That Sinking Feeling: M3 Falling at 1930s Pace

This should not be happening: the US money supply is falling hard. We have stimulated, liquidified, pumped, swapped, backed, TARPed and done about everything years of academic analysis of the Great Depression told us to do. Ambrose Evans-Pritchard (AEP) of the UK Telegraph penned US Money Supply Plunges at 1930s Pace that headlines: 

The M3 money supply in the United States is contracting at an accelerating rate that now matches the average decline seen from 1929 to 1933, despite near zero interest rates and the biggest fiscal blitz in history

This plunge has no precedent since the Great Depression. The fall seems due to debt deleveraging, which is accelerating, without any corresponding new commercial debt issuance. Credit remains frozen. In a fiat currency economy, debt creates money, and write-down of debt reduces the money supply. 

In a growing panic, the Obama administration is now thinking of throwing more stimulus onto the fire of debt deleveraging. This risks repeating the mistake of Japan, pushing public debt even faster to dangerous levels. The IMF is already quite concerned over US fiscal policy:

Under the Obama administration’s current fiscal plans, the national debt in the US (on a gross basis) will climb to above 100pc of GDP by 2015 – a far steeper increase than almost any other country

Ironically, Ben Bernanke, the student of the Great Depression, built his reputation on credit, and follows what AEP calls "creditism", explained here, an untested theory that disavows the seminal work of Milton Friedman on how Fed mistakes in the early 1930s exacerbated the Great Depression - and ignores M3 and other money supply measures. Creditism has failed to restore the velocity of money, which would be a consequence of restoring normalcy to credit. Bernanke may now try to adopt an explicit inflation target, which may crash markets (bonds and stocks). He cannot "go off gold" and reflate the currency (see chart, courtesy Jesse's Cafe Americain). He may, indeed, have run out of magic bullets. 

In the 1930s the rapid deflation in effect reset the system. This time Bernanke is trying everything he can to avoid deflation. Yet:

The Fed has been largely ineffective at doing anything but fattening bank cash flows by squeezing savers and allowing banks to collect generous margins on the performing consumer loans they do have. The bailout money sits in bank coffers, withheld from an economy that now depends on loans for its very survival

There has been a lot of reaction to AEP's dramatic headline. The most common is the plunging money supply is foreshadowing a double-dip recession. There is increasing data from sources like the BEA that show slower GDP growth, and have been interpreted to predict negative GDP as soon as Q3.  ECRI's leading indicators have also been slowing, and had the biggest plunge in a long time in mid-May. While they are still showing positive growth, the fall is ominous. It is dropping at a rate that would make it negative 5% or more by Q3, an area consistent with forecasting a recession. 

 

M3 was dropped by the Fed in 2006 due to its sensitivity to portfolio balancing, making it over and under-shoot. There are more money supply measures than M3 - AEP chose the most dramatic. Also, Jesse points out that Eurodollars are often left out of these calculations, and that the Fed often is jerky in managing money aggregates - pedal-to-the-metal than back off and see if the car takes off. So momentary hysteria over M3 may abate if the Fed reverses its course. The other M's have plunged in rate of growth, but not yet gone into negative growth on a year-over-year basis. Does this discredit AEP? No - the other M's have seen a recent drop in total supply, like M3, and this means their YoY growth is destined to run below zero shortly. This drop in M3 is now showing up in other economies, such as Australia, indicating there is more to it than momentary Fed clumsiness. Here is a chart which shows money metrics growth falling, albeit not yet below zero:

One of the lessons of the 1930s is the Fed tightened prematurely in the summer of 1931, responding to the collapse of the Creditanstalt bank, Britain leaving the gold standard, and an international banking crisis that caused the Fed to try to protect the US gold supply from a run (see chart courtesy Jesse).   

We may be making adifferent but equally tragic mistake this time around: we are backstopping the wrong banks and letting Main Street whither on a drought of credit. We are in thrall to the theories of an academic elite that lack worldly experience, have spent their careers pampered by commissions, conferences and cushy positions, are captivated by their big bank sponsors, and have never left the incestuous little world of elite universities, Wall Street advisory positions, and government jobs. 

Comments

[Molecool]

Great roundup of very important charts - thanks for posting this.

[Trending Cow]

Since 2006, M3 is no longer published or revealed to the public by the US central bank (Discontinuance of M3, Federal Reserve, November 10, 2005, revised March 9, 2006). Note your transition from red to blue on the figure.

Question: How is the M3 modeled in your figure and the assumptions made in order to calculate it? Just curious about how this is treated and the data source that allows such an analysis.

I would have liked to understand Bernanke's paper in terms of math for V as well. If he ignores m3, then it seems he's fundamentally altering how me calculate V (=GNP/M). Am I over thinking this?

[yelnick]

Trending Cow, the Fed published a version of M3 into 2006, and then Shadow Stats (John Willimas) kept publishing the continuation. Some people argue with his assumptions, since he is a critic of many official govt stats, such as CPI and unemployment. So look beyond M3 to other money measures that are also falling: 

http://www.shadowstats.com/charts/monetary-base-money-supply

I have no facile answer to how Bernanke would measure V in a creditism world that disregards money supply. I think what they actually do is watch various M's but no longer explicitly target any M, relying instead on targeting a 2% inflation rate and using interest rates to do so. There is a ton of academic discourse on targeting 2% inflation, whether it is the right level and so forth. Oddly enough, very little of what I have read raises the question of whether that 2% policy is sustainable ie. what if inflation creeps up? Do you let it or tighten? Since CPI has become to politicized, the Fed I think uses the GDP deflator as their inflation measure. I wonder if that is any more accurate than any of the M's? 

One implication of the failure of Creditism, which is based on Money being hard to measure and therefore to target, is to change the Fed's role. Maybe it should not push for full employment at the same time it stabilizes money (the idiotic Humphrey Hawkins bill of the 70s), nor target interest rates (which can be set by markets), nor even try to manage the money supply. Maybe it should be the backstop for banks and provide liquidity to regional banks with varying interest rates based on local conditions - its original role, and the role its precursor system had. 

[Chabazite]

"We are in thrall to the theories of an academic elite that lack worldly experience, have spent their careers pampered by commissions, conferences and cushy positions, are captivated by their big bank sponsors, and have never left the incestuous little world of elite universities, Wall Street advisory positions, and government jobs." Plus ca change, Yelnick. The world is full of people who talk a better job than they do! At least in the UK we now have a government that seems prepared to go through the quangos with a big stick. High time too!

[yelnick]

Chab, quango is one of those perfect names to describe that cluster of incestuous, quasi-govt roles. Go get them!

[Hank Wernicki]

For Friday , tonight's ES Trade setup :

THIS ES TRADE IS VERY AGGRESSIVE << IT'S UP TO YOU <<<<

DO NOT EXECUTE UNLESS YOU CAN AFFORD TO SUBSTAIN A "BIG LOSS"

THE ES IS CLEARLY DISPLAY A CHILD TOP HERE AT 1102.25 NOW

THE PARENT TOP IS 5/28 6:00 AM <<<<<

STOP IS 1105.52 , TODAY'S INTRADAY HIGH ON A 2HOUR CHART

ABOUT A 3 POINT RISK ( $ 150.00 )

PERSONALLY I WOULD WATCH THIS CONTRACT FOR A FAILED RALLY

THERE IS ALWAYS ANOTHER ENTRY POINT FOR THE TRADE

I.E., TOMORROW MORNING <<<<<<<<<<<<<

THAT WOULD BE A STRONG CONFIRMATION FOR LOWER PRICES

BE VERY CAREFUL --- "EXIT IMMEDIATELY" ABOVE THE STOP

TARGET IS 40 POINTS DOWN

HANK WERNICKI M.A.

MARKET FRACTALIST

[PaperTrader in College]

The Point & Figure chart that I follow on the S&P will breakout of this current triangle above 1125. Too many Bears to move significantly lower in my opinion. Heading to 1125 over the very short-term.

[robert]

I'm going to respectfully call nonsense on all short term technical calls for more upside. A point of recognition is developing. This thing is going down like a $20 hooker.

[nspolar]

Mama B B;

Gold appears to be melting away, slowly but surely.

The ultimate indicator here, imho.

If gold goes the rest ain't gonna be pretty.

ns

[Paper trader in High School]

This thing is going down like a $20 hooker.

Posted by: robert | Thursday, June 03, 2010 at 08:09 PM

Dude, Dude, you know, $20 hookers are rare and don't go down easily or willingly as they feel their services are worth way more than $20 bucks (so much for deflation).

Looks like you agree with the paper trader college dude?

Dude, dude, you gotta think about what you write. What college did YOU go to anyway?

[KRG]

Y : The linkage described thru interest rates on GNP-M3-V in monetary and or credit theories as above seem to miss the income/wealth effects on all the macro variables. I used to think that this is the main contribution of Keynes to economic thought and not a mere credit vs money description

Unwinding of excess leverage will produce reverse income effects and economic slowdown that cannot be easily countered by pricing credit cheap. How else does one explain Japan's lost decade?

Would like to know your thoughts on this

Cheers

[bob m]

Whew - the market did NOT like NFP! Could turn into a reversal candle but it will be an ugly open (if you are long)

[min]

Sometimes it's better to be lucky than good? My QQQQ calls sell to close limit order was filled at top tick afterhours —and I was upset about this at the time! WHEW, too close for comfort!

Looks like Hank nailed this one but if he waited till this morning, like he suggested you could, more than half of the projected move is already gone.

Looks like my alternate scenario might be in play.

Can't say enough about disciplined money management. This opening would've been real ugly had I gotten sloppy. Taking quick profits on the long side was the right thing to do.

Man that was close.

[min]

Now reloaded with a tight stop. This will be a very quick trade lest I tempt fate

[min]

Stop now to break even on QQQQ long

[Mamma Boom Boom]

>Most likely scenario: 1085 tomorrow.

Posted by: Mamma Boom Boom | Thursday, June 03, 2010 at 01:35 PM<
------------------

Mamma did it again! Mamma, ...how do you do dat?

A: Well, it's quite easy. I COUNT THE WAVES. You see, I have a large window in my office. And, all day long people go by and wave to me. I have learned to determine if these waves are positive or negative. Then, I record that information on a spreadsheet, and apply a complicated mathematical formula to it. The results allow me to predict the market direction, with magnitude. I know, it sounds very complicated, but it's not.

As Neely and Prechter have always said, "It's in the waves".

True story.

[upstart]

Glad to have another chance to add some longs.

[Paper Trader In High School]

Too funny!

While Mama pats herself on the back, other dudes are out there actually making it happen.

Waves being churned through a mathematical formula is not complicated, it's simply airy fairy, Ivory Tower Manure that only works in the land of milk and honey

Cha-Ka Boom, Cha-Ka Boom, Chaka-Boom-Boom

[Min]

Moving my stop up on QQQQ calls. Now in the money.

Good call Mama, forgot you also called it.

Did you make some money on the deal?

[DG]

Posted by: Paper Trader In High School | Friday, June 04, 2010 at 07:14 AM

Sounds like "sour grapes" to me.

Let's face it, you NEVER even put yourself out there with an advance statement of what you think will happen. So, you can posture all you want that you're catching all these moves, but I don't think anyone really believes you anymore. Maybe when you first showed up, but, seriously, your 15 minutes of fame for being a REAL TRADER are definitely over. Time to find a new blog to harass.

[Min]

Time to close this long for a nice gain and in about 5 minutes and step back a bit.

[Paul]

The Dow will probably make a new low in the coming weeks. I see an upside down flag pattern developing during the last couple weeks. Additionally, the Dow could not close above that 200 day MA. I see a head and shoulders pattern in silver. Gold I'm not too sure about. Probably will follow silver on the downside. Gold had been forming a cup and handle.

[Oraclelurker]

Can this jobs report break this up-phase? Can tossing a boulder into the ocean change the tides? If you need me I'll be on the mountaintop.
(praying for a close on the sso over 36:)

[David Lefcourt]

Question for you Yelnick,

Is anyone counting the flash crash as wave 1, the sharp rebound as wave 2, breaking flash crash lows wave 3, the current rebound as wave 4 and a wave 5 to come to finish off
primary wave 1. It seems in this senario 2 and 4 would alternate. Anyone else see this as a strong probability?

Thanks,

Dave

[Paper Trader In High School]

"Sounds like "sour grapes" to me."

Posted by: DG | Friday, June 04, 2010 at 07:26 AM

Nah Dude, you're one of the "other guys making it happen" I am referring to.

The Boom Boom babe gets it wrong plenty of times but she hopes no one ever notices those. She also never risks anything. Man, I hate posers.

I don't trade either but don't act like some big shot. A few guys hear like you and Hank and Min are what I want to do. It does no good to say what the market's gonna do without the balls (or ovaries) to go do it.

Chill out.

[Min]

David;

One of my alternate scenarios is similar and with this downdraft today I have to look closer at it.

I had:

1. flash crash as 1 of C down
2. susequent rebound as 2 of c
3. Next down leg to lower lows as 1 of 3 of c
4. Subsequent rally as 2 of 3 of c

So this could be the start of 3 of 3 of c if this scenario is playing out.

[Mamma Boom Boom]

Min
I'm using it to add to long positions, preparing for the surge I see coming. Very seldom make day trades, although this one would have been fun.

------------------
DG
This is an issue with this type of forum. Any fool can create an identity and post idiotic comments. In the end, I wonder if it;s detrimental to the forum, or do lurkers just take it as dandruff? I don't know the answer.

[Min]

Small H&S on QQQQ just confirmed, may take another long position at H&S target.

Got out of the last one just in time, one handle below top tick.

[Roger D.]

For Friday , tonight's ES Trade setup :

THIS ES TRADE IS VERY AGGRESSIVE << IT'S UP TO YOU <<<<

DO NOT EXECUTE UNLESS YOU CAN AFFORD TO SUBSTAIN A "BIG LOSS"

THE ES IS CLEARLY DISPLAY A CHILD TOP HERE AT 1102.25 NOW

THE PARENT TOP IS 5/28 6:00 AM <<<<<

STOP IS 1105.52 , TODAY'S INTRADAY HIGH ON A 2HOUR CHART

ABOUT A 3 POINT RISK ( $ 150.00 )

PERSONALLY I WOULD WATCH THIS CONTRACT FOR A FAILED RALLY

THERE IS ALWAYS ANOTHER ENTRY POINT FOR THE TRADE

I.E., TOMORROW MORNING <<<<<<<<<<<<<

THAT WOULD BE A STRONG CONFIRMATION FOR LOWER PRICES

BE VERY CAREFUL --- "EXIT IMMEDIATELY" ABOVE THE STOP

TARGET IS 40 POINTS DOWN

HANK WERNICKI M.A.

MARKET FRACTALIST

Hank good work.

MCD made a wave "e" on Wednesday so I shorted at the close. Thursday's open spiked and then completed 1 and 2, today is paying dividends so far. Sometimes you have to trade what you see.

Roger D.

http://www.screencast.com/users/parisgnome/folders/Default/media/78022686-e0f3-40f8-916f-ee1fffd7cd56

[Min]

MBB;

My top count has more upside as well.

Depending on how this gap down progresses that could change for me though. At any rate, to early to tell at this point.

The gap down short from yesterday would've been fun but staying disciplined to what you know best is better in the long run.

[Hockthefarm]

Read my lips:

It's big gubmint that is crushing us:

http://www.chartoftheday.com/20100604.htm?T

Fortunately, big Gubmint is about to implode on itself. Just ask the fools in Hungary.

Hock

[Hockthefarm]

I can hear the hound dogs callin Mamma!
Callin me a cheatin man.
EW

[Roger D.]

The barometer of deflationary risk,we are in deflation!

Roger D

http://www.screencast.com/users/parisgnome/folders/Default/media/06d28f6b-5798-4e72-8d47-76b403f9bb10

[yelnick]

David, the count you suggest (flash=1, bounce=2, retest=3, last week=4, we are in 5) is similar to the June Swoon count but one impulse needs to extend. The retest wave 3 was shorter than the flash 1, which suggest 1 as the extension, and this implies that 5 cannot go beyond 3, giving a target above Sp970. Some of the wavers have seen the earmarks of a leading diagonal (LD) in the smaller waves, but so far very few have cottoned to the idea that the whole drop off 1220 is a large LD. This is ok since it is almost always premature to call an LD as the pattern looks an awful lot like a nested 1-2 1-2. 

To summarize:
the EWI June Swoon is a nested 1-2 count with a large wave 3 to go down towards Sp850the LD alternative predicts a drop to Sp970-1000

In both cases taking a short position makes sense, as the wave down will tell us the character of the count.

[Roger D.]

MCD

http://www.screencast.com/users/parisgnome/folders/Default/media/301bb248-e279-4c3e-8bd3-e8e57a864047

[yelnick]

KRG, the wealth effect is a critique of Keynes in that deflation turns out to be the cure, not the problem. Deflation increases wealth and the increased spending of the newly wealthy counters the drop in aggregate demand. We actually are seeing that right now before real deflation hits, as spending aspirational brands (near luxury) is up. I have blogged that deflation also makes the diminished income of workers/unemployed go farther and ameliorates the hurt. One of the stunning mistakes of the GD was the attempts by both Hoover and FDR to keep wages and prices high rather than let things self-correct.

Keynes argued that in a liquidity trap the wealth effect would not work. We are supposedly in a liquidity trap right now but things are not behaving as Keynes had predicted (ie low interest rates are not curing it, nor has huge increase in reserves by a gift of the Fed). What seems to be hindering the wealth effect is not any liquidity trap but the excessive efforts to avoid deflation

The answer to why Japan is in the funk appears to be this: low rates did not cure their depression, but gave rise to the carry trade which allowed the govt to continue to finance stimulus via public debt markets. This debt-fueld stimulus has not worked to get them out of the mess, but it has kept them afloat. The recent breakdown in the carry trade due to higher volatility of exchange rates may lead ot Japan finally falling off the cliff it has so far put off for over a decade.

[David Lefcourt]

Thanks Min and Yelnick.

[Chico]

Looks like Hank nailed this one but if he waited till this morning, like he suggested you could, more than half of the projected move is already gone.

That was a good call, but officially it goes down as a loss, as the 1105.50 stop was hit overnight.

[Roger D.]

MCD's Wave 5 EDT

http://www.screencast.com/users/parisgnome/folders/Default/media/8e38ad2d-1d88-43c7-af36-694d462256ef

[Roger D.]

Nested 1,2,1,2's ?? acceleration big time coming??

Roger D.

http://www.screencast.com/users/parisgnome/folders/Default/media/8ab7980c-cf48-407e-8768-afae2e609be8

[bob m]

Paul,

"I see a head and shoulders pattern in silver. Gold I'm not too sure about. Probably will follow silver on the downside. Gold had been forming a cup and handle."

I don't think GOLD follows silver MAYBE the other way around. I am long silver, and that trade in the red. BUT, I went long GOLD this morning on the down open and THAT is in positive territory. I take courage from the fact that gold and stocks are parting ways. They seem to be de-coupling. I am not sure SILVER will join the party. It seems to have a mind of its own (or none at all). So while I am happy with the situation, I am vigilant for signs of that you are right and that gold could follow silver so that I can abandon BOTH trades.

http://www.google.com/finance?chdnp=0&chdd=0&chds=0&chdv=0&chvs=maximized&chdeh=0&chfdeh=0&chdet=1275681600000&chddm=25024&chddi=86400&chls=CandleStick&cmpto=NYSE:SLV&cmptdms=0&q=NYSE:GLD&ntsp=0

[yelnick]

Roger D, terribly overlapping chart today ...

[Roger D.]

http://www.screencast.com/users/parisgnome/folders/Default/media/9e0cbe28-9df1-4dd3-b58d-d1d6560e8ce7

Yelnick,

that's the carry trade's relentless selling. Will it continue into the close? Probably so unless the Euro rallies.

Roger D.

[yelnick]

Roger D, we seem to have broken out of a wave 4 pause in the DX! The Euro is now rushing towards 1.16-1.18 and purchasing power parity. maybe it overshoots. AUD is down again too. Some unemployment report! A world of hurt ... curious how the STU will parse this today

[Paul]

bob,

Actually, I think we're seeing the flight to quality (i.e. gold) and the GS ratio expanding. Silver is an industrial metal, so it should tank along with the economy. Gold should go down too, but not as hard. But I think we'll see a final blow-off top in gold, based on the cup and handle patten that I see, before it goes down. Gold's wave form doesn't look complete.

[Paul]

bob,

It is unusual to see silver going down and gold going up. I think we're seeing the flight to quality, thus the GS ratio expanding. Gold's wave form doesn't look complete. I see a final blow-off top coming out of it's cup and handle formation. But I expect both to be a lousy investment over the next several years.

[Master P]

MAMMA... Don't let your kids grow up to be Cowboys!!!

Have a nice weekend everybody.

:)

[OracleLurker]

well this report was more like an asteroid landing in a swimming pool then a boulder into the ocean... this up-phase is seriously damaged.

Greed got the best of me and I have paid dearly for it today but my long exposure is now greatly reduced. I still think that bears will be frustrated for a couple of days next week before the market can really kick into gear on the downside.

[Min]

Reloaded on QQQQ calls near the close when price bounced off the prior upleg's 50% retracement level.

It will be a quick trade unless I find something good to hang my hat on (or I get stopped out).

Wish I had been here to ride this thing down. When I saw that H&S confirm early on in addition to the 5 wave decline in the premarket, I could smell the pleasing, alluring aroma of a high odds trade but only if I could monitor it closely.

Better to be safe than sorry as Oraclelurker can attest to. I almost got whacked as well and have been there many times in the past. It can ruin your whole year sometimes. No thanks!

No matter how good one can read waves and other TA Indicators, it all is for naught without super-strict money management. That's the only thing that saved me today and believe me I learned it the hard way from many past blunders!

[Min]

I still think that bears will be frustrated for a couple of days next week before the market can really kick into gear on the downside.

Posted by: OracleLurker | Friday, June 04, 2010 at 02:48 PM

USUALLY NDX convincingly leads DOW/SPX up or down at major turning points. Today it barely did that so I'm with you Oraclelurker.

Today could've been the first wave of an eventual triangle to correct the advance of the last week or so with wave c of the countertrend rally still to come. This would make for a typical go nowhere summer. One of many possibilities.