Economists rarely agree on anything so there is no surprise that we have two distinct camps over the question of the US money supply. Should that bother us you may ask? It sounds a bit dry and dusty as a topic doesn’t it? Well yes we should take an interest and here’s why.
On the same day that Timothy Geithner is reported in the Washington Post to be in London urging the new British administration to get its debt situation under control his colleagues back in Washington are urging the Obama administration to spend another $200bn on a new stimulus program. Just weeks after Obama vowed to rein in a budget deficit of $1.5 trillion (9.4% of GDP) this year Larry Summers, top economic adviser to the administration, is to ask Congress for a further stimulus package to stave off a double dip. Quoted in a Telegraph article he is said to have stated “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 quantitative easing. If the Fed doesn’t act, a double-dip recession is a virtual certainty,” he said. Their fear is that a combination of the European debt crisis and Asian cooling is restricting the impact of the previous stimulus package and the ability of the US economy to continue to grow. Supporting their worries 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.
So much for the Keynesian economists at the Fed and in the White House. Plenty of others are pointing to an entirely different reason for the economy’s failure to gain traction, namely money supply. Although a measure of M3 money supply is more favored in Europe than in Washington the fact remains if it had been tracked during the US housing boom the bubble’s burst would have been foreseen. Double-digit growth of M3 during the US housing boom gave clear warnings that the situation was out of control. The sudden slowdown in M3 in early to mid-2008 – just as the Fed talked of raising interest rates – gave a second warning that the economy was about to go into a nosedive.
Since last summer, M3 has been shrinking, and since the beginning of this year the decline has accelerated. 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 9.6%. The assets of institutional money market funds fell at a 37% 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 is quoted as saying in the article.
Only time will tell if the Fed/White House or more traditional economists are right to be concerned about the recovery and the solutions. What is becoming increasingly likely is that the US, along with many other OECD countries could be heading for that feared double dip.