Amidst the financial flight-wave to safety, with stocks plunging, gold soaring, and Treasury bond rates collapsing — and all the European banking fears which go with that — there’s an important sub-theme developing: An almost-forgotten monetary indicator, M2, which is mostly cash, demand-deposit checking accounts, savings deposits, and retail money-market funds, has been soaring.
According to the St. Louis Fed, M2 is up 24.2 percent at an annual rate over the past two months. Almost out of the blue, that comes to a near $500 billion increase. In rough terms, the M2 explosion breaks down to $165 billion in demand deposits and $335 billion in savings deposits.
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What’s going on here? There’s a flight to government-guaranteed accounts. Some people believe Europeans are withdrawing from their own banking system and parking their money in the U.S. banking system, guaranteed by Uncle Sam. Kelly Evans reports in her Wall Street Journal column of a $30 billion outflow from equity mutual funds that has probably gone into cash.
This is a very disconcerting development. Normally, big M2 growth would signal a faster economy, and maybe even higher inflation. But as economist Michael Darda points out, the velocity, or turnover, of money seems to be plunging.
“The recent pickup in broad money in the U.S. looks like a dash for risk-free cash assets,” writes Darda. He also notes that widening corporate-credit risk spreads and shrinking government-bond rates signal a recession risk, not a coming boom.
So contrary to monetarist theory, the M2 explosion seems more closely related to a deflation/recession risk. Economist-blogger Scott Grannis writes, “The recent growth of M2 surpasses even the explosive safe-haven demand for money that accompanied 9/11 and the financial crisis of late 2008. Something big is going on, and it can only be the financial panic that is sweeping Europe as money flees a banking system that is loaded to the gills with PIIGS debt.”
Grannis concludes, “In short, it looks like there is a run on the European banks and the U.S. banking system is the safe-haven of choice.”
On the other hand, all may not be lost — at least from the standpoint of the American economy.
Economist Conrad DeQuadros, who acknowledges the precautionary demand for high cash balances in the current financial uncertainty, believes that the economic data do not yet signal recession. DeQuadros points out that jobless claims, hours worked, retail sales, and industrial production are all picking up. He also notes that profits are still rising, even though their growth is slowing. And C&I business loans have grown at an 8 percent annual rate over the past three months.
I would just add to all this: The biggest problem for the plunging stock market is coming out of Europe. Fears over the safety and solvency of European government debt and banks are haunting the stock market. I still don’t believe it’s 2008. But yes, like everyone else, I’m worried.
That said, we are awash with liquidity everywhere. U.S. banks and companies have more cash than they know what to do with. The problem is they are immobilized by fiscal policy run amok. We desperately need a regulatory rollback and flat-tax reform to boost asset prices and to get banks to loan, companies to invest, and America back to work.
– Larry Kudlow, NRO’s economics editor, is host of CNBC’sThe Kudlow Report and author of the daily web log, Kudlow’s Money Politic$.
It's times like this when I wish the government was still keeping track of M3 - it would probably be quite enlightening indeed for the purposes of understanding this seeming conundrum with M2.
The story with extremely broad money aggregates is why I haven't been particularly worried about inflationary pushes from QE... if anything, some recent government policy (most notably Dodd-Frank) has taken more money out of the economy (in M3 terms) than all the QE rounds combined have put into it by increasing the indirect costs of lending.
I don't know if I'd call Dodd-Frank "deflationary". Clearly, Obama's anti-business regulatory agenda including D-F, Obamacare, EPA regs, oil/gas moratoria, etc have stifled economic growth, but that's different than deflationary. What QEII clearly did was debase the Dollar which has caused pernicious commodity inflation-- fuel oil, fresh foods etc. Hence, we have STAGFLATION.
There is another one that isn't 'money' but for all intents of economic impact it may as well be - HELOCs and credit card lines of credit were used increasingly like cash for two decades before 2007. They instantly create real money when they were used. The removal of access to trillions of dollars of instant cash has certainly been one of the dampers on our economy for the last couple years.
Larry, this is a good analysis. The problem is that many interpret the increase in M2 as money created by the Fed. If it is money parked by Europeans fleeing their own banks, then you are correct, it is deflationary and we are in a kind of liquidity trap. I claim the only way out is an investment-led recovery. This means untaxing capital and corporate income, broadening the tax base, and reducing the debt.
Maybe I'm wrong, but Monetarism in theory is pretty simple and sensible... the money supply should grow in direct proportion to the underlying growth of real goods and services - no more and no less. Velocity matters because money that doesn't move doesn't buy or make much. The problem discussed herein seems to be that nobody can really measure money supply any more. The rush to US treasuries in the wake of a much deserved downgrade just says that really bad money (the Euro) is looking for a safe haven that doesn't look as bad as the place being left. It's the "least dirty shirt in the bag" theory of finance.
It's all getting pretty darned pathetic.
Even China doesn't trust it's muscle enough to let the yuan float. Money has finally been disconnected from reality.
Thank you Leviathans everywhere.
I wish I was 20, energetic, and had a rich dad who bought gold low and then died so I could help pick up the pieces of this mess.
But I'm not, and I don't have a government pension with a COLA and the power to put a gun to the head of fools like me who worked hard, deferred gratification, saved a few sheckels and are just waiting around for the powers that be to inflate price levels (whether intentionally or not) to ensure they can continue to take away most of my savings to finance their social engineering schemes for a few more election cycles.
Falling interest rates, falling home prices, falling wages, yep that's deflation. Businesses going bankrupt, people losing jobs, people losing their homes, yep that's deflation.
Enviornmentalist and Leftist blocked energy development, restricting energy supplies and driving up the costs of globally traded consumer items. Inflation? or Supply problem?
This is carburetor tinkering. The connecting rods have blown out through the crankcase. You can tinker 'til hell freezes over. If you don't rebuild the engine, and take some of the loads off it, you will fail.
At this point, everything is up for grabs. All the old rules are negotiable.
Would you rather revisit a World War? Kinda puts "disaster" in perspective, don't it?
I think, unless we want to descend to a barbarity none of us can really comprehend, that compromise is not the answer. No matter how many "experts" claim the Sun sets in the East, it doesn't make it so. Compromise would be that the Sun rises and sets at noon. That is the level of argument we have today.
Some people are right, some are wrong. We need to learn the difference. And defend it.
It's good to see that Kudlow is finally understanding the deflationary threat to the economy that Bernanke and others have been concerned about for years.
Trying to increase velocity by printing more money is like trying increase blood flow in a corpse by hanging a nice bag of B-Positive. All they're doing is pushing the price of dollar denominated commodities higher, which is why the cost of linen and terry has doubled since January. (Hotelier, so that one stands out.) Pumping surplus fluid into a corpse may make the arm jump, but that doesn't mean it's alive. It's not deflation. It's just dead and there's nothing left the Fed can do about it. Bernie's just trying to look busy in case the relatives look in.
Trying to increase velocity by printing more money is like trying increase blood flow in a corpse by hanging a nice bag of B-Positive. All they're doing is pushing the price of dollar denominated commodities higher, which is why the cost of linen and terry has doubled since January. (Hotelier, so that one stands out.) Pumping surplus fluid into a corpse may make the arm jump, but that doesn't mean it's alive. It's not deflation. It's just dead and there's nothing left the Fed can do about it. Bernie's just trying to look busy in case the relatives look in.
Panic sure screws up conventional wisdoms doesn't?
1) Roll regulations back to the end of the Reagan years.
2) Get rid of ALL federal taxes and replace them with ONE consumption tax, exclude only one type of transaction, capital acquisitions.
3) Repatriate liquidity held overseas, FREE.
4) Slash federal spending in real terms by 40%.
5) Call the troops home, we're gonna need them.
6) Open federally owned lands for ALL types of uses, including sale to private ownership.
7) Place a moritorium on lawsuits that are only designed to impede economic re-investment. (Good bye snail darters of the world).
Of course we could simply allow things to remain the way they are. Afterall we did survive the Great Depression didn't we?
And no there isn't a chance in the world that even a tiny piece of any of these actions are going to be a part of the "plan", from either Repugnicans or Dumbo-crats.
BTW, find Robert Reisch's plan for the economy released yesterday I think. It is a trial balloon for the post Martha's Vineyard plan from Odooma-Glooma, ooops, Obama.
I wouldn't say inflation is quite out of the picture. After all, Gold has more than tripled in price against the dollar over the last 4 years. The value of the dollar since 2000 has fallen 22%.
Long term deflation, however, remains a disctinct possibility as our economy is geared towards a highly leveraged consumer base. And for more than 35 years, the Baby Boomers (76 million plus) were the consumer base. The 2010 Census data indicated that the rate of our population growth was the slowest since 1929. The median age in the US is now over 37 (it is near 45 in Europe). We're already suffering from an excess inventory of residential housing, as wel as retail and commerical real estate. Demand for consumer goods, food, and energy will probably peak this decade before falling. Hence the threat of delfation.
So we have an inflationary monetary policy fitted to an economy that is ripe for deflation, and a federal regulatory system that is determined to micro-manage every aspect of our lives. Not a good mix.
JPK - the change in CPI over the last 5 years comes to 2.15% per year. Over the last 10 years, 2.40% per year. Over the last 15 years, 2.45% per year. Over the last 20, 2.55% per year. Over the last 25, 2.95% per year. Over the last 30, 3.10% per year.
This is low stable inflation and it is falling pretty much monotonically, not rising. The market agrees (it is not a mere reporting issue) and expects such inflation rates in the future - the break even rate on inflation adjusted treasuries is ranges from 1.85% for the next 5 years and 2.25% over the next 10.
The present crisis in a deflation and not an inflation. Gold is higher on speculation and on safety demand for all forms of money or money substitutes, not inflation. It has been in a 15% a year bull market for a decade, like stocks in the 90s or real estate in the oughts, accelerating to 30% recently. Those are not remotely overall inflation figures, they are pretty much all real price change. That is why it is not joined by oil and other commodities - to say nothing of house prices - remember those? - or wages.
In case nobody looked it up, wages are about 7 times the weight in overall inflation of all commodities plus all materials manufacturing (steel chemicals etc) combined, because that is where the bulk of the value added and with it the cost structure of the US economy resides.
The only commodity price with enough weight in actual goods consumed to move the needle for whole US economy is oil, and it takes a $20 change in its price for a 1% impact. Even that somewhat overstates its weight, because domestic producers benefit from higher oil prices, mitigating its impact - in a pure terms of trade sense, it takes a $35 change in the price of oil to cost the US 1% of its economy.
Prices of narrower products can bounce around like pinballs and routinely do, without it meaning there is overall inflation in their weighted average. You can always select the one rising most, ignore its low weight, and allege inflation, but statistically that's nonsense.
Outstanding post. Excellent on the facts. You are absolutely correct. The Fed's big fear is not inflation, but rather deflation, about which it can do very little. If people and banks cut their economic activity, then GDP will drop. High levels of liquidity just do not encourage consumption and investment when the outlook is uncertain and confidence in the Administration is extremely low.
@JasonC,
Even inflation is as low as 2% (which it is not), computed over a decade the net loss in "value" is 20%. If a person deposited $100 in a simple savings account, the value of his deposit over 10 years would be $80. The bank would have to offer 2% interest during that period to offset inflation.
But, if we are to compute inflation by the same methods used in 1981, we would find that inflation is not 2% or 3%, but closer to 9%. Anyone who either lives on fixed incomes, or stagnant ones know this everytime he visits the supermarket.
As far as gold goes, it averaged just over $200 an ounce in 2001. Gold prices increased by a magnitude of 9 in 10 years. That isn't speculation. And the demand for gold is inversely proportional to the value of the dollar. Begining with Bush and accelerating with Obama, the dollar has plunged in real value. You don't see gold prices spike like they do because there's a "bull market" for gold. The demand for gold is high because the dollar is losing its value. That is inflation. Gold prices are the best measure of a currency. Your talking points would make more sense if gold was priced around $500/ounce - but not $1800.
Larry,
These are the death throws of a dieing Republic. Military over-reach, welfare rot, family breakdown, fiat currency gone mad, and a final crisis of confidence as people finally realize that its all been a big fat illusion pedaled by the US government. The wheels are coming off the cart.
The Fed will use the stock market selloff to issue QE3. The stock market will go berserk, gold will ignite, commodities will again go through the roof. The only way out of the debt trap Larry is to deflate the currency or default. I know that the owners of DC at the Too Big to Fail banks will not give up their stranglehold on us without a monstrous fight so I think they will inflate away, destroying the savings of the old to redistribute it through the DC income tax to pay interest on the national debt.
We're in a new financial era. We are where the Soviet Union was about 25 years ago.
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