Saturday, November 01, 2008

U.S. Monetary Inflation Reignited

For the last few months we've seen what one might call a battle between the inflationary forces of the Fed and the deflationary forces of the financial distress ad deleveraging going on. For that reason, I have by the end of each week for the last few weeks reported to you my analysis of the weekly numbers, something which I will continue now.

For a while, it seemed like the deflationary forces were taking a upper hand. Starting last week though, MZM picked up again. And this week it rose again-and rose quite significantly. So much, in fact that combined with last week's increase, it has now risen above the peak reached in July to a new all time high. A very slight increase over 3 months is not really significant, but the 1.6% 2 week increase sure is. That increase is likely a key factor behind the combined stock- and commodity price rally we saw this week, just as the preceding contraction was a factor behind the sell-off in those markets.

The problem with using money supply data to predict market prices is first of all that it is not the only factor involved, and so even you had immediate information of it, it would sometimes give false signals. The other key problem is that is not published until 10 days after the fact (It's even worse in most other countries where only monthly data is available) when they to a large extent have already had an impact. That means that we'll have to try to assess how the numbers will develop before. That is never easy or even possible to do with any certainty, particularly in these times when there are two counteracting forces (Fed inflating vs. deleveraging) at work. But the sheer size of the increase in the Fed balance sheet means that it is more likely for it to "win" in the short term. The Fed balance sheet rose another $69.6 billion in the week to October 29, to $1,872.9 billion. It's up nearly a trillion dollar since mid-September. Moreover, that was the weekly average. The absolute level was $1,953.9 billion on October 29, indicating that next week's increase will be even greater.

The fact that the effective Fed funds rate has slumped to a mere 0.3% on October 30 , down from 0.67% on October 28 also suggest that the Fed is flooding the banking system with ever larger quantities of money.

In a similar turn of event, bank credit rose sharply again. It rose above $10 trillion for the first time ever in the week to October 22. Specifically, it rose $162.5 billion (1.64%) to $10,062.9 billion. In the 7 weeks from September 3 to October 22, it rose a cumulative $669.2 billion (7.12%). As I've pointed out before, the increase in previous weeks reflected mostly or even entirely a shift in credit transactions from money markets to bank balance sheets, but given the fact that money market mutual funds and commercial paper has again started to increase in value, this most recent increase likely reflect genuine credit expansion.


Anonymous Anonymous said...

Hi Stefan. I have a question. What happens if the narrow measure of money supply (e.g. M0) increases by the same amount as the broader measure decreases (e.g. M2 excluding M0) so the net effect is zero or close to. I mean in the short and long run.

11:38 PM  
Blogger goo8734 said...

Hi Stefan:

Cato has a new article on Greenspan and the money supply. They argue that Greenspan was NOT to blame for the housing bubble and that, in fact, he was not particularly inflationary. Anyways, I would be VERY interested in your thoughts on the article. It's located here:

5:12 PM  

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