U.S. M-2 money supply rose $12.4 bln Jan 12 week

U.S. M-2 money supply rose $12.4 bln Jan 12 week
Thursday January 22, 4:31 pm ET

From your link:

The U.S. Money Slowdown: Should You Be Worried?
2004-01-22 08:30:00
U.S. monetary growth has plunged in recent months. The reasons are not fully understood, but there is no corroborating evidence of a liquidity squeeze.
The eye-catching slump in U.S. money growth would be very bearish if it was signaling building problems in financial intermediation. However, there is no support for such an interpretation. Money weakness in late 2003 reflected the unwinding of an earlier surge related to mortgage refinancing and tax cuts. More recently, it may have been due to a shift out of deposits into equities. The money slowdown in the early 1990s was associated with severe banking problems as shown by the high level of our Financial Stress Index. The Index is currently very low. Bottom line: weak money is troubling, but not yet alarming. Stay tuned.

Money weakness in late 2003 reflected the unwinding of an earlier surge related to mortgage refinancing and tax cuts. More recently, it may have been due to a shift out of deposits into equities.

Sounds informed, but I don't see any explanation of the mechanics (which I doubt they actually have).

As far as shifting deposits into equities, I've read that reason before, but again without any explanation of how it is supposed to actually happen. When equities are bought, money flows from the buyers bank account into the sellers bank account and remains in the money supply.

Comstock Partners, Inc.

What's Wrong With the Money Supply?
http://www.comstockfunds.com/screenprint.cfm?newsletterid=1062

January 15, 2004

What?s wrong with the money supply? The three-month annual rate of change in M2 was plus 10.5 percent in late August, and is now dropping at a rate of 5.2 percent. MZM, which was growing at 15.6 percent, is now plunging at a rate of 8.5 percent. Hardly anybody pays much attention to money supply these days, but old-timers will remember when the Street used to pay even more attention to the new money supply releases than they do to the employment figures today. The Fed used to target money supply, although they gave up the practice officially in 2000, and, unofficially, some time before that. Even so, the correlations between money supply and the economy are still important, and the economists at the Commerce Department continue to use M2 as one of the 11 leading indicators of the economy. In fact, of the 11, M2 ranks second, statistically, in its ability to lead the business cycle.

At a time when the Fed is easing vigorously, it is certainly odd that money supply is falling. Keep in mind, however, that when the Fed prints money it is not automatically included in the money supply. Money held in a Federal Reserve or bank vault that is not in anyone?s name is not money. In order for it to become money somebody must want to use it. The Fed basically has a limited number of ways it can attempt to control the money supply. First, it can raise or lower bank reserve requirements. Raising required reserves takes money out of the system whereas lowering requirements adds money to the system only to the extent that some one wants to borrow it. Second, the Fed can buy or sell Treasury bills and notes. Third, it can change the fed funds rate. Note that it is relatively easy for the Fed to pull money out of the system, but can only increase the money supply if somebody wants to use it That is the reason why we have, in past comments, been so concerned about the Fed pushing on a string, and, is also, we suspect, the reason why the Fed is so much more concerned about deflation than inflation.

Having said that, we admit that the majority of leading indicators are still positive, and that there are some definitional problems as to what constitutes money. In addition some observers that we respect think that the drop in M2 and MZM is a result of people reallocating funds from money market instruments to other investments such as equities, bonds or commodities. In this case, however, it seems to us that the money merely changes hands between buyer and seller, and there is no net change in overall money supply. All in all we suspect that the plunge in money supply may be confirming our belief that the economy is about to slow in the months ahead. It also could be related to the 80 percent drop in mortgage refinancing (REFI) since last summer. Since the annualized rate of cash-outs on these REFIs were 3.5 times the amount of the last tax cut, this also means there is less cash in the hands of consumers as we enter the new year.

Comstock Partners, Inc.

A Reader's Question
January 22, 2004

Reserves and Money Supply

A reader asks:

I would not want to be long stocks today, even if the DOW makes a new high, more or less confirming some sort of bull market. Even my position in gold shares scares me, since it seems clear that all stocks will get sucked into the whirlpool of collapsing market values.

What gives me confidence in my conviction that stock prices ought not to climb much higher is the pronounced slowdown in money growth as measured by Frank Shostak's Austrian School of Economics money supply (ASM). The economic recovery, stock prices, gold, and other commodity prices should all be affected at some point by the progressive slowdown in AMS, which has endured for 2 years?

...With inflation flat for now, a major stumble in the recovery accompanied by a big decline in stock prices would rally bonds big time.

In the meantime, inflation could still pick up later, as 8 to 9 percent money growth works its way through the system. However, that money growth so far has gone primarily into security prices and real estate speculation as the mania continues. Later, if the demand to hold money starts rising in response to weakening credit prospects in a weakening economy, then rising CPI inflation may never come to pass.

This leads me to a question. I assume the slowdown in the M's reflects the slowdown in the monetary base. I also assume the base has tapered off in response to purposeful Fed policy, to keep speculators off balance, and to prevent inflation from running wild. If so, then it would follow that the Fed might step up its creation of reserves as soon as the economy stumbles, again promoting higher rates of currency depreciation. Any comments?

Our answer:

To answer your question-we don't think the current slowdown in the money supply is due to a slowdown in the monetary base. The base consists of currency in circulation and reserves in the banking system. The currency in circulation at this time is more dependent on foreigner's fear of devaluation of their own currencies and the grey market in the U.S. The reserve part is dependent upon the FOMC purchases of Treasury securities, but if the banks receiving the proceeds don?t loan the money out (or if there is little demand for loans) the Money Supply numbers will drop. This process is called "pushing on a string" and is what happened in Japan over the past 13 years and the U.S. in the Depression. We have included the Monetary Base and M2 and MZM so you can see the MB is not declining as much as the money supply. The decline in the money supply may be indicative of the deflationary cycle we have been predicting. By the way the money velocities are also declining sharply.

So the short answer to your question is that we believe you are giving the Fed far too much credit for being able to control the money supply. They can only target one item at a time, either the supply of reserves or the overnight lending rate and they have chosen the latter, having officially stopped targeting money in 2000?and unofficially long before then. We believe they made this choice since they know they can't control the demand for the reserves (only the supply).

monetary base

mzm

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