With quantitative easing under way, money supply is going to become an increasingly important gauge.
Morgan Stanley notes the measure will be a key indicator of when ‘QE’ actually starts to kick in. Before adopting QE, all excess reserves created by the Fed were being hoarded by banks. Rather than increasing, the so-called money multiplier (the link between the Fed’s balance sheet and the money supply) had actually plummeted. The only other time this has happened is during the Great Depression, say Morgan Stanley. But there is reason to be optimistic. They write:
…there now appear to be some tentative signs of a turnaround. In the latest weekly data reported by the Fed, M1 jumped a whopping US$44 billion. And this follows on the heels of a US$33 billion jump in the prior week. To be sure, the monetary aggregates can be quite volatile, and special factors such as the recent hike in the deposit insurance cap can lead to short-term distortions, but going forward we will be watching the growth in the money supply in order to gauge the effectiveness of QE.
Worth noting is this chart which Morgan Stanley says shows QE is off to a stellar start in the US, the UK and the ECB (much stronger and faster than in Japan).
Of course with all eyes on money supply it’s worth remembering the Fed abolished its measure of M3 on March 23, 2006 - saying it was no longer relevant. The statement read:
M3 does not appear to convey any additional information about economic activity that is not already embodied in M2 and has not played a role in the monetary policy process for many years. Consequently, the Board judged that the costs of collecting the underlying data and publishing M3 outweigh the benefits.
This didn’t go down well with everybody, one of main critics being congressman Ron Paul. He stated before congress his belief M3 was actually the best description of how quickly the Fed was creating new money and credit. We quote:
Common sense tells us that a government central bank creating new money out of thin air depreciates the value of each dollar in circulation.
Some other institutions agreed, among them Capital Economics and Lombard Street Research. They continue to track the measure according to the Fed’s old models as best they can.
Accordingly, in August 2008, Mish’s blog noted to what degree M3 had actually contracted.
It was the sharpness of the drop rather than the absolute level that was most disturbing, according to Mish. Moves of this speed are extremely rare.What followed in September is, of course, well documented.
Considering the broad QE-driven expansion of the monetary base, a much narrower measure than M1, the following observation in the Asia Times by Martin Hutchinson, author of Great Conservatives, is worth noting:
M2, the broadest money supply measure now published by the Federal Reserve, was up 7.4% in the 12 months to November 3 (suggesting a potential inflation rate of 6-7% since gross domestic product growth was around 1% in real terms.) The St Louis Fed’s Money of Zero Maturity, the closest we can now get to the old M3, discontinued by the Fed in 2006, is up 10.0% in the last 12 months, suggesting a somewhat faster rate of inflation, perhaps 8-9%. More recently, however, the two measures have diverged; in the eight weeks to November 4, M2 was up at a 19.9% annual rate while MZM rose at a 0.7% annual rate - a huge disparity that has yet to be explained.
Could this suggest the spectre of inflation is not out of the way yet?
While we ponder those thoughts here’s a striking chart showing the shocking expansion of the US monetary base over 100 years (hat tip to Marc Ostwald from Monument Securities).
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