Tuesday, March 24, 2009

Real money supply: surging in some countries, not so much in others

The Fed's recent and extreme policies have made people nervous about inflation. They should be, but just not right now. Key central banks recently added hydrogen to their engines in the form of quantitative easing, causing high-powered money to surge. However, the multiplier is collapsing, and therefore, the new base is simply a measure to keep the money supply afloat. Some economies, though, are showing worrisome trends in their money growth rates.

The chart illustrates the 6-month annualized growth rate of the U.S. monetary base, commonly referred to as high-powered money. High-powered money is bank reserves plus currency, which does not cause inflation until it gets lent out to consumers and firms and turns into money. I like the 6-month growth rate because it captures more recent policy measures.

The chart illustrates the 6-month annualized growth rate of the broad measure of real money in the U.S., the U.K., Japan, and the Eurozone. In spite of the massive surge in the U.S. monetary base, 231% over the last 6 months, the real U.S. money supply grew just 22.6% over that same period. Can you imagine what would have happened had the Fed not eased so substantially? Troublesome deflation. The money multiplier is collapsing as banks hoard cash and consumers and firms pull back.

Furthermore, like the Fed, the Bank of England (BoE) is engaged in quantitative easing, resulting in a similar 6-month money growth rate, 22.8%. The ECB and the Bank of Japan (BoJ) are still increasing their broader measures of real money on a 6-month basis, but at a much slower rate. Admittedly, the BoJ is engaging in alternative policy measures, but the ECB and the BoJ are not pulling out all of the "easing stops" as are the Fed and the BoE.

This chart illustrates the monthly growth rate of the real measure of broad money for the same economies. The money supply data is current as of January 2009 for Japan and the Eurozone and February 2009 for the U.S. and the U.K. For now, the monthly real money supply growth rate remains above zero in the U.S., the U.K., and Japan. The European Central Bank (ECB) has let the money supply growth rate go negative; this is slightly worrisome if the trend continues.

This is a necessary policy action, given the alternative of allowing the money supply to collapse. However, John Taylor is worried, and frankly so am I. Because given the QE policies in place, the worst-case scenario or surging inflation, can only be avoided if the Fed gets its timing right. I tend to think that it will, but then again it might not.

Rebecca Wilder


  1. Your analysis is entirely bogus.

    Milton Friedman, Paul Volcker, Alan Greenspan, Ben Bernanke, etc. have copied the old and false notion that the "monetary base" as defined in this article is a "base" for the expansion of bank credit and the money supply. This is absolutely false.

    It follows from Dr. Leland James Pritchard, Ph.D - Economics, Chicago, 1933, Statistics, Syracuse:

    An expansion of currency held by the non-bank public draws down the volume of legal reserves. This would cause a multiple contraction of bank credit and money unless this increase was offset by an expansion of Reserve Bank Credit.

    but the trend rate of currency has been up ever since the 1920's. And the composition, or ratio, of currency included in the monetary base is now upwards of 90%.

    It is therefore both incorrect in theory and thus inaccurate in practice, to refer the DAMB figure as a monetary base.

    The only base for an expansion of total bank credit and the money supply is the volume of legal reserves supplied to the member banks by the Fed in excess of the volume necessary to offset currency outflows from the banking system.

    The adjusted member bank legal reserve figure is that base.

  2. 2006 jan 45496 0.04 0.03
    feb 43084 0.01 -0.04
    mar 41242 0.02 -0.08 top
    apr 42920 0.03 -0.03
    may 43648 0.02 -0.02
    jun 43278 0.01 0
    jul 43328 0.03 0
    aug 41162 0.06 -0.02
    sep 40865 0.08 -0.03
    oct 40088 0.08 -0.06
    nov 40543 0.06 -0.11
    dec 41461 0.07 -0.04
    2007 jan 43113 0.11 0.05
    feb 41214 0.09 -0.04
    mar 39159 0.11 -0.1 bottom
    apr 41072 0.09 -0.05
    may 42699 0.05 -0.01
    jun 42034 0.05 0.02
    jul 41164 0.08 0.01
    aug 39906 0.07 0
    sep 40460 0.07 0 top
    oct 40161 0.04 -0.03
    nov 40331 0.04 -0.06
    dec 41048 0.04 0
    2008 jan 42398 0.07 0.08
    feb 41070 0.05 0
    mar 39731 0.04 -0.07
    apr 41642 0.03 -0.01
    may 43062 0.01 0.05
    jun 41616 0.04 0.04
    jul 42083 0.03 0.04
    aug 42055 0.02 0.05
    sep 42456 0.04 0.05
    oct 46930 0.17 0.14
    nov 50363 0.24 0.19
    dec 53723 0.3 0.31
    2009 jan 62404 0.45 0.57
    feb 57740 0.4 0.39
    mar 54322 0.39 0.26

    As I stated, rates-of-change in excess of the seasonally adjusted rates (excessive rates-of-change) is inflationary and in this case currently bullish for stocks.

    And Wells Wilder's technical indicator consisting of an outside day & outside week applies.

    But as the demand for loan funds by the private sector begins to clash with the public sector's demand for loan funds, the economy's recovery will abort (or crowd out the private sector).

  3. Contrary to the conventional wisdom, to appraise the effect of the federal budget deficit on interest rates, it is necessary to compare these deficits, not to GDP, but to the volume of current savings made available to the credit markets. As planned, the Obama administration's projected budget of 1.845 trillion is absorbing 110% percent of 3rd qtr 2008 gross savings.

  4. Are you sure the euro area real M3 growth figure is correct? Jan-09 M3 was EUR 9,384.170 bln, Dec-08 was 9,390.635 bln: a nominal growth rate of -0.07%. Monthly inflation in Jan-09 was -0.17. So real money growth was positive 0.10%.
    Moreover: in Feb-09 nominal money growth was 0.46%, inflation 0.25%, real money growth 0.21%(higher than US)
    Data from www.ecb.int

  5. Mathijs,

    At the time of posting, nominal M3 fell 0.15% from 9385.7 in December to 9371.7 in January. Since then, the numbers have been revised. Also, on inflation, I used a seasonally adjusted series from Global Insight, which grew 0.18% over the month.