More Evidence of Sharp Contraction in Money Supply (Not for the Fainthearted)

We had written in mid July that money supply in the US, as measured by M1 and M2, had been contracting for several month s . Eurozone M1 growth had also fallen to near zero growth levels, and M4, the broadest measure of money in the UK, had actually dipped into negative growth territory. As we noted then:

Many have criticized the Fed for “printing money” of late. But the evidence suggests otherwise. First, all of the cash injections that the central bank has undertaken via its alphabet soup of new lending facilities have been met with roughly equal withdrawals though open market operations. Thus the new facilities themselves have not led to monetary expansion.

Second, critics like to point to the Fed’s negative real interest rates as lax monetary policy. In the dot-bomb environment, which was not a credit crisis, that charge is accurate, and that policy helped create our current mess.

But we now have credit contraction. Deleveraging is deflationary. Somewhat loose monetary policy is appropriate. Unlike 2002, banks or securities firms are not going out to create new debt, which is the mechanism by which low interest rates lead to inflation or asset bubbles. Mortgage lending has become dependent on the Federal government via Freddie, Fannie, and the FHA (and the future of that support is now in question). Consumer credit of all sorts is being reined in. Dow Chemical had to go to Warren Buffett to borrow to acquire Rohm & Haas because it could not get funding from banks. Our credit intermediation system is barely functioning.

The Telegraph story that highlighted this development provided additional detail:

Paul Kasriel, chief economist at Northern Trust, says lending by US commercial banks contracted at an annual rate of 9.14pc in the 13 weeks to June 18, the most violent reversal since the data series began in 1973. M2 money fell at a rate of 0.37pc…

Leigh Skene from Lombard Street Research said the lending conditions in the US were now the worst since the Great Depression. “Credit liquidation has begun,” he said.

Note that the Federal Reserve gave up being interested in money supply in the early 1980s, when new banking products made the data behave differently. But that hardly seemed a reason to abandon a useful tool, at least not without trying to understand how the new instruments affected monetary aggregates. Instead, the Fed sets target interest rates in a not-terribly-scientific fashion.

Note that while the Fed still published M1 (narrow money, currency plus demand deposits) and M2 (M1 plus time deposits, savings accounts, and non-institutional money market funds), it stopped reporting M3 (M2 plus large time deposits, institutional money market accounts, and short-term repos) in March 2006. However, some economists and services provide estimates,

The Telegraph tells us today that those private calculations of M3, like the publicly available monetary aggregates, show a sudden contraction, a deflationary signal. From the Telegraph:

Data compiled by Lombard Street Research shows that the M3 ”broad money” aggregates fell by almost $50bn (£26.8bn) in July, the biggest one-month fall since modern records began in 1959.

“Monthly data for July show that the broad money growth has almost collapsed,” said Gabriel Stein, the group’s leading monetary economist.

On a three-month basis, the M3 growth rate has fallen from almost 19pc earlier this year to just 2.1pc (annualised) for the period from May to July. This is below the rate of inflation, implying a shrinkage in real terms.

The growth in bank loans has turned negative to a halt since March.

“It’s obviously worrying. People either can’t borrow, or don’t want to borrow even if they can,” said Mr Stein.

Monetarists say it is the sharpness of the drop that is most disturbing, rather than the absolute level. Moves of this speed are extremely rare….

Monetarists insist that shifts in M3 are a lead indicator of asset prices moves, typically six months or so ahead. If so, the latest collapse points to a grim autumn for Wall Street and for the American property market. As a rule of thumb, the data gives a one-year advance signal on economic growth, and a two-year signal on future inflation.

“There are always short-term blips but over the long run M3 has repeatedly shown itself good leading indicator,” said Mr Stein…

M3 surged after the onset of the credit crunch, but this was chiefly a distortion caused by the near total paralysis in parts of the American commercial paper market. Borrowers were forced to take out bank loans instead. The commercial paper market has yet to recover

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  1. Anonymous

    ‘Monetarists insist that shifts in M3 are a lead indicator of asset prices moves, typically six months or so ahead.’

    A fall in the fall? Tracking the funds exiting stocks, that is, those that exist after losses, will be interesting.

    This current course, if it continues, should put paid to the idea of extreme or even moderate inflation going forward.

    Interesting times indeed.


  2. Jason

    This is a great blog article but my boss, Mark Sunshine, has been saying for months that deflation rather than inflation should be the real concern of the Federal Reserve. He has been telling us at company meetings that the real effect of the credit crisis is shrinking money supply and that the Federal Reserve emergency lending facilities were designed to stop an uncontrolled fall in money supply similar to the great depression. And since March he has been arguing that the lack of growth in M2 is a deflationary indicator and that the dollar will rally.

    Mr. Sunshine has been public in his predictions and analysis. He is a regular guest on FOX Business Network as well as has his own blog. Some of his blog articles relating to money supply are:

    INFLATION, FED POLICY AND THE LIQUIDITY TRAP – THERE’S STILL TIME! – 7/13 (which includes a link to a February, 2008 appearance on FOX)



    MONEY SUPPLY AND ECONOMIC DATA WEEKLY WATCH (Part 1 – Money Supply and Federal Reserve Action) – 8/3




  3. Richard Kline

    The ibanks may have been hurting for a year, but the banking system has much money in motion from many mid-size fish. Those fish stop issuing loans pretty much altogether in May, and really hit the no-go button in July. To me, this more likely reflects an unwillingness to take on new exposure than a complete collapse in _borrower requests_ of various kinds. At a very wild guess, this may be found subsequently to correlate with the point at which impending Commercial Re losses became fully evident to exposed banks. Residential mortgages have been packaged and moved upchannel, and their sponginess has hurt the big players—but not so much the middies. Commercial re is sucking the oxygen out of their incubator loans, methinks. Our lame quack Administration looks to get high-lowed by GSEs and the a crash in the middle of the banking system this fall—which we can be confident they will bungle grossly given their track record.

  4. S

    velocity matters. Is this such a shock. The fed has already resorted to printing money and handing it ut. That didn;t work. If you are banking on the Fed to fix the problem it created, you are in a state of denial or delusion. As the honroanble Senaotr said: “you want us to give you more power to solve the problem, sir, you are the problem.”

    There problem here is that the Fed is tryiong to protect something that is totally unsustainable, but letting nature take its course risks civil upset/rancor. In the end the market will win.

    The real question is when the Fed realizes it has been rendered importent (when it cuts rates further), what action will the nefarious forces dream up to deal with debt destruction (think FDR gold devalue, $ devalue). Gameplanning for such a move seems like a valuable exercise.

  5. Anonymous

    “Mr. Sunshine has been public in his predictions and analysis. He is a regular guest on FOX Business Network…”

    Who cares what Mr. Sunshine thinks. Anyone with a brain avoids Fox. Perhaps if appeared on a non Faux channel, he might get some respect.

  6. Anonymous

    I don’t think so. Deleting M-3 was for good reason……to skew the remaining numbers. Leveraging continues at obscene rates. So far only debt has been moved around in exchange for Treasuries. In deflation the US$ bull would return and not just a bear dead cat bounce. Banks failures have been just forced consolidation with a few write downs, nothing like what is needed for liquidation which is true deflation. Moving debt to one balance sheet from another is not deflation.

    It’s like talking points from Government economists, obscure, confuse and pretend because the world economy could not withstand the effects of true deflation at this point in time. Delay delay delay.

  7. Anonymous

    When I look at the blowouts in credit spreads I wonder how much control the Fed has left.

    Perhaps the Fed will open some more abc credit windows? How about a window for people that are upside down on their planned vacation? Maybe another for those that can no longer afford dental floss?


  8. jm

    Everyone should read “Balance Sheet Recession” by Richard Koo (former Chief Economist of Nomura) regarding Japan’s lost decade.

  9. AnoninCA

    Yves, I read blog daily, but I don’t trust the data in this post.

    According to the St Louis Fed’s Fred database. M2 is about $7.7 trillion right now and as of their last data (2006) M2 comprised about 70% of M3. (So a $50 billion dip in M3 is just noise.)

    The only M3 component series the Fed’s now maintaining is Inst. Money Market Accounts, not surprisingly these figures have been increasing at an exponential rate through the credit crisis. What’s been going on with the smaller categories of repos and long term deposits isn’t clear, but it’s also not clear that they are big enough components to generate huge changes — especially given the surge in money market accounts.

    It is true that M2 was flat from April through June, but that was only after stunning growth from January through March. Besides money supply measures are incredibly unstable, so it’s a mistake to put too much emphasis on short-term trends (i.e. there’s a reason the Fed found targetting money supply unreasonably difficult).

  10. AnoninCA

    That should be “I read blog your blog daily”. Just trying to make the point that I have great respect for what you have to say.

  11. S

    Whether M is growing or not it is being held up on the stilts of the Fed baalnce sheet in hopes of mainting the illusion of an equilibrium. but that equilibrium is not sustainable. So the you can play the game and hope the wheel keeps turning. At some point this ends and the great sucking sound will ensue. let’s hope a good portion of those dollar exports are being used for munition stores – only partially kidding.

  12. Anonymous

    Maybe money is no longer currency. Maybe we got poker chips in our pockets and maybe the casino is about to be condemned.

    Maybe it’s time we studied the survival skills of those the G7 has plundered since Woodrow and the WZO and Balfour gifted us with reserve currency systems.

    Maybe it’s time we harvest the rich – that’s why we have a zoo full of `em, right? That’s why god created rich people, right? Mighty tender meat on the bones of the children from the Houses of the Unholy. And in troubled times, they make mighty good eating!

    Eating the rich is not sport, it’s the god given right of the proletariat!

  13. jest

    hmm, i mentioned this topic in the comments section here not too long ago.

    the (rhetorical) questions that still remain are:

    -how does this relate to the super hot PPI that came out today?

    -is this decrease real or just noise?

    -since the fed doesn’t measure M3 is this data going to affect monetary policy in any real way? (i doubt they stopped paying attention to M3, b/c they probably still calculate it, they just don’t report it.)

    -if so, will this be the trigger that causes the fed to finally print?

    we’d also have to look at high powered money in other nations as well. yves pointed out in a previous post that it’s not the fed that’s expanding money, it’s foreign central banks. and it seems most of them are starting to turn dovish.

  14. Anonymous

    I would like to take this opportunity to spread my thoughts on how to help reduce some of the mortgage problem we are facing.
    Allow those who have 401(k)’s and IRA’s to make a one time withdrawal from their account with no penalties or taxation. This would go straight to a lending institution to either reduce or pay off a mortgage debt or allow those who need to make up a loss in housing price, refinance there home to a fixed mortgage.

  15. Anonymous

    There is absolutely no evidence of contraction of the money supply… yet. The rate of increase of M3 has slowed steadily since early 2008 until about December 2008. But it has not contracted.

    We are in an inflationary recession.

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