Another Week of No Money Supply Growth

Last week the Federal Reserve once again announced that money supply as measured by M2 declined on both a seasonally and non-seasonally adjusted basis. For the week ending August 18th, money supply shrank on a seasonally adjusted basis by $10.5 billion and on a non-seasonally adjusted basis by $8.9 billion. The rate of growth of money supply since the middle of March, 2008, has been very low which reflects a hawkish Fed stance.

Since March 2008, after adjusting for inflation, money supply has been shrinking at a rapid pace and the strengthening of the Dollar and the decline in commodity prices are reflective of tight monetary policy. As stated years ago by Milton Friedman, the level of interest rates is less important than the rate of growth of money supply when trying to read economic “tea leaves”.

By holding the Federal Funds rate low but restricting money supply growth, the Federal Reserve is attempting to hold the line on inflation while encouraging an upward sloping yield curve (i.e., longer term Treasury securities paying higher interest rates than shorter term Treasury securities).

The upward sloping yield curve tends to increase the core earnings power of the banking sector which should help repair the damaged banking sector.

Ben Bernanke and the Fed remain on the inflation watch and continue to balance competing interests with expertise in monetary policy rarely seen in central bankers.

Comments

[MarvinMBA:]

If thats true I'm waiting for bank interest rates to rise which really has not happen...the time premium in non-existant and many 7 month rates are higher than 4 year rates believe it or not. Investors are staying short term...how long do they have to wait to get a reasonable time premium?????? I think your comments are just wrong at this time. Lets take a look at this a few months down the line because its just not happening now!!!!

2008 Sep 02 11:31 PM

[GKM:]

That makes complete sense. The Fed is doing everything to bail out the banks who fed the crack/debt to the public and now will raise the long rates on that crack/debt so that history will continue to repeat itself. As long as Joe Public doesn't know the myriad ways he's getting screwed, all is well.

2008 Sep 03 12:18 AM

[flow5:]

The importance of Vt in formulating – or appraising monetary policy derives from the obvious fact that it is not the volume of money which determines prices and inflation rates, but rather the volume of monetary flows (MVt) relative to the volume of goods and services offered in exchange.

The evidence of inflation is represented by “actual” prices in the marketplace. The “administered” prices of the world’s oil producing countries, would not be the “actual” market prices, were they not “validated” by (MVt), i.e., “validated” by the world’s central banks.

2008 Sep 03 10:43 AM

[Matt Blackman:]

According to a third party estimate of M3 thanks to the myopic decision by the Fed to reduce transparency and discontinue the series, it was growing at 16% the last time I checked.

Inflation may be moderating but it has nothing to do with Fed restrictions. Good to his promise, Bernanke continues to throw money out of helicopters and the macro picture remains a concern (see tradesystemguru.com/co.../ ) Week to week changes are of little consequence. And besides, its an election year. Any government or Fed sponsored report must be considered highly suspect.

2008 Sep 03 12:37 PM

[Mark Sunshine:]

I am the author.
My company is very active in the capital markets and is a lender. The time premium is a bit skewed but is still there. I think that the reason that it is not what you might expect is because there arebig credit and liquidity premiums in various maturities that are overwhelming the time premium and causing distortions. I know of good quality short term commercial loans that are clearing the markets in the mid to high teens (the sector of lenders is out of cash and the risk premium is high) while at the same time there are certain 30 year mortgages that are clearing the markets in the single digits (which is a wide spread by historical standards but not in the double digits). The difference is where there is government or other liquidity support and where there isn't.
On the topic of M3, I wrote a blog article a couple of weeks ago that pointed out there are no one can calculate M3 because the government no longer publishes the components of M3. Moreover, the Fed stopped publishing the actual compilation of M3. M3 was too distorted by factors that were irrelevant to its usefulness as a predictor of economic activity.
Thanks for reading the blog and thanks for commenting.

2008 Sep 03 10:45 PM

[Ricknplano:]

The comments above criticising the Fed for gaming the system to help the banks at the expense of the public are forgetting the reason the Fed exists at all. The Fed was created to protect the banking system, to make sure banks are solvent, as their first and primary responsibility. They have no mandate to protect the public except indirectly as they maintain, if possible, a vibrant financial system. So the Fed policies used to keep bank profits high at the expense of depositors and others is exactly what they are charted to do.

2008 Sep 17 01:45 PM