Stock forum members examine the question of money supply growth.
To kick things off on the Stockhouse moderated macroeconomics group (see background article here), SH writer/editor and group moderator Robert Arber (known on Stockhouse as SH_Arber) put out a call to the participants to define inflation – what it is, what it means, and how it is manifested in the economy.
In this installment of the “Inflation and money supply” series, members address the question of how to measure money supply growth, a fundamental determinant of inflation. Respected economist Paul van Eeden is taken to task as our own Stockhouse analysts dig deeper into the money-printing debate.
For a refresher on how the discussion has been proceeding to date, check out the following links:
Investor groups launch with macroeconomics discussion
Inflation and money supply, part I: Treasuries crowd bonds
Inflation and money supply, part II: Buyer’s remorse
Inflation and money supply, part III: Indeflationists unite
Inflation debate stirs investors
Please add your comments at the bottom of the page, and enjoy!
[Editor’s note: Posts have been edited for punctuation, spelling, grammar and length.]
SH_Arber: Anyone catch Paul van Eeden on BNN recently? The guy blows the inflation trumpet louder than anyone, and he was on the show to tell the world why oil's real dollar value is only $3.00 a barrel - that the rest of the increase in the price of oil over this level (which harks back to the early 50s) is due strictly to inflation - the growth of money supply.
Now, here is something I think everyone needs to be clear on. Van Eeden pulled up a chart of the price of oil as compared to money supply growth - M3. The question is: Is the growth of M3 the best way to gauge the growth of the money supply? Van Eeden is only "right" about the real price of oil if everyone accepts that measuring M3 (and M3 only) is the "right" way to calculate money supply growth.
I think it was Gary North that challenged this idea in a big way, and said that inflation is nowhere near as bad as people are claiming, because measuring M3 to judge money growth is NOT correct.
Recently [Steven] Saville brought up the point that agreeing on a money growth measurement is more important than ever these days, because up until recently, the various money categories had been moving more or less in tandem, so it didn't really matter which category one used. Now that they're diverging in rates of growth, it's crucial that we figure out how to measure money accurately when we're talking about a rate of inflation (if we agree that inflation is a monetary phenomenon).
So: How do we measure money growth? Does it even matter?
StilesBC: Rob, Mike 'Mish' Shedlock, Gary North and Frank Shostak have all been touting M (M prime) as their favored method of gauging money supply. Here's some info on it:
http://globaleconomicanalysis.blogspot.com/2007/01/money-supply-and-recessions.html
http://globaleconomicanalysis.blogspot.com/2007/05/money-supply-is-soaring-right.html
http://globaleconomicanalysis.blogspot.com/2008/01/money-supply-trends-are-deflationary.html
http://globaleconomicanalysis.blogspot.com/2008/04/mzm-m3-show-flight-to-safety.html
For the record, I think van Eeden is an arrogant SOB with very little clue. His tireless touting of raging inflation does not align with anything approaching reality. I remember a debate he had with Dennis Gartman a couple of years ago, in which he was made to look silly. It was actually the start of myself taking a closer look at matters, and resulted in me moving away from the inflationist camp and closer toward the deflationists.
littleguy123: StilesBC, nice to see another voice jump into the fray. I have to agree with you that the more I see of Paul van Eeden the less he impresses me.
Regarding monetary inflation/money supply growth, I read a very interesting piece (sorry, can't remember who [wrote it]) about the relationship between economic growth and price levels. What the writer observed was that if the money supply remained absolutely constant as an economy grew, this implied deflation. Specifically, the economic growth implies an increase in the production of goods, but with the same number of dollars chasing more goods, prices would fall - and you would have a very healthy deflation where people simply got 'more bang for their buck'.
Pursuing that line of thought, if money supply growth perfectly matched economic growth (the supposed goal of all central banks), you would have perfect price stability - no visible indication of growth or contraction in the money supply. To go one step further, I would suggest a very workable definition for "money supply growth" is the absolute rate of increase in money supply (I prefer M3) minus the rate of economic growth - since where the money supply is increasing slower than economic growth, it's hard to argue there is a greater supply of money.
To relate this to Rob's question about van Eeden specifically, by not accounting for economic growth in his analysis, he is overstating the actual inflationary growth of the money supply (or the inflation caused/reflected in prices by the increase in the money supply).
frontline_jason: Just a quick note: The CPI figures that van Eeden uses are from John Edwards's Shadowstats, so the numbers may actually be somewhat meaningful when viewing the relationship between money and price increases.
[Editor’s note: To understand what frontline_jason is referring to in the following paragraph, please see the following article with charts: http://www.kitco.com/ind/VanEeden/jun022008.html]
At a glance, TMS (True Money Supply) seems to be more of a gauge of economic activity than inflation/credit growth. If you look at the periods where TMS contracted, they line up quite well with recessions (1980-82, 1990-91, and 2000-01). I can't really make a call on 1974 because the lines are blurred and overlap. With regards to inflation and resulting price increases, if you look at the chart, there is a kink right after 1970 when the pace of money growth picked up, which provoked widespread price pressures three years later. Notice that there was a kink in 1995 when M3 began to explode, and commodity prices bottomed in aggregate in 1998. Statistics tell us that a two-trial sample shouldn't lead us to any conclusions, but my gut tells me otherwise. And I'll vocalize again that we're in for some serious price increases next cycle.
Now, as a fun tidbit, it appears as though M3 is a useful gauge for asset bubbles. As long as M3 keeps growing, there are asset classes that will do well (and ultimately do so well that they collapse under their own weight). The 1950s and '60s had the "Nifty fifty." Commodity prices (particularly gold, silver, and oil) soared in the 1970s. Japanese stocks were the big winner in the 1980s along with corporate debt (which collapsed before Japanese stocks). Then we had technology stocks in the late 1990s, followed by the current global boom in non-government debt real estate (prices are still going through the roof in many places), EM (emerging market) stocks (in aggregate), and commodities.
It is also worth noting that after the banking crisis in the late '80s, M3 STALLED, and there were no widely investable asset classes that performed well (developed and EM stocks were in the toilet, corporate bonds did poorly relative to benchmark, commodity prices fell, and home prices in the G7 stopped appreciating).
The current backdrop is encouraging because with virtually every sector under fire and M3 still growing, it may be possible to make a killing next cycle if you pick the right sector/country. Put another way, market breadth will be so narrow that so much money will be channeled into so few assets that it has the potential to create a mania the likes of which has not been seen for decades.
Just some food for thought, which has made me hungry...
arnoldj: Great discussion so far. Hope and trust this is something like what Rob had in mind. [Editor’s note: It is exactly what he had in mind.]
To pick up on comments about Mike Shedlock, he has clearly distinguished money and credit in the inflation and deflation discussions. I wholeheartedly agree with him that the distinction is central to inflation vs. deflation.
In the U.S., we have underway right now the destruction of credit and with that the purchasing power for a consumption-driven economy. One of the major problems with measuring money supply growth is many include credit into that figure. Credit is not money. Money is used to re-pay credit and the consequences when you have credit growth outstrip money supply growth, as of recent years, is an inevitable contraction in credit back to levels supportable by the supply of money. This is compounded further when the underlying assets supporting credit growth rapidly depreciate.
One of the problems with M3 that I've argued about is the fact that there are sources of money that had existed outside the formula for the measurement of M3, such as the ABCP market, and only due to the destruction of that market, money flowed into money market funds and other instruments that are included in the calculation of M3. As a result, it appeared M3 was taking off due to the creation of money and credit where it was really a re-allocation of existing sources of money and credit.
Core to the deteriorating credit market is the fractional reserve banking system and its leverage of a contraction in credit. I think this should be a material element at one point in our discussion as its irresponsible governance is a source for much of the turmoil we see today. In this environment, if the contraction of the banks’ balance sheets accelerates, and in my opinion that's inevitable, the contraction of credit in the broader economy will be in the trillions. The question is, What will offset this credit contraction? More money creation, i.e., pure money printing from central banks?
Foreign central banks have been printing money to recycle into the US dollar, but the Fed has been out of this loop. I think the practical question central to what happens next is does the Fed join this party, with all the blowback?
Observe what is unfolding in terms of inflation in those other countries engaged in this practice. We've all read the articles, seen the news with the civil unrest blowback as prices for raw goods breaches thresholds of affordability. Credit is contracting in a rapid rate in the U.S. and I fear a period not too dissimilar to Japan of the past two decades (almost) or worse is on our doorstep.
Yet, foreign sources of raw pure money are increasing; observe the competitive currency debasement all around us. Talk about Charybdis vs. Scylla. StilesBC is fully correct about the pressures on wages and salaries during this period. A box of corn flakes - 70% of the cost is wages. Products of Charybdis and Scylla will be the push and pull on prices from a contraction in real incomes vs. imported inflation from other nations. I don't know who prevails but I think its going to be one torrid and quick resolution.
I think the hand of the Fed is going to be forced over the first term of the next U.S. President as they realize the implication, fully and completely, of, measured in NPV, $62 trillion installment payments blowing the budget to hell. I believe Medicare kicks in, in 2011. It hits the fan +/- 1 year from then.
Charybdis or Scylla will be rallying for a knock-out blow at that time, which one though, I don't know. The consequential blowback to the economy and society from either is too destructive and negative to tacitly accept.
For disclosure, either way I have positioned heavily into gold. Also add: I enjoy the conjecture and discussion very much. I also have a feeling that many others are about to get a crash course in theories of money supply, what is money vs. credit.
This group discussion was conducted with members of the Stockhouse community.
Next: In part V, the final installment of the “Inflation and money supply series,” gabrielgray and littleguy123 take on “the derivative Death Star” in this look at what money is (and isn’t) in a follow-on analysis of Paul van Eeden’s work.
Archive
Investor groups launch with macroeconomics discussion
Inflation and money supply, part I: Treasuries crowd bonds
Inflation and money supply, part II: Buyer’s remorse
Inflation and money supply, part III: Indeflationists unite
Spin-offs
Inflation debate stirs investors
