Recently by Michael Pollaro: America, Poised for a HyperinflationaryEvent?
Monetary Aggregates, Where We Are
After December’s blistering rates of growth, the U.S. money supply aggregates based on the Austrian definition of the money supply, what Austrians call the True Money Supply or TMS, slowed markedly in January, with narrow TMS1 posting an annualized rate of growth of just 2.1% and broad TMS2 an annualized rate of growth of 4.6%. That brought the annualized three-month rate of growth on TMS1 and TMS2 to 21.5% and 14.7%, respectively, still high, but down from December’s 22.3% and 18.1% rates. No doubt some of this pullback was seasonal, as was December’s surge, but as we discuss below it’s a data point worth watching, as private banking institutions were a total no show in January.
Turning to our longer-term twelve-month rate of change metrics – more indicative of the underlying trends – and focusing on our preferred TMS2 measure, we find that TMS2 saw another healthy increase in January, growing at an annualized rate of 9.9% for the second month in a row. As we said in last month’s Monetary Watch, we think that’s close enough to 10% to mark January 2011 as the 24th time in the last 25 months that TMS2 posted a twelve-month rate of growth in the double digits. That equates to a cumulative increase in TMS2 of some 26% over those 25 months. To put those numbers into perspective, the run-up to the now infamous housing bubble turn credit implosion turn Great Recession saw a string of 36 months of double digit growth for a cumulative increase of 48%. So yes, today’s inflationary largesse may be only 54% of that which brought on the Great Recession, but this one’s still going strong.
M2, the mainstream’s favorite monetary aggregate, is now decidedly up, in January posting a year over year rate of growth of 4.3%. That’s up 70 bps from December’s 3.6% and marks the highest year over year rate of growth since November 2009. As readers of this site are aware, although THE CONTRARIAN TAKE posits M2 as a grossly misleading measure of the money supply, the mainstream does not. They think M2 is a perfectly fine measure of the money supply, including the world’s most powerful money printer, Chairman Bernanke. And as we argued in The Bernanke Arbitrage, all other things equal, a rising M2 could at some point give Bernanke pause, a reason to slow his QE efforts and in so doing slow the growth in the money supply. But all other things are not equal to Chairman Bernanke. To the Chairman, unemployment is still too high, core inflation is still too low and housing and municipal bound problems are all around. In the Chairman’s mind, these all other things are the things that argue for more not less QE, especially with M2 growing at a still relatively low, although rising rate of 4.3%. Clearly though it’s a data point we’ll be watching.
True “Austrian” Money Supply (TMS), January 2011
A Look at TMS2 Internals
As we discussed in last month’s Monetary Watch, we put a lot of effort into analyzing the drivers behind the growth in the money supply, a component view we call TMS2 by Economic Category and Source. And while one month’s data point does not make a trend, this month’s component analysis reveals just how important the Federal Reserve’s QE II asset purchase program may be to the continued double digit growth in the money supply.
As a reminder, our component view zeroes in on the who and the how behind the ebb and flow of the money supply, reducing monetary inflation to two basic institutions and three primary venues:
- The Federal Reserve, via the issuance of what Austrians call covered money substitutes: the simultaneous issuance of on-demand bank deposit liabilities and bank reserves by the Federal Reserve, created through its purchase of assets, by writing checks on itself, and later, when those checks are deposited by the sellers of those assets in their respective banks, completing the issuance by crediting those banks’ reserve balances at the Federal Reserve for the full amount of the checks.
- Private banks, via the issuance of what Austrians call uncovered money substitutes: the creation of on-demand bank deposit liabilities by private banks unbacked by any reserve cover, created through their issuance of loans and purchase of securities when they pyramid up those loans, securities purchases and deposit liabilities on top of their reserves.
- The Federal Reserve, via the largely passive issuance of currency: the issuance of Federal Reserve notes, created when the public chooses to redeem their on-demand bank-issued deposit liabilities for currency. In contrast to covered and uncovered money substitutes, the issuance of Federal Reserve notes is by and large neutral with respect to the total money supply, as it simply substitutes one form of money, namely covered and/or uncovered money substitutes for another, namely currency.
The combined total of covered money substitutes plus currency is what economists call the monetary base, and by definition completely under the control of the Federal Reserve. And the issuance of covered money substitutes is more popularly known as quantitative easing or QE.
With those definitional reminders in mind (for a more thorough discussion see last month’s Monetary Watch), one look at the table above tells us exactly who gassed the money supply in January – the Federal Reserve via the issuance of uncovered money substitutes. Indeed, uncovered money substitutes grew at an annualized rate of 42.6% in January taking the three-month rate of growth to an annualized 30.1%. In contrast, after private banking institutions had been showing a marked willingness to grow their issuance of uncovered money substitutes over the last clutch of months, in January they were nowhere to be found, the result being the three-month rate of growth in uncovered money substitutes fell fairly sharply, from December’s rate of growth of 20.5% to January’s 13.4%.
To repeat, one month does not make a trend. Indeed, the more important twelve-month rate of growth in uncovered money substitutes is still growing at a healthy 12.9%, albeit down a bit from December’s 14.3%. And with $1 trillion plus in excess reserves sitting on banks’ balance sheets and – because of the Federal Reserve’s QE II asset purchase program – growing by the day, the fuel for these banking institutions to explode the money supply is certainly there, even if that only be through an asset purchases program of their own; i.e., through the purchase of U.S government securities. But that was not to be in January. Needless to say, we’ll be watching this space like a hawk as we move through 2011.
And that’s a perfect segue into this month’s topic du jour…
What’s Next on the Monetary Inflation Front – Obama’s budget, the GOP and its implications for inflation
As we discussed in an Essay we wrote back on February 8th, it’s a long standing proposition of many, and one which we wholeheartedly endorse, that the surest road to inflation, and a whole lot of it, is one grounded in a government whose answer to every economic and social problem is to borrow and spend the problem away, supported by a banking system able, willing and ready to finance the effort. That support is of course to simply print the money through which to buy the debt so issued by the government – what is euphemistically called monetizing the debt – thereby exploding the supply of money and eventually trashing its value.
Michael Pollaro [send him mail] is a retired Investment Banking professional, most recently Chief Operating Officer for the Bank’s Cash Equity Trading Division. He is a passionate free market economist in the Austrian School tradition, a great admirer of the US founding fathers Thomas Jefferson and James Madison and a private investor. He is a columnist on the Forbes blog.