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Wednesday, January 09, 2008 9:21 AM

Money Supply Trends Are Deflationary

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Let's take a look at charts of M1, currency, demand deposits, and M3. It's also time to update my own monetary indicator, M Prime (M'). Those charts will be followed by a discussion of the trends.

Those not familiar with M' can find a writeup in Money Supply and Recessions. The primary rationale for M' is sweeps. A detailed discussion of sweeps can be found in Where's the Cash?

Bart at NowAndFutures created the chart of M3 and the charts of M'.

Click on any chart in this series to see a much sharper image.

M1 is Contracting

Currency in Circulation is Plunging

Demand Deposits are Falling Rapidly

M Prime is at 0% and Falling

Real M Prime is Contracting and Signaling Recession

M3 is Soaring

From Bart at NowAndFutures on M3:

"Note that much of the large growth in M3 lately has been in flows into CDs and Money Market Funds, a normal occurrence during financial turmoil."

Dave Rosenberg at Merrill Lynch Addresses "Reflation"

In a letter to clients, Rosenberg had this to say about monetary reflation:

  • For all the folks out there complaining about monetary reflation, let’s look at the data before jumping to conclusions:
  • Since the Fed cut the discount rate for the first time this cycle in mid-August, the St. Louis Fed adjusted monetary base has contracted at a 2.2% annual rate. The YoY trend has slowed to 1% from 3%. That does not sound like monetary reflation to us.
  • Since mid-August, bank reserves have collapsed at a 13% annual rate and the YoY trend is running fractionally below 0%.
  • M1 has not grown one dollar since the Fed first eased the discount rate last summer and the YoY pace is running at -1.4%. Excuse us – how do you build a monetary reflation story out of this?
  • There has been no growth at all in currency in circulation for crying out loud; the YoY trend at +1.2% is the second lowest on record. The lowest ever was flat in Jan/01, the same quarter the last recession began.
  • Demand deposits are down 9.7% YoY and bank chequable personal deposits are down 1.8%. You can’t make this stuff up – transaction-related household deposits are shrinking at a very rapid rate.
  • Oh yes – but M2 is running at almost a 6% YoY rate: well, of course it is – most of it is situated in non-transaction savings accounts and these are up almost 8% from a year ago. So transaction balances are falling and precautionary balances are rising – what does that tell you about consumer spending and saving behavior? This is all, from our lens, very deflationary. Not the other way around.
  • At the same time, since mid-summer the banks have seen $800 bln of assets come back onto their balance sheets as the financial institutions assume the responsibility from the SIVS and conduits; while capital has declined by roughly $50 bln. For the next few years, the banks will have little choice but to cut dividends, sell assets and raise capital to deal with these newly-found balance sheet exposures.
I have been singing the same tune as Rosenberg for quite some time, most recently in Things That "Can't" Happen. Inquiring minds will also note that there will be No Helicopter Drop For Failed Banks.

In addition there is absolutely no way the Fed can inflate out of this mess with unemployment rising and global wage arbitrage in full force. Here is the story on jobs: Unemployment Soars as Private Sector Jobs Contract.

There are no grounds for harping about inflation here as long as you you understand what inflation is.

Mike "Mish" Shedlock
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