Monetary Deflation - Not Visible Yet

As a reminder, in a purely fiat monetary system, inflation and deflation are the result of policy decisions, and not any endogenous factors in the economy.    Extreme outcomes such as a protracted deflation or hyperinflation are almost always the result of some policy decision which may be in error, unless they are caused by some exogenous shock or force.

This is a fundamental fact of how a fiat money system works, and what makes it different from a system in which the money is tied to some external control or standard, or some other relatively inflexible metric from the perspective of the system.

Please see Money Supply: A Primer if you wish for an explanation of some of these money supply measures.

And for all the Austrian economists, I have included True Money Supply as the second graph.

Updated Money Supply Figures: Dude, Still No Deflation

For comments see the original post from August 2010, US Money Supply Figures

My forecast remains for a severe stagflation with the continuing devaluation of the dollar relative to real goods, in a Potemkin economy masked by newspeak and distorted metrics designed to make looting appear to be recovery, crime as sensible compromise, torture as benevolence, tyranny as stewardship, and hell as heaven. 

Despite a drop in aggregate demand the monetization that the Fed is performing will do its work. However, this liquidity's diversion into the banking and health sectors to the relative exclusion of productive investment will create a third world economy with large pockets of wealth amongst generally reduced living standards.  One cannot stimulate a failed economy into vitality while the corruption that caused the collapse still remains.

The solution is to go back to the 1980's when the median wage began to stagnate and see what changed, and begin constructing the remedies from there.  I doubt this will occur as the American middle class has been almost as thoroughly indoctrinated to its own destruction as any people had been in the first half of the twentieth century, without even realizing it.   Edward Bernays would have been proud. 

“Money is a new form of slavery, and distinguishable from the old simply by the fact that it is impersonal – that there is no human relation between master and slave.” Leo Tolstoy

Note: I see in the news that the NYSE and the Deutsche Boerse are in merger talks. One ring to rule them all...

“Independently of its misdeeds, the mere power, the bare existence of such a power, is a thing irreconcilable with the nature and spirit of our institutions.” Nicolas Trist, secretary to Andrew Jackson, writing on the privately owned Second Bank of the United States (Schlesinger, The Age of Jackson, p.102)

M2

M2 Year Over Year Growth

MZM

MZM Year Over Year Growth

True Money Supply (TMS) from Mises




 

US Money Supply Figures: Dude, Where's My (Monetary) Deflation?

As a review or refresher please read: Money Supply A Primer if you need to remind yourself what these money supply figures represent.

Considering the high unemployment and sluggish GDP the fall off in year over year growth in the money supply figures is to be expected, especially after the bubbliciously high growth rates (11% and 16% respectively) just prior to the financial crisis. That is why one should look at both the nominal and the percent year over year charts.

There is certainly price deflation from slack aggregate demand fueled by stagnant wages and high unemployment, and it may get worse as the Fed and the government coddle their unreformed pet Banks, leaving the real economy and most Americans to twist in the wind. But there is no true monetary deflation yet, the kind which is supposed to stiffen the back of the dollar and all that.

There is also sufficient room for concern about the US dollar and its sustainability as the world's reserve currency. This would be familiar to most economists as Triffin's Dilemma. As the world shifts from the Bretton Woods II compromise to a less dollar specific regime the adjustment could be quite traumatic, especially to the financialization industry. Here is another description of the same phenomenon called the Seigniorage Curse. It is why I have called the US dollar and its associated bonds The Last Bubble.

"The Seigniorage Curse appears to hollow out the economy by the following manner: First, the premium charged to holders of dollars becomes a new source of accrued, aggregate revenue. This extra capital flowing into the economy is initially seen as a global honoring of our economy’s strength, and innovation. But when innovation falters and less value is created, seigniorage is maintained–and thus the unhealthy dynamic begins. From this point forward, whether the US economy either leads in innovation, or lags in innovation, the Dollar advantage grows regardless. It then becomes clear that manufacturing Dollars, rather than manufacturing goods, is a better value proposition. Once that dynamic is in place, then a long cycle of financialization ensues, in which innovation and talent moves from design and manufacturing to the financial sector. The financial sector then becomes rapacious, as it scours what’s left of the economy to monetize. Whereas manufacturing and innovation were once monetized, the financial sector begins to monetize itself...

Every inheritance starts out as a gift. Just as oil-cursed nations remain ever vulnerable to swings in the price of oil, the United States is now vulnerable to its own number one export–the value of the US Dollar and by extension the value of US Treasury Bonds."

True Money Supply is included for all you Austrian Economists, and it has enjoyed a bumper expansion under Bernanke's chairmanship. This is the money that is ready and able to be used as a medium of exchange, what the Austrians consider 'real money.' I am quite sure that Messrs Ludwig and Murray would be aghast at Bernanke's banking practices.

I include Eurodollars chart at the bottom. This is the 'missing component' from the M3 series. Several commentators seek to estimate M3 by obtaining the other M3 components from existing sources and then estimating eurdollars based on correlations and trending. See M3 Hysteria and a Look at M2, MZM, GDP and PPI.

The Eurodollar is a particularly interesting money measure to me be because of the two enormous dollar short squeezes which we have seen in Europe as customers demanded dollars based on dollar assets deposited in dodgy CDOs. It was on a parabolic trajectory BEFORE the squeezes, and one can only wonder where they are now.

I am still comfortable with my forecast for a severe stagflation, considering both a protracted monetary deflation and hyperinflation as less probable 'on the tail' events that almost certainly would reflect fiscal and monetary policy errors. What also concerns me is the failure to reform and address the grossly imbalanced economy. I am less confident today however, that Bernanke and the Congress will not make these errors because of the blind greed of the oligarchy and their influence over the country.

M2



M2 Year over Year Growth



MZM



MZM Year over Year Growth



True Money Supply (aka Rothbard Money Supply)

"The True Money Supply (TMS) was formulated by Murray Rothbard and represents the amount of money in the economy that is available for immediate use in exchange. It has been referred to in the past as the Austrian Money Supply, the Rothbard Money Supply and the True Money Supply. The benefits of TMS over conventional measures calculated by the Federal Reserve are that it counts only immediately available money for exchange and does not double count. MMMF shares are excluded from TMS precisely because they represent equity shares in a portfolio of highly liquid, short-term investments which must be sold in exchange for money before such shares can be redeemed. For a detailed description and explanation of the TMS aggregate, see Salerno (1987) and Shostak (2000). The TMS consists of the following: Currency Component of M1, Total Checkable Deposits, Savings Deposits, U.S. Government Demand Deposits and Note Balances, Demand Deposits Due to Foreign Commercial Banks, and Demand Deposits Due to Foreign Official Institutions."

Eurodollars

I think a case could be made that the US is exporting its monetary inflation overseas, particularly to Asia. At some point these eurodollars may come home to roost, and the arrival could be quite memorable. I try to recreate some sense of Eurodollar growth from the BIS reports, especially when verifying these eurodollar short squeezes, but the lags of over a quarter in reporting are quite tiresome.

Austrian Economics: True Money Supply, Deflation and Inflation

Here is the Austrian theory of money supply and its measures in a nutshell.

"The True Money Supply (TMS) was formulated by Murray Rothbard and represents the amount of money in the economy that is available for immediate use in exchange. It has been referred to in the past as the Austrian Money Supply, the Rothbard Money Supply and the True Money Supply.

The benefits of TMS over conventional measures calculated by the Federal Reserve are that it counts only immediately available money for exchange and does not double count. MMMF shares are excluded from TMS precisely because they represent equity shares in a portfolio of highly liquid, short-term investments which must be sold in exchange for money before such shares can be redeemed.

For a detailed description and explanation of the TMS aggregate, see Salerno (1987) and Shostak (2000).

The TMS consists of the following: Currency Component of M1, Total Checkable Deposits, Savings Deposits, U.S. Government Demand Deposits and Note Balances, Demand Deposits Due to Foreign Commercial Banks, and Demand Deposits Due to Foreign Official Institutions."

True Money Supply, Ludwig Von Mises Institute

Here is some additional reading on the subject. The Austrian Theory of Money by M. Murray Rothbard

The weakness in TMS is the same as in all of the narrower money supply aggregate measures, in that it is very volatile in the short term because of seasonal demand. Ideally one would perform long term trending to get a better idea of the expansion or contraction of the money supply.



As one can see, the trend in money supply growth has been quite strong, almost parabolic.



Why do I present this? Because I thought it would be a good idea for those who aspire to be Austrian economists to know what the Austrian School thinks about money supply and how to measure it.

So when some point to M3, for example, and see an argument for deflation rampant, they should at least understand that they are not being 'true to their school.'

I should disclose here that although I have sympathy for many of the things that the 'Austrian School' says, I am not an 'Austrian' or a member of any economic school of thought for that matter. I think the Austrian school has been influenced to the point of being hijacked by the neo-liberal economists, due in large part to its marginalization in the study of economics and its lack of vigor.

Returning to what the Austrians think, a fairly recent discussion of this deflation issue was penned by Richard M. Ebeling in The Hubris of Central Bankers and the Ghosts of Deflation Past.

"One fact should be pointed out in terms of the current economic crisis. There has been no monetary deflation -- that is, an absolute decrease in the quantity of money and credit in the economy. Just the opposite. Since 2008, the Federal Reserve has increased the total amount of reserves in the banking system by around $1.5 trillion, mostly by buying up many of those "toxic" mortgages that were guaranteed by Fannie Mae and Freddie Mac.

This huge expansion in the potential quantity of money and credit that could flood through the financial markets and generate significant price inflation has been held off the market due to the fact that the Federal Reserve has been paying banks interest to hold those sums as unlent reserves. With key market interest rates being kept artificially low at near zero or one percent through activist Fed policy, banks have found it more profitable earn that positive rate of interest at the Federal Reserve.

But unless the Fed finds some way to drain those "excess reserves" out of the banking system, significant inflationary -- not deflationary -- forces may be at work looking to the next few years ahead."

This could help some people understand why the expected effects of monetary deflation have not been appearing as they planned.

There is certainly an undeniable slump in aggregate demand that it putting pressure on prices, and some sectors, like housing, are experiencing the collapse of asset bubble.

Some point to credit contraction as deflation, but as the Austrian school would point out, credit is not money, only a means of money creation. The Fed owns a printing press, and as most recently seen, can expand its Balance Sheet and True Money Supply almost at will.

Some things I have seen recently from 'Austrians' leads me to think that a portion of that camp has been hijacked by the neo-liberal economists. That would indeed be a shame if it is true, and ti becomes a trend. Stranger things have happened. But I see it clearly in the calls for austerity, and liquidationism, and 'free markets' from some who wear those school colors.

Markets are always and everywhere never naturally free. They require diligent effort and serious work to be maintained free of fraud, corruption, and inefficiencies. But some find it easy to believe in or at least promulgate economic theories based on the natural goodness of man, and assorted fairly tales and urban myths, if it suits their ideology or duplicitous agenda. One can usually spot them by the quantity of invective and rhetoric against the quality and detail of their thought.

As for Ben's printing press, baby, you ain't seen nothing yet.