M3 Is Contracting Now

Includes: DIA, SPY
by: Kay McDonald

There have been several very recent articles discussing the ongoing fears of deflation in Europe and Japan. Now, the United States' contracting M3 level is also being noted.

This Bloomberg article cites Spain and Ireland for being most at risk of deflation, noting spare capacity, high indebtedness and plunging spending. Germany and France are least at risk and there is a growing challenge facing the European Central Bank concerning policy due to these challenging economic variations between the countries. European economist Ben May calculates that "were the so-called output gap, a measure of excess of supply versus demand, to widen to around 4 percent of gross domestic product, that may push core inflation down 2 percentage points for every year it remains there." And although factories increased capacity usage on assembly lines for the first time in two years this quarter by 1.1 percent, May is not convinced the threat of deflation is over.

And this WSJ article reviews Japan's deflationary conditions. This past year wages have fallen, and food and clothing prices have fallen. Their aging demographics, low birth rate, and high national debt burden (equal to 190% of the country's gross domestic product) are problems that will not disappear anytime soon.

Ambrose Evans-Pritchard discusses M3 contraction in the eurozone and is brave enough to bring up the subject of M3 and deflation as related to the United States in this UK Telegraph article in which he states:

The picture is even starker in America where M3 has shrunk at an annual rate of 6.5pc over the last three months, a pace of contraction not seen since the 1930s.

Though the government stopped reporting M3 in 2006, two sources continue to track M3 data, "Shadow Stats" and "Now and Futures".

Perhaps it's time to take a look at the most recent chart from Shadow Stats:

Money Supply
Chart of U.S Money Supply Growth. M1,M2,M3

M1: M1 includes funds that are readily accessible for spending.

M2: Equals M1 + savings deposits, time deposits less than $100,000 and money market deposit accounts for individuals. M2 represents money and "close substitutes" for money.

M3: Equals M2 + large time deposits, institutional money-market funds, short-term repurchase agreements, along with other larger liquid assets.

(Abbreviated definitions from Wikipedia.)

And another M3 tracker, Now and Futures, provides us with this short term graph:


Note that my interpretation of the above graph is that, roughly, the annual rate of growth is slowing to downwards of 2% and trending lower. The M3 peaked at around 14.4 trillion and has dropped to roughly 13.8 trillion in a 3-4 month time period.

And, their long term graph:


And, then, this one goes back to 1915:


In another good discussion concerning M3 contraction, this quote from Washington's blog makes an excellent point about M3 as related to the deflationary side-effect of banks building up their capital:

But isn't it good that governments are requiring banks to raise their capital rations?

Sure, but unless they force the banks to write off their bad debts, they will remain giant black holes, and will never be adequately capitalized. If they are never adequately capitalized, they will never release money out into the economy through loans and other economic activity which increases M3.

As just one example, remember that the nominative amount of outstanding derivatives dwarfs the size of the global economy. As another example, remember that several of the too big to fails have close to a trillion dollars each in toxic assets in off-book SIVs.

IMF chief Dominique Strauss-Kahn says that the history of financial crises shows that "speedy recovery" depends on "cleansing banks' balance sheets of toxic assets". "The message of all financial crises is that policy-makers' priority must be to stop the quantity of money falling and, ideally, to get it rising again," he said.

It's too early to say where these trendlines will be six months or two years from now, but for now, the above graphs definitely show contraction.

Grey swans, anyone?

Disclosure: No stocks or ETFs owned.