Historic Rate of Money Supply Contraction Getting Noticed

| May 28, 2010

We have been monitoring the steep contraction in broad money supply (M3) since early this year, and John Williams over at Shadow Government Statistics has noted that a sharp drop such as this one has always been followed by meaningful weakness in the broad economy. The graph below displays the historic nature of the current decline.

Very few others were discussing this important development while the stock market was moving up to new speculative highs in March and April, but now that we have experienced a mini crash in global equities and economic concerns have started to grow, this trend is being addressed more often in the mainstream financial media. For example, an article entitled “US Money Supply Plunges at 1930s Pace as Obama Eyes Fresh Stimulus” appeared in the UK Telegraph this week.

“The M3 money supply in the United States is contracting at an accelerating rate that now matches the average decline seen from 1929 to 1933, despite near zero interest rates and the biggest fiscal blitz in history. ‘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 said.”

You can see why the precipitous drop in M3 is such a cause for concern when you review both M2 and M1. While M3 is now contracting at an annualized rate of over 9%, both M2 and M1 remain near historic highs.

Liquidity is still being pumped into the system, but it isn’t going anywhere as banks continue to channel those new funds directly into reserves. As a result, the money multiplier remains well below 1 and broad money supply continues to contract.

We expect to see continued deterioration in the economic data as we move into the second half of the year as a direct result of this trend.

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Category: Commentary, Market Update


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