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.
“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