and us stocks? where is he invested and in what currency?

2007 Dec 23 08:12 PM

[armadillo:]

Why do you think they stopped measuring M3.......

2007 Dec 24 02:30 PM

[Sr. Pessimist:]

M3 non self-sustaining, eh? M2 might be harder to hide. One-time pad is only good for one use. M1 is still money. M0 is less effective than barter given some straightforward counterfeit methods. I don't know what America is going to do without an effective money system. It's just open-season for cyber attack on the capital systems. Baby. Maybe we literally do need helicopters dumping cash on the streets. Whir the actual printing press, spin out M0, expire all computerized currencies, and load the helicopters with cash. Then dump the cash on the streets.

What I think would be cool is if they gave all the women money and took all the money away from men. Then men could go chasing after women for their money, and if the men put out for the women, then the women could buy the men dinner. Then women would know what it's like to be preyed on like that. So I could get paid and fed to date whatever girl wants me instead of the other guys.

So let's us make a mathematical milestone on the Riemann Hypothesis, kill off all residual practicality of using electronic currency exchange, huddle all the women on one side of a fence and all men on the other, send the helicopters to the women's side, and let them drop the cash. Then the girl who offers me the best entire package, where money is just an element of stability (or some bull like that), then I could get laid and get paid and get fed just because I've got bigger muscles and bigger other stuff than the other guys. Then when I cheat on her and we divorce then I could sue her for child support and alimony, as she is the default provider.

Then two additional years pass by.

2007 Dec 24 07:58 PM

[Kunst:]

Brian: What if those women decide to keep the cash and let you find your own dinner? They're not men, after all.

2008 Jan 03 04:09 PM