This should end the foolish inflation fears of many commentators. That was never going to be a problem. This decline was going to be the problem and it is now upon us.
Remember the money supply? For the past decade, really stupid people rediscovered the joy of lending lots of money far in excess of prudent bank capital ratios. During that time they grossly inflated the money supply. There was inflation. Not particularly dramatic but sufficient to diminish the real cash flow of the same folks that they were lending money to.
Now we have the consequences. We are seeing a massive contraction in the money supply take place because the banks are sufficiently weakened that they cannot continue to lend to anywhere near the same levels as originally sustained. The financial system will contract hugely.
The only escape is quantitative easing which is the new double speak for simply printing the damn money and pumping it into the system. Buying down State and in Europe sovereign debt is a good start.
What no one seems to understand is that this money has already been put into the system through bad loans, We are printing the replacement cash needed to keep the financial system going and to back stop government spending programs.
The Worst Money Supply Plunge Since The Depression Means A Double Dip Is Now A 'Virtual Certainty'
The stock of U.S.
This 9.6% annualized contraction is unprecedented in the post-Depression era, and shows how, in this sense, America U.S.
The positive take on this is that we don't have to worry about either inflation or the Fed tightening significantly any time soon.
The negative take is that this crashing money supply will lead to both deflation and a double dip recession:
"It’s frightening," said Professor Tim Congdon from International Monetary Research. "The plunge in M3 has no precedent since the Great Depression. The dominant reason for this is that regulators across the world are pressing banks to raise capital asset ratios and to shrink their risk assets. This is why the US
Mr Congdon said the Obama policy risks repeating the strategic errors of Japan, which pushed debt to dangerously high levels with one fiscal boost after another during its Lost Decade, instead of resorting to full-blown "Friedmanite" monetary stimulus.
"Fiscal policy does not work. The US
The danger, critics such as Mr. Congdon say, is that Bernanke as a Keynesian may fail to appreciate the signifance of the recent money supply drop, failing to avoid a new recession.
Read more
US
The M3 money supply in the United States
By Ambrose Evans-Pritchard
Published: 9:40PM BST 26 May 2010
The M3 figures - which include broad range of bank accounts and are tracked by British and European monetarists for warning signals about the direction of the US economy a year or so in advance - began shrinking last summer. The pace has since quickened.
The stock of money fell from $14.2 trillion to $13.9 trillion in the three months to April, amounting to an annual rate of contraction of 9.6pc. The assets of insitutional money market funds fell at a 37pc rate, the sharpest drop ever.
"It’s frightening," said Professor Tim Congdon from International Monetary Research. "The plunge in M3 has no precedent since the Great Depression. The dominant reason for this is that regulators across the world are pressing banks to raise capital asset ratios and to shrink their risk assets. This is why the US
The US
Larry Summers, President Barack Obama’s top economic adviser, has asked Congress to "grit its teeth" and approve a fresh fiscal boost of $200bn to keep growth on track. "We are nearly 8m jobs short of normal employment. For millions of Americans the economic emergency grinds on," he said.
David Rosenberg from Gluskin Sheff said the White House appears to have reversed course just weeks after Mr Obama vowed to rein in a budget deficit of $1.5 trillion (9.4pc of GDP) this year and set up a commission to target cuts. "You truly cannot make this stuff up. The US governnment is freaked out about the prospect of a double-dip," he said.
The White House request is a tacit admission that the economy is already losing thrust and may stall later this year as stimulus from the original $800bn package starts to fade.
Recent data have been mixed. Durable goods orders jumped 2.9pc in April but house prices have been falling for several months and mortgage applications have dropped to a 13-year low. The ECRI leading index of US economic activity has been sliding continuously since its peak in October, suffering the steepest one-week drop ever recorded in mid-May.
Mr Summers acknowledged in a speech this week that the eurozone crisis had shone a spotlight on the dangers of spiralling public debt. He said deficit spending delays the day of reckoning and leaves the US
However, Mr Summers said it would be "pennywise and pound foolish" to skimp just as the kindling wood of recovery starts to catch fire. He said fiscal policy comes into its own at at time when the economy "faces a liquidity trap" and the Fed is constrained by zero interest rates.
Mr Congdon said the Obama policy risks repeating the strategic errors of Japan, which pushed debt to dangerously high levels with one fiscal boost after another during its Lost Decade, instead of resorting to full-blown "Friedmanite" monetary stimulus.
"Fiscal policy does not work. The US
Mr Congdon said the dominant voices in US policy-making - Nobel laureates Paul Krugman and Joe Stiglitz, as well as Mr Summers and Fed chair Ben Bernanke - are all Keynesians of different stripes who "despise traditional monetary theory and have a religious aversion to any mention of the quantity of money". The great opus by Milton Friedman and Anna Schwartz - The Monetary History of the United States
Mr Bernanke no longer pays attention to the M3 data. The bank stopped publishing the data five years ago, deeming it too erratic to be of much use.
This may have been a serious error since double-digit growth of M3 during the US
Mr Bernanke built his academic reputation on the study of the credit mechanism. This model offers a radically different theory for how the financial system works. While so-called "creditism" has become the new orthodoxy in US
Paul Ashworth at Capital Economics said the decline in M3 is worrying and points to a growing risk of deflation. "Core inflation is already the lowest since 1966, so we don’t have much margin for error here. Deflation becomes a threat if it goes on long enough to become entrenched," he said.
However, Mr Ashworth warned against a mechanical interpretation of money supply figures. "You could argue that M3 has been going down because people have been taking their money out of accounts to buy stocks, property and other assets," he said.
Events may soon tell us whether this is benign or malign. It is certainly remarkable.
** While the Fed does not publish M3, it still publishes the underlying components. The indicator is reconstructed accurately for clients by Dr John Williams. See it here.
