Predicting Recessions The Easy Way: Monetarists, MMT, And The Money Stock

Aug. 24, 2015 2:08 PM ETSPY, SH, SSO, SDS, VOO, IVV, UPRO, SPXU, SPXL, RSP, RWL-OLD, EPS, VFINX, SPLX, SFLA-OLD, SPUU, RYARX12 Comments
Steve  Roth profile picture
Steve Roth
39 Followers

Summary

  • Recessions are reliably predicted over the last half century by declines in real household net worth.
  • Stock investors leaving the market as of the decline reported in the March 6, 2008 Fed Z.1 report avoided the 50% S&P decline over the next twelve months.
  • This pattern reveals a modified "monetarist" view of the economy, with real household net worth representing the "money stock." When households have less money, they spend less.

If you see a year-over-year decline in real household net worth, you are just into, or about to be into, an NBER-designated recession.

That's been true in the U.S. since the late 60s (click for source):

Every time this measure went negative, a recession ensued -- with one exception: Q3 2011. It's eight for seven over the last half century. Change the criterion, "YoY decline greater than 1%," and it's seven for seven. Yes, that's a small sample size, but...

If you'd followed this indicator as an S&P 500 investor, you would have gotten out of the market on release of the March 6, 2008 Fed Z.1 release (which showed a 3.2% YoY decline in real household net worth as of Q4 2007), avoiding a 50% market decline over the next twelve months.

This has me thinking like a monetarist, but with a very different definition of the "money stock" (or the utterly incoherent term, "money 'supply'"): Real Household Net Worth (inherently including the net worth of all firms, which are ultimately owned by households).

Key emphasis here: "Net." Hold that thought.

When the quantity of money declines (absent a matching runup in velocity), spending declines. So production and employment decline. It's a fairly simple and straightforward (behavioral) economic story: When people have less money, they spend less. Big surprise. (Pace the monetarists, the proportion of that money that's stuffed in mattresses is rather immaterial to how much they choose to spend.)

If this definition of the money stock holds water, we need to think about what affects the money stock. Short answer, in strict accounting terms:

• Government deficit spending. The government spends dollars into existence, ab nihilo. Sovereign currency issuer and all that. Pure Modern Monetary Theory.

• Runups and declines in existing-asset markets. (This will raise

This article was written by

Steve  Roth profile picture
39 Followers
Steve Roth is a Seattle-based serial entrepreneur, investor, and student of economics.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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