The only Reason Stocks Have Been Surging

Y/Y growth rate in the money supply and the Fed balance sheet.

U.S. Money Supply Update: Y/Y Growth Rate Near 10 Year Lows Having Tanked for 14 Months

The U.S. money supply growth has tanked for over a year, the saving rate has hit rock bottom, interest rates are rising. By the looks of things, the only thing keeping stock prices elevated is confidence, a shaky factor which by the looks of things (Dow down 10.4% last five days) are now being tested.

Chart of The Day: The Real Bust Must Be Fast Approaching

As of 24 Nov 2017

Related: A Glum Note On The U.S. Savings Disaster

U.S. Stagflation - Much More To Come By The Look of Things...

Also see:

Why You Should Expect No Improvement In U.S. Productivity And Economic Growth

More Serious Than Stock Market Participants Appear To Believe

Related:

The Money Cycle, Stock Market, And The Return Of The Inflation Premium - This Chart Is Off The Scale

A Toxic Development: VIX Hits All-Time Low, Money Supply Volatility Hits 9-Year High

Why could this development be a toxic one? Because money supply volatility may lead to increased financial instability. In fact, it often precedes it.

In simple terms, the increases in money supply volatility, driven by sharp declines in the growth rate, that have taken place all year, and especially since March, represent increased risk for financial investors.

The VIX on the other hand, which a few days ago hit record lows, is indicating stock market participants do not expect much volatility.

In other words, the VIX could be sending the completely opposite message of that of the money supply volatility and may, especially at this stage with stock market prices and valuations at record highs, indicate a low degree of risk aversion or even complacency among investors.

With a surging money supply volatility and a record low VIX, this combination could be an especially toxic one for stocks if (when?) the money supply volatility triggers increased financial instability. This again would likely trigger increased stock market volatility and lower valuations which would, given the current level of the VIX, be completely unexpected. And, as we know, the stock market does not like negative surprises.

For more on the importance of money supply developments, see:

The Austrian Theory Of The Business Cycle - A Short Synthesis

The Money Supply High Tide Ebbs And Becomes Low Tide

For more on this subject, see:

Economic Issues Unfold As The Money Supply High Tide Ebbs And Becomes Low Tide

Chart of The Day: Waiting For Money Supply Volatility To Spread To Financial Markets

Money Supply Update: Shorter- and Longer Term Growth Rates Are All Heading Down

Either way you look at it, the U.S. money supply growth rate is falling, in some cases sharply (39 weeks- and one year basis). 

YTD, the money supply has hardly moved at all being up just 0.18%. This compares to an average annual expansion of 7.2% since 1986.

This is of grave importance as it is during such times that the unsustainability of the previous expansion is revealed. In real life, this usually means sharp falls in a range of asset prices such as stocks and real estate and a GDP recession.

Purely based on monetary developments, the probabilities of a stock market correction or even a crash are hence growing ever larger. 

At the same time, the government is quickly running out of cash as deposits with the Fed (which forms part of the money supply) have now dropped to just $82 bn.

Recommended reading:

The Austrian Theory Of The Business Cycle - A Short Synthesis

Money Supply Growth Falls Again, Dropping to 105-Month Low

By Ryan McMaken,

Growth in the supply of US dollars fell again in May, this time to a 105-month low of 5.4 percent. The last time the money supply grew at a smaller rate was during September 2008 — at a rate of 5.2 percent.

The money-supply metric used here — an "Austrian money supply" measure — is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure than M2. The Mises Institute now offers regular updates on this metric and its growth.

The "Austrian" measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short time deposits, traveler's checks, and retail money funds).

M2 growth also slowed in May, falling to 5.6 percent, a 20-month low.

Read the full article here.



For more on the Austrian True Money Supply click here.

Bust Chart of The Day: As The Reserves Plus Money Supply Growth Rate Tanks

Chart of The Day: A Primary Reason Many Economic Indicators are Moving Sideways or Down Slightly

Updated as of 2 June 2017

Learn more about the money supply growth rate and its impact on economic developments here and here.

A Main Determinant of Financial Stability Has Turned Volatile

From December 2014 to October 2016 the y/y money supply growth rate for the U.S. experienced a period of unprecedented stability based on data covering the last 28 years. This might very well have contributed to the financial stability also experienced in recent years.

But now the volatility of the money supply growth rate has picked up remarkably in recent months. The question then becomes if recent developments will be a precursor for increased market volatility as well.

Also notice how the 2000 and 2008 financial turmoil were preceded by record-low levels of volatility in the money supply growth rate. Whatever the case may be, one thing is for sure: increased money supply volatility is not ideal for financial markets, especially when it's driven be a declining growth rate as is the case today. 

Money & Credit Update

The money supply is still declining on a rolling 13 week basis, though it fell less this week than during the previous six weeks...

...driven by declines in bank credit...

...which consists of bank lending, which makes up about 73% of bank credit....

...and securities owned by banks which makes up the remainder (about 27%) of bank credit.

Growth in banks' securities portfolios has therefore acted to partly counter the declines in bank lending, especially during the last seven weeks.

Charts of The Day: U.S. Bank Credit Growth Plunge Continues

This is starting to become serious. 

And finally, Michael Pollaro's "a bastion of leveraged financing into the financial markets."

U.S. Bank Lending Contracts Further - Here's What Happened Previously When It Did

The slide in the U.S. money supply growth rate continues to be fueled by declines in bank lending.

Since the peak in December of last year (US$9.2 trillion) loans outstanding have now declined by US$124.9 billion, or 1.4%. This might perhaps not sound like much of a decline, but it is really the growth rate of lending and money supply that matters.

If we look at the growth rate on a rolling quarterly annualised basis, the recent decline becomes more pronounced.

The importance of this slide in bank lending is that it is nearly always associated with economic problems of some sort, certainly during the last 36 years. Here's the same chart, but going back to 1981.

And here's a quick recap of what happened during previous periods when the rolling quarterly growth rate turned negative in the U.S.:

• Late 1980s/early 1990s: savings and loans crisis

• 1998: the fall of Long Term Capital Management, stock market turmoil

• 2000-2002: dotcom/telecoms bubbles popping

• 2007/08 - 2009: banking crisis (subprime crisis)

• 2017 - another banking crisis????

For more on the bank lending and money supply topic, see the range of articles I've published on Seeking Alpha recently, including: 

Inflection Point For The U.S. Economy As This Recession Trigger Now Put In Motion

Bank Lending Growth Continues To Tank Driven By Plummeting C&I Lending Growth

Following on from the article earlier this week and the money supply report this morning, bank lending growth tanked again this week.

The drop was driven by steep declines in the growth of Commercial and Industrial lending.

The four biggest components of bank lending (y/y % change)

As bank lending is by far the biggest of the two main components of bank credit (the other being securities owned by banks), the bank credit growth rate is being pulled down as well...

...which then drags the money supply growth rate down with it. 

Though there are lags involved, red flags should by now be flashing for Austrian Business Cycle practitioners. 

Could This Be One Of The More Important Charts This Week?

Related:

Timing The Coming Downturn - Is This The Calm Before The Storm?

Breaking: Bank Lending Growth In The U.S. Is Plunging

Absent Federal Reserve interventions, increased lending by commercial banks is by far the most important driver of U.S. money supply growth. Hence, when the loan growth declines the money supply growth rate will be lower than otherwise as a result. This has important implications for the business cycle since an expanding money supply growth rate drives the upward swing of the cycle while a declining one triggers the downswing (e.g. see The Austrian theory of the business cycle). 

Starting toward the end of October last year, the loan growth rate started falling regularly every week on a year on year basis. In recent weeks, the growth rate has plunged to just north of 5%, a drop in the growth rate of more than 35% (2.8 percentage points) compared to the January 2015 to October 2016 average. 

U.S. Banks year on year lending growth: January 2015 to February 2017

These large drops in the growth rate are of great economic importance as those businesses and projects dependent on credit might now find it more difficult to attain the necessary funds. Also, though not noticeable quite yet, the money supply growth rate will likely start falling more over coming weeks as a result which affects everything from corporate sales and earnings to interest rates and prices in general. Since declining loan growth by commercial banks now seem to have become a trend, this could very well also indicate this credit cycle is fast approaching the end and signal the onset of yet another financial crisis. 

                         U.S. Banks year on year lending growth: January 1974 to February 2017

Recap 2016: The "Austrian" True Money Supply for the U.S.

Over the years, there have been some debate about the proper way to define the money supply. This debate centres on the broader components of the money supply as there is no debate that the most liquid components such as currency and demand deposits should be included. 

As a response to this debate, Austrian school economists Murray N. Rothbard and Joseph T. Salerno responded by compiling a measure of the money supply “…that is consistent with the theoretical definition of money as the general medium of exchange in society” [1] and which was “…based on the definition of money [in the broader sense] as originally formulated by Ludwig von Mises in his book The Theory of Money and Credit.” [2] This Austrian school definition of the money supply is better known as the “Austrian” True Money Supply, or simply as the True Money Supply (TMS).

A distinguishing feature of whether an item should be counted as money according to Rothbard and Salerno is if it serves as the final means of payment in all transactions. The use of credit cards illustrates this point. When payments are made with a credit card, the debt is not finally discharged until money is transferred from the bank account of the credit card holder to the credit card issuer. The credit card transaction is hence just an intermediary transaction, while money transferred from the bank account is the final payment. Therefore, credit card balances are not counted as part of the TMS, while cash in the bank account is. 

A second test for including items in the TMS is that they should be instantly redeemable, par value claims to cash. For example, Large Time Deposits do not qualify to be included in the TMS since they are not par value claims to immediately available money. Why? For the simple reason they are time liabilities not payable by the issuing institution before maturity. It could perhaps be possible to draw on them immediately, but this would come with a financial penalty of some sort. In a similar fashion, Small Time Deposits are excluded from the TMS because they “… involve loans by the public to banks and thrifts.” [3] Also, Retail Money Funds are not money as they pass neither of the two tests.

Based on these two tests described above, the TMS consists of the following components, all of which can be downloaded individually from the Federal Reserve website on a monthly basis (items are hyperlinked so you can click for a closer look at each): [4]

• Currency Component of M1
• Demand Deposits at Commercial Banks
• Other Checkable Deposits
• Total Savings Deposits at all Depository Institutions
• Deposits with Federal Reserve Banks, other than Reserve Balances: U.S. Treasury, General Account: This account is the primary operational account of the U.S. Treasury at the Federal Reserve. Virtually all U.S. government disbursements are made from this account. Some tax receipts, primarily individual and other tax payments made directly to the Treasury, are deposited in this account, and it is also used to collect funds from sales of Treasury debt.
• U.S. Government Demand Deposits and Note Balances: U.S. Government demand deposits at commercial banks plus note balances at depository institutions. Calculated by the Federal Reserve Bank of St. Louis.
• Demand Deposits Due to Foreign Commercial Banks
• Demand Deposits Due to Foreign Official Institutions

The first four of these components are also included in the widely cited Federal Reserve definition of a broader measure of the money supply - the M2 money supply  - while the last four are not included in any of the money supply aggregates reported by the Federal Reserve. The TMS hence include money balances held by the government and official institutions while the official definitions of the money supply do not. 

The reasons these government/official institution money balances are included in the TMS are straight forward. First of all, money held by government institutions can be just as readily spent as money held by the non-bank public. Secondly, these balances pass the two tests of what should be defined as money.

As they did not pass the two tests described above, Travelers Checks, Small Time Deposits and Retail Money Funds - all included in the M2 aggregate - are all excluded from the TMS. Large Time Deposits is not included either for reasons mentioned above. 

We see therefore that the main difference between the frequently sited M2 money supply and the lesser known TMS is that the former includes Small Time Deposits and Retail Money Funds while the latter excludes both. Additionally, the TMS includes balances held government institutions while the M2 money supply does not. 

For reasons already mentioned, the TMS is superior to M2 as it applies a precise definition of money. Naturally, there is a close correlation between the two as both count currency, demand- and other checkable deposits, and savings deposits as part of the money supply. These items make up the bulk of the money supply in the broader sense no matter how it is defined. For example, at the time of writing these items make up about 88% of the M2 money supply and 96% of the TMS. Given the dominance of these items, the M2 money supply is useful as a measure of monetary inflation. But, since the TMS is superior as a definition of the money supply and as significant differences can occur between the two at times, especially with respect to the growth rate (which is more important than the absolute quantity of money), TMS should be the monetary aggregate of choice. Today, this is more true than in a long time since Treasury deposits with the Federal Reserve have grown rapidly in recent years.

Historically, U.S. Treasury deposits with the Fed played a negligible role for the money supply as it averaged just US$5.8 billion on a monthly basis during the January 1986 to September 2008 period. Since 2009 however, the average has jumped to US$103.5 billion. At the end of 2016 the balance was US$311.3, the highest ever recorded and representing about 2.6% of the TMS. 

This component of the money supply has therefore become increasingly important of late. Why this change? The answer appears to be twofold. Firstly, there are indications the Federal Reserve is now actively using this account as part of monetary policy. In an effort to reduce bank reserves, tax revenues are now collected in this account with the Fed instead of in U.S. Treasury accounts with commercial banks. [5] Secondly, the account balance has apparently also increased due to the treasury receiving interest payments from the Federal Reserve’s large holdings of treasury- and mortgage-backed securities. These interest payments to the Treasury have grown significantly in recent times following the substantial increase in interest-paying assets accumulated by the Fed during the 2009 to 2014 period (QE 1, 2 and 3). [6] Unless the Federal Reserve undertakes a policy shift and decides to dramatically shrink its balance sheet, this component of the money supply will be of significance going forward as well. [7]

A feature of the elastic money supply (soft currencies) employed today is that the quantity of money constantly increases at a high rate. In contrast, a largely inelastic currency (hard currencies) such as money backed by gold, would only increase relatively modestly over time. As mentioned briefly above, it is not the absolute amount of money per se that matters to economic developments. Instead, it is the rate of change in the money supply that affects developments, of which the business cycle is of great importance. That is why investors, economic pundits, and any student of economic developments must include monetary developments in their analysis - the analysis would be half-hearted without. 

Following the surge in the money supply during the four-year period spanning 2009 to 2012, the money supply growth rate dropped significantly in 2013. Until summer 2016, the growth rate was characterised by unprecedented stability (certainly when based on data since 1986) before it increased sharply until October 2016, caused by a surge in Treasury deposits with the Federal Reserve. The growth rate then fell sharply in October and November, but ended the year up  8.7% - the highest year-end growth rate since 2013. The money supply expanded US$973 billion during 2016, the biggest increase ever in monetary terms, to end the year on US$12,158 billion (more than US$12 trillion). 

Here are some other observations based on the table:

• The money supply has more than doubled since 2008 - an annual growth rate of 10.5%.

• Since 1986, the money supply has expanded an average of 7.1% every year.

• The money supply has contracted on only two occasions on a yearly basis since 1986: 1989 and 1995.

• On a 5-year annualised basis, the growth rate of the money supply prior to 2001 looks moderate compared to what has been the case ever since. 

An increase in the quantity of money confers no benefit to overall society. What people really desire is increased purchasing power. Sadly, an ever-inflating money supply achieves the exact opposite. So, while any economic aggregate measured in monetary terms, e.g. GDP (both nominal and real) and stock market indexes, have increased as a consequence, many people have found that their purchasing power has declined significantly. True, there has been no financial bust and crisis yet since 2008. What has happened instead is a substantial loss in purchasing power for the great majority of Americans. This can be seen clearly in the chart below where personal income as a percentage of the money supply has fallen more or less consistently since the early 2000s. Currently, the ratio is at the lowest level ever based on data since 1987. 

Personal income / True Money Supply

Whether we get another bust or not in 2017 remains to be seen. But as long as the money supply growth rate remains high, we should not become surprised if the purchasing power of most Americans continues to slump further this year. 

---

[1] The "True" Money Supply: A Measure of the Supply of the Medium of Exchange in the U.S. Economy (Salerno, 1987).

[2] True Money Supply (Mises Wiki 2016).

[3] (Salerno, 1987, p. 4).

[4] The first four items are also available on a weekly basis. Definitions of the items are taken from the Federal Reserve website.

[5] Federal Reserve Watch (Mason, 2016).

[6] See The Cozy Relationship between the Treasury and the Fed (Howden, 2016) and Treasury Deposits at Fed Prop Up Money Supply Again in January (McMaken, 2016). As McMaken notes: “With the economy weakening and deflationary pressures mounting, this close relationship between the Fed and the Treasury has proven to be an easy way to increase the money supply.” It should here be noted that these interest payments do not actually lead to an increase in the money supply as the initial interest payments from the U.S. Treasury to the Federal Reserve lead to a reduction in the money supply. When the treasury then next receives interest payments back, this merely helps to offset part of the initial reduction in the money supply. Howden points out that the Fed returning interest payments to the Treasury means the U.S. government’s net interest expense is reduced accordingly (as almost 55% of the Fed’s assets, or nearly US$2.5 trillion, consists of U.S. Treasury Securities as of March 2016 according to the Federal Reserve balance sheet). This arrangement with the Fed hence reduces the Treasury’s borrowing costs and effective interest rate on debt significantly. Also, this arrangement means the government gets its hands on more money than otherwise would be the case if these securities were in the hands of the non-bank public instead of the Fed (as investors, and not the Treasury, would then receive the interest payments).

[7] The Treasury Borrowing Advisory Committee (TBAC) has recommended the treasury keeps a US$500 billion balance in this account: “…the TBAC recommended that Treasury hold a $500 billion cash balance, or 10-days of liquidity, to ensure that all government obligations could be met in the event that Treasury lost market access” (U.S. Department of the Treasury, 2014). If there ever was a firm commitment to keep an emergency balance of say $500 bn, this would mean we could exclude that amount from the money supply as long as the Treasury has access to markets. Removing it would of course reduce the money supply accordingly.