Donnerstag, Mai 27, 2010

The Long Hand...

According to Keynes:

The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.

We can see the insight of this almost every day. The irony, of course, is that it is now Keynes who is the defunct economist that he himself refers to.

This gives pause for thought.

Keynes thought that such numbers were, at the end of the day, not really very important: he rejected the monetarist positions that basically said if you keep your money accounts in order, everything else will fall into place. He recommended ignoring them and watching the GDP numbers instead (let us remember that GDP was a fairly new concept when Keynes wrote his masterpieces (and don't get me wrong: they really are such), with emphasis on incomes. The business of government was full employment, inflation via monetary excesses easily avoidable.


The M3 in the US has been largely ignored over the last decade, reflecting both an ideological standpoint (Keynesian vs. Chicago School, with the Chicago School winning the hearts and minds of business, but Keynesian thought won in government and the Democratic Party) and the fact that indeed M3 and other monetary statistics can be erratic and are difficult to analyze in the short term.

It is now falling at the fastest rate since the Great Depression.

First of all, for those not conversant with the M1, M2, M3 and other monetary statistics, what is the M3?

It is the sum of notes and coins in circulation, traveler's check issues by non-banks, demand deposits (basically checking accounts and the like which are accessible at all times and without notice), other checkable deposits (OCDs), which consist primarily of negotiable order of withdrawal (NOW) accounts at depository institutions and credit union share draft accounts, savings deposits (also accessible at all times and without notice), time deposits of less than $100k and money-market deposit accounts for individuals, as well as large time deposits, institutional money market funds, short-term repurchase and other larger liquid assets.

The important part is: liquid assets.

What does it mean when the M3 starts to fall?

Well, let's understand what it means when the M3 starts to increase: it represents increases in money due to economic activity (aka "profit"), as well as inflation effects. Hence M3 in and of itself can't explain what is going on, as you can't tell if it is showing inflation (bad) or increases in economic activity (good).

But let's look at how money supply moves in conjunction with economic activity. Here we'll use what is called the M2, which is available, as the M3 was discontinued in 2005 (with the argument that the M2 did the job just as well: the M2 is the M3 minus the large time deposits, institutional money market funds, short-term repurchases and other larger liquid assets).

Something ... odd emerges.

The ratio of GDP (nominal) to M2 is fairly stable and moves around 42% from 1970 until around 1987, then starts to increase rapidly in the 1990s to over 53% in 1997Q3. It then falls in two stages, from down to an average of 48% in 2002-2005, then falls once again back 42% in 2009.

This ratio increases during strong periods of economic expansion: it falls when the economy cools. The reason? This is a measure of liquidity, of available monies. During economic expansions this increases as profits are not invested immediately, during economic downturns it decreases because monies are already tied up and profits fail to increase at the rate "needed" to keep M3 up.

Hence the answer to the question of what it means when the M3 falls is that the cash flow, as it were, of the entire country is in contraction, meaning not so much that there isn't any money out there, but rather that it's simply not easily available.

Hence while the economy may be showing signs of growing (ex the rather large stimulus programs, of course), a credit crunch is developing (shucks, it's already there and has been) that points to a severe brake on the economy.

The further drop in the money supply as reported here is disturbing: it means that despite the government acquiring, literally, trillions of new debt in order to prime the pump, that there is less and less liquidity in the market.

This deserves further observation: the less liquidity in the market, the less the real economy can finance operations. If they can't do that, then the house of cards falls down: it is akin to the speculator who is so heavily leveraged in their investments that they literally can't, despite millions of assets, afford to have the car fixed because virtually their entire income goes to financing their investments. One little misstep and insolvency is the result, of being unable to meet aggregated debt servicing.

Now, the US is far from that point, right?

Hmmm: let us look again at the Daily Treasury Statement from 25 May 2010: US debt (Table IIIC) is at 90.52% of the debt ceiling, and at 89.9% of GDP.

You can extrapolate from that: the US is, effectively, not even one paycheck away from insolvency, and the Rating Agencies, once again, have failed to properly downgrade a country that does not, at this point, deserve a AAA rating.

But if not the US, who?

Ye gods.

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