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The Return of M3

Last year, we lamented the passing of M3 reporting. This broadest of money supply measures had shown a discomforting increase in liquidity, far greater than what M2 was revealing. 

At the time of the M3 announcement, we suspected the Fed was attempting to cover their tracks, disguising an ongoing increase in money supply and an unstated "easing" in Fed bias. Since that time, we have learned: the Treasury Department was also adding liquidity -- a duty they have assumed, in part, in addition to the same performed by the Fed. Indeed, based on the credit growth data Doug Noland published last month (October Credit Review), it appears that the Fed has – despite increasing interest rates – actually eased over the last two years.

In light of all this excess cash sloshing around, we wondered what M3 might look like if it were still being reported.

Wonder no more:  We  have located 2 separate sources  for the reporting of M3. The first is Nowandfutures.com. As this article discusses, recreating M3 from publicly available data was relatively easy to do (to 5 nines accuracy).

As the chart below shows, M3 is alive and well and growing significantly. (A longer term M3 chart can be found here).

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M3 January 2003 to present
click for larger graph

Source: Now and Future

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Why is this significant? Well, M3 is growing quite rapidly, with the annual rate of change now over 10%. Prior to the announcement of M3's demise, its growth was in the range of 3 - 7%.

Anytime a government agency stops reporting about their goings on, it should raise a few eyebrows. Now we see what happened once the reporting of M3 was killed -- that measure of money supply spiked much higher -- a rate of change that's even greater than 10%+.

Funny how we alter our behavior when we think no one is watching what we are doing, isn't it?

What makes this particularly egregious is that the broadest measure of Money Supply that is still "officially" reported -- M2 -- and its been flat for 2006 (as my pal LK likes to remind me all the time).

Have a look at this chart: 

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M2 versus M3 Money Supply Growth

Source: Shadow Government Statistics

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This is a classic case of "ignore what they are saying, because what they are doing is speaking so loud:"  While the Federal Reserve has been reporting rather flat money supply growth in M2 (blue line), in reality they have been dramatically increasing the cash (red and blue line) available for speculation.

Hence, that sloshing sound you heard. They have been providing the fuel for the rally, the huge M&A activity, the explosion in derivatives -- even the eye popping Art auctions are part of the shift from cash to hard assets. It is just supply and demand -- print lots of lots of anything, and that thing becomes increasingly devalued. It works the same for cash as it did for Beanie Babies.

Its not just the increase in Money Supply that should be concerning to investors -- its the misdirection about it. If Money Supply matters so little, as Fed Chair Bernanke has been out explaining to anyone who will listen, why pray tell has the Fed been working those printing presses overtime?

Given M3 increases, its no wonder the European Central Bankers laughed at the suggestion.

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William McChesney Martin, Jr., Fed  Chair from April 2, 1951 to January 31, 1970, famously described the role of Central Banks thusly:  "The job of the Federal Reserve is to take away the punch bowl just when the party starts getting interesting."

It seems the present Fed is not only NOT taking the punch bowl away -- they are spiking it with alcohol. I am not looking forward to the hangover that's to follow . . . 

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UPDATE: November 21, 2006 4:05pm

Our M3 discussion was picked up by WSJ's MarketBeat:

Money (That’s What I Want)
David Gaffen
WSJ,  November 21, 2006, 12:55 pm
http://blogs.wsj.com/marketbeat/2006/11/21/money-thats-what-i-want/

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Sources:
M3 b, repos & Fed watching: Is M3 1 really gone?
April 25, 2006
http://www.nowandfutures.com/articles/20060426M3b,_repos_&_Fed_watching.html
http://www.nowandfutures.com/key_stats.html

Alternate Data Series
Shadow Government Statistics
Nov 19, 2006    
http://www.shadowstats.com/cgi-bin/sgs/data

Credit Bubble Bulletin, Financial conditions
Doug Noland
October 13, 2006
http://tinyurl.com/ymq8on

Tuesday, November 21, 2006 | 06:01 AM | Permalink | Comments (66) | TrackBack (3)
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Comments

Europe? Did I hear you right? I've always thought you guys should get out a bit more often, but does this mean it's gonna happen?

Posted by: Charles Butler | Nov 21, 2006 7:44:16 AM

And most people are duped into believing there is little to no inflation. It's running at 10% per year!

Posted by: Mike M | Nov 21, 2006 8:39:47 AM

"Hence, that sloshing sound you heard. They have been providing the fuel for the rally, the huge M&A activity, the explosion in derivatives -- even the eye popping Art auctions are part of the shift from cash to hard assets."

THINK about this statement.......

Increasing cash supply while moving to HARD ASSETS.
Is this so we don't notice the shift in currency in asset classes? We all know corrections redistribute wealth....
Are they preparing for a market/currency correction by buying hard assets and moving away from cash?

Those who survive any market correction need to be aware that their cash ain't nothin' but trash when devalued by supply.

If BIG FISH are buying hard assets, (which have inherent value less volatile than cash) perhaps we should all be thinking this way.....

Posted by: Craig | Nov 21, 2006 8:43:45 AM

Looks like BB is practicing what he preaches.

"Deflation: Making sure it doesn't happen here"

As an economic dilettante, I have a question: If there is a 10% annual expansion of the money supply and GDP is growing at 0.8% to 1.6% (depending on whose spin you prefer), does that mean that actual monetary inflation is 8.4 to 9.2%?

If we are actually in a recession this quarter, is real monetary inflation rate higher yet?

Posted by: Idaho_Spud | Nov 21, 2006 8:47:55 AM

So the Fed is printing money and then giving it to people to put on time deposit? Is it really that simple? Surely a more realistic argument is that the proceeds of the US current account deficit, which in yesteryear accrued to primarily private sector agents, is now being financied by the Asian and Middle Eastern public sector. So whereas in the past, the proceeds from the deficit were earned and spent by, say, Toyota and Sony, the proceeds are currently being accrued by the PBOC, BOK, SAMA, etc. These guys put the money on deposit (thereby inflating M3), then eventually spend the money on Treasuries and Agencies.

So the issue is not that the Fed is jamming the economy with liquidity, but that the Fed has lost control of monetary policy and broad money growth, an even more disconcerting prospect...

Posted by: Macro Man | Nov 21, 2006 9:00:39 AM

I don't see where anyone actually explains the significance of this. What exactly is increasing? Institutional money funds? Eurodollar accounts?

That would have made a much more informative column, rather than simply feed the conspiracy theorists....

Posted by: Bob_in_ma | Nov 21, 2006 9:06:29 AM

Idaho Spud,

Actual inflation is 10%. This is inflation. Most people focus on price inflation, which is based on prices of a basket of goods and services. This basket is tinkered with, and adjusted probably to look more favorable (lower). Not all monetary inflation ends up in prices. But that money will end up somewhere, perhaps an inflated stock market, housing market, whatever.

The Fed should focus on low monetary inflation. Instead they put the focus on price inflation. This is a scam.

Posted by: Mike M | Nov 21, 2006 9:08:04 AM

Ok,

The Fed cannot control M3 growth. They just can't do it. That's one of the reasons they stopped reporting it. I agree it was a suspicious move but if you understand what's in M3 you realize it cannot be curbed or expanded by the Fed.

The only aspect of M3 the Fed controls is the repurchase agreements.

Everything else is handled by Wall Street.

So this amazing expansion in credit is not due to a power the Fed has but the lack of power the Fed has.
It's just banks coming up with creative lending & new financial products.

At least that's my understanding of it.

Posted by: na | Nov 21, 2006 9:08:33 AM

"So the issue is not that the Fed is jamming the economy with liquidity, but that the Fed has lost control of monetary policy and broad money growth, an even more disconcerting prospect..."

This sounds very plausible to me - who knows nothing about M3 or economics. Are treasuries and dollars held by foriegn central banks counted in M3?

Posted by: Sailorman | Nov 21, 2006 9:17:48 AM

Sailorman

Treasury and Agency holdings would not be counted in M3, but time deposits and eurodollar deposits are. A lot of the reserve assets, when first accrued, are slapped on deposit until they can find a more permanent home.....by which point even more dollar FX reserves will have been accrued to take the placing of the maturing time deposits. China by itself is accruing $20 billion a month in foreign exchange reserves, of which maybe $13 billion would be kept in dollars.

Posted by: Macro Man | Nov 21, 2006 9:28:07 AM

Quite right, MM: that the Fed and the Treasury have little or no control over money growth is disturbing enough without having to believe in a conspiracy. Petrodollar recycling and Chinese reserve growth probably account for a good chunk of what's going on. "Bretton Woods II" is alive and well, in other words.

This explains why I range from 50-100% hedged out of US$ and do not mind when I take losses on those hedges.

Posted by: wcw | Nov 21, 2006 9:48:06 AM

this market has walked a benevolent line for the past few weeks. my feelings are that the party ended yesterday for mr.market. i see the writing and have changed my posture. november 07 spx puts on-sale at a brokerage near you.

Posted by: erik | Nov 21, 2006 10:02:52 AM

M2 report from last Friday:

This week marks the eighth consecutive week of growth in M2, now the longest period of continuous expansion in the last three years. The last eight weeks have resulted in $102.6 bil of growth in M2, around 36% of the total growth for 2006. Over this period, the average weekly growth rate is more than double the 2006 average.

Posted by: jill | Nov 21, 2006 10:13:10 AM

2007: Chinese year of the Pig.
Gold bars on sale for 175 yuan/gram

2002: CHinese year of the Sheep.
Gold bars on sale for 92 yuan/gram

...a compound annual inflation rate of 13% for all to see.

"Anytime a government agency..."
Sorry, but I must take issue with this statement. I mean, really?

Posted by: tjofpa | Nov 21, 2006 10:58:27 AM

There are three distinct factors that are helping make the credit cycle go much longer and much further than anyone thought possible.

1. Foreign purchases of US assets are effectively creating a backstop bid for assets that the private sector would never touch. Agencies (backed by suspect collateral), Treasuries. If the dollar gets too weak intervention will take place.

2. CDS and securitization are allowing credit risk to be extended to the riskiest of all borrowers. Anyone can speculate in high risky bonds because they can buy a CDS to hedge there exposure. Everyone wins in because the issuer collects the premium and the buyer believes he is protected from default on the bonds.

3. Moral Hazard. The genius fed has intervenied so many times to prevent a market collapse that everyone knows they are going to come to the markets rescue. The fed has been blackmailed by the credit markets.

Thus, the markets continue in this relentless search of profits by lending to worse and worse borrowers. However, when the music stops things will go get out hand quickly.

LBO's are doing deals at 9.5 ebitda and junk bonds are yielding 7.4 percent vs over 8 last year. At some point the music stops and all the bad credit that has been written will be repriced and I assume many hedge funds that are offering cds will be overwhelmed and the buyers of protection will find that there really isn;t enough insurance going around.

Posted by: James | Nov 21, 2006 10:58:50 AM

thank you, barry, for poking around and doing the hard work. until you are further rewarded by Mr Market, let enlightenment be its own reward. i thought they stopped publishing M3 in time to flood the markets for the election (also, somewhat less self-interested: to ameliorate the housing contraction), and this confirms it. but question: what can stop them? if Bernanke wants to keep printing money for life, does that mean the market in fact does grow to the sky? i understand the guy has an overwhelming fear of Depression, but does that mean he can throw all professional and historical discretion to the wind? are there no grown-ups left? anywhere? Schwab's giving me 5% for cash. i want 10%. cash.

Posted by: scorpio | Nov 21, 2006 11:19:11 AM

Macro Man wrote:

"So the issue is not that the Fed is jamming the economy with liquidity, but that the Fed has lost control of monetary policy and broad money growth, an even more disconcerting prospect..."

I agree that this assessment is more likely the correct one.

Posted by: winjr | Nov 21, 2006 11:46:05 AM

Barry,

My understanding is that the Fed's charter directs them only to buy short-term Tres. with their freshly created money. To wit, they cannot legally increase M3 without increasing M2.

Furthermore, can you spend M3 without its being converted to M1 or M2?

I think the M3 growth is coming from Asian banks & petro recyclers buying our long-term Tres debt.

Posted by: algernon | Nov 21, 2006 11:50:14 AM

I dont think so. Read Doug Nolands article below Barry's post above. He has spent the most time examining the credit system.

Posted by: James | Nov 21, 2006 12:29:22 PM

The fed can control M3 because it works off the money multiplier. All they have to do is raise reserve requirements and the banks can't multiply to such a high degree.

The ratio of the gears is what matters.

Thanks for 'outing' this Barry. The fed has been lying like this and the lap dog Main Stream Media has bought and sold their 'rate hike/rate slash' propaganda for years being more than complicit in helping the fed sell that garbage to the public. This is another example of the fed saying one thing to the public and doing something else behind the scenes. In the real world we call that fraud and the rest of us go to jail for it. Not those at the private banking institution called the fed.

I hope America has enjoyed her 10% dilution in purchasing power. Real money folks call it a stealth tax hike because that is exactly what it is. A tax on people's cash via dilution of their purchasing power. The effect may not be felt until that money comes flooding home from overseas but it will be felt eventually.

I hope more media folks get the courage to stand up like Barry does. People need to be educated. Watch your back though Barry. That truly is a dragon's tail you are whacking away at

Posted by: DavidB | Nov 21, 2006 12:37:56 PM

. . . the issuer collects the premium and the buyer believes he is protected from default on the bonds. . .

Excellent post, James. One question, though: What metrics does the buyer use to form the belief that he is protected -- are there FICO or AMBest equivalents for the CDS buyer?

Posted by: wyler | Nov 21, 2006 12:42:46 PM

James, I believe you have hit that nail right on the head. Its a like a game of musical credit chairs, only there's about three chairs and dozen players.

I believe this is the reason we are seeing so many massive mergers in the banking and related industries. They know the day the music will stop is close, and they are positioning themselves to be classified as "too big too fail" by the government.

I'd also like to point out that the explosion of M3 began during the first years of the Clinton presidency - at least fiscal irresponsibility is non-partisan.

Posted by: L'Emmerdeur | Nov 21, 2006 12:48:54 PM

and from Minyanville
"
Ultimately, an unforseen and uncontrollable financial accident will ripple through our financial system and wash ashore all the sins of our uber-leveraged asset economy. "However, no one knows the day or hour when these things will happen, not even the angels in heaven or the Son himself.* Only the Father knows." (Matthew 25:36).
"

Posted by: Bob A | Nov 21, 2006 12:57:37 PM

The whole system has distorted risk taking to a level that has never been seen before. Governments have no idea how to allocate resources. Does anyone think Communist China can allocate anything properly? What is scary is that no one and nothing is safe in this system and at some point its going to collapse. Fil at Minyanville is correct.

Posted by: James | Nov 21, 2006 1:20:27 PM

people forget that fed not controls rate, makes a coupon pass/does repos, but also the REGULATOR for banks.

Posted by: sam | Nov 21, 2006 1:20:50 PM

December 2008

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