Monetary Statistics

Recently, I was asked a question about money statistics. The person asked if I thought a particular unofficial index is better than the official indexes: M1, M2, M3, MZM.

The article by “Mish” discusses a recent article by Frank Shostak. I am familiar with the work of both men. They are thoughtful, well-informed analysts of economic trends. Shostak does this for a living. He actually invests money for clients. Mish is an advocate of Elliott wave theory forecasting. I am not. Shostak is an Austrian School economist, a view I share. But I don’t always follow his logic. This may be my fault.

Mish’s article makes several important observations about the relationship between the most prominent monetary aggregates and the economy. He finds that M1 is far better than the other three in forecasting recessions.

In a detailed report to my Remnant Review subscribers in April, 2007, I compared the four major monetary aggregates as predictors of price inflation. Only M1 was remotely accurate over the last four decades.

Mish has come up with a new aggregate, which he calls M-prime. He symbolizes it as M’. Using Shostak’s article as a guide, he argues that M’ is superior theoretically because it does not include any credit transactions, i.e., “sell this asset and get money.” I agree with his assessment.

Then he presents some charts on the success in predicting recessions by using M’. He says that 6 of the last 6 recessions were called accurately, with two as false signals: 1985 and 1995. This, if true, makes M’ the best indicator of the five monetary aggregates.

Here is his claim: whenever the increase dipped below 5% per annum, a recession followed in 6 out of 8 times. He provides a detailed chart.

Click through. Print it out. I’ll wait.

All right, let’s look at the chart.

From 1968 until 1984, the M’ figure for money in circulation moved up slowly and steadily. Yet this was a time of very high price inflation. It was also a time in which there were three major recessions: 1970, 1975, and 1981 (some would separate 1981 and 1982). Looking at the chart, I would have missed all three, as well as gold’s boom after 1967.

Mish says that we should focus on the rate of change. This is provided by the yellow line. This does seem to be an accurate forecasting tool.

Notice what has happened since 2002. The rate of increase peaked in early 2004: 10% per annum. It fell to 5% in late 2005. In January, it was slightly above 0%. The last time it was this low was in 2001, just as the recession began. It was slightly below 0%, but only briefly.

When coupled with the inversion of the yield curve earlier this year, and the present inverted condition of the 90-day/10-year rates, with the 90-day/30-year rates flat, I regard the M’ indicator as pointing to a recession.

The problem with M’ is that it is an unofficial statistic. If someone published it on a week-to-week or even month-to-month basis, I would use it as a supplement. But as far as I know, Mish’s articles are the only public references to it.

The article was published in January. Mish did a follow-up on May 9: “Money Supply Is Soaring — Right?

It takes to task the use of M-3. I agree wholeheartedly. In my report to Remnant Review subscribers in April, I showed that no monetary aggregate has a worse track record for predicting price increases. M-3 vastly overstates the rate of monetary inflation and therefore price inflation. The Federal Reserve System finally ceased reporting M-3 a year ago. It took them two decades to come to the realization that the statistic has always been useless. Bureaucrats learn slowly.

Mish reported that M’ was slightly below 0%. This has not happened since just before the 2000 recession.

He drew some conclusions from this information. He asked: What does it mean? His answers:

Credit is expanding rapidly but with fractional reserve lending via sweeps and other mechanisms such as GSE debt creation and various carry trades, actual money itself is now contracting.This is further proof that the Fed has now totally lost control. What else can it mean when credit is soaring in the face of what otherwise appears to be rather tight monetary policy?The distinction between money and credit is significant. A huge expansion in money supply leads to hyperinflation like the Weimar Republic or Zimbabwe.A huge expansion in credit eventually leads to things like the tulip mania implosion, the railroad bust, and the great depression.The Fed will fight this tooth and nail but right now their hands are tied. When the Fed starts lowering rates to combat this malaise, look for gold to soar.Long term, there is no way out. The policies of Greenspan and Bernanke will be repudiated.

The FED is now walking a tightrope. It doesn’t want to push the economy into a recession. It also wants to avoid mass inflation, what Ludwig von Mises called the crack-up boom.

So far, Bernanke’s FED has successfully walked the tightrope. Consumer price increases are slowing. The housing bubble has ended, but it has not popped nationally. The Dow Jones Industrial Average rose to 14,000 on July 19 before turning downward. The fact that it was still down from its 2000 high by about 30% as measured in euros did not get any attention by the media. The public is not worried about the economy.

I see the FED as capable of monetizing everything listed on any exchange, and then some. I see no limit on fractional reserve banking’s ability to destroy the purchasing power of a nation’s currency. I believe that the crack-up boom is ahead of us, not behind us.

This is why I rely most heavily on the statistic published by the Federal Reserve Bank of St. Louis: the adjusted monetary base. This statistic reveals what the FED is doing to inflate, stabilize (ha!), or decrease the money supply. It reports on the FED’s holding of monetary reserves for the American banking system. You can access it here.

In periods of transition to lower price inflation, the FED reduces the rate of monetary inflation. We have been in such a transition period ever since Bernanke took over as FED Chairman in February, 2006. The FED has been remarkably tight: around 2% per annum.

If we look at the effects on M’, the reduction of monetary growth has been remarkable. It had been declining ever since 2004. The rate has now gone negative.

I applaud the FED for its action. I hope this continues from now until doomsday. But if it does, there will be an intermediate doomsday in the financial markets and the housing markets. This doomsday is what Congress will tell Bernanke to avoid. The FED will reverse its policy again. It will respond to political pressure. But I think it will take a much lower stock market and a much higher unemployment rate for this pressure to be applied by a unified Congress.


I think M-prime is a better measure than the other M’s. If I could get access to it every month on Mish’s site, I would consult it.

I think we should use whatever data are available to us, but always within a framework of the Austrian theory of the business cycle. I have written about this here.

The weekly update of the adjusted monetary base is useful in assessing the recent direction of FED policy. The yield curve is also important to see how investors regard the threat of a fall in the short-term interest rate. If they think short rates will fall rapidly due to recessionary conditions, they will buy long-term bonds. This forces down the long-term bond rate.

August8, 2007

Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 19-volume series, An Economic Commentary on the Bible.

Copyright © 2007