[THS] Ambrose Evans-Pritchard: US money supply plunges at 1930s pace

[The Harder Stuff in news and commentary]

http://www.telegraph.co.uk/finance/economics/7769126/US-money-supply-plunges-at-1930s-pace-as-Obama-eyes-fresh-stimulus.html


US money supply plunges at 1930s pace as Obama eyes fresh stimulus
The M3 money supply in the United States is contracting at an accelerating rate that
now matches the average decline seen from 1929 to 1933, despite near zero interest
rates and the biggest fiscal blitz in history.


By Ambrose Evans-Pritchard
Published: 9:40PM BST 26 May 2010

The stock of money in the US 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 Photo: AFP

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 is not recovering
properly," he said.

The US authorities have an entirely different explanation for the failure of stimulus
measures to gain full traction. They are opting instead for yet further doses of
Keynesian spending, despite warnings from the IMF that the gross public debt of the
US will reach 97pc of GDP next year and 110pc by 2015.

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 at the mercy of foreign creditors. Ultimately,
"failure begets failure" in fiscal policy as the logic of compound interest does its
worst.

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 has just tried the biggest fiscal experiment in
history and it has failed. What matters is the quantity of money and in extremis that
can be increased easily by quantititave easing. If the Fed doesn’t act, a double-dip
recession is a virtual certainty," he said.

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 -
has been left to gather dust.

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
housing bubble gave clear warnings that the boom was out of control. The sudden
slowdown in M3 in early to mid-2008 - just as the Fed talked of raising rates - gave a
second warning that the economy was about to go into a nosedive.

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 central banking, it
has not yet been tested over time and may yet prove to be a misadventure.

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.