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Money Supply And Economic Data Weekly Watch – Lots of bad news while money supply hits a new all time high

Money Sup­ply

The Fed is back at it again; its push­ing money sup­ply as it tries to rein­flate the econ­omy. Money sup­ply, as mea­sured by sea­son­ally adjusted M2, hit a new all time high of $7,870.4 bil­lion and on a non-seasonally adjusted basis rose to $7,867.5 bil­lion. How­ever, because the global econ­omy is stuck in a liq­uid­ity trap, the Fed’s stim­u­lus isn’t hav­ing much of an effect. But, sooner or later the liq­uid­ity trap will clear and all of the mon­e­tary stim­u­lus will sud­denly cre­ate a liq­uid­ity bub­ble. Unless the Fed can pull a really big rab­bit out of its mon­e­tary hat, they are set­ting the econ­omy up for new asset bub­ble and prob­lems in 2009 and 2010.

A liq­uid­ity trap exists when inter­est rates are at or close to 0% and mon­e­tary pol­icy is no longer hav­ing a stim­u­la­tive effect. The cure for a liq­uid­ity trap is fis­cal stim­u­lus and not con­tin­ued expan­sion of the mon­e­tary base. Right now the economy’s issue isn’t a short­age of money but rather the hoard­ing of cash by credit inter­me­di­aries and a drop in the veloc­ity of money. Falling veloc­ity means a decrease in the speed at which money turns over and is spent and respent. When money is hoarded and veloc­ity goes down it feels to the econ­omy just like money sup­ply is drop­ping. The result is defla­tion, reces­sion and indis­crim­i­nant credit rationing. So while it feels like money sup­ply is too small, the real prob­lem is that the turnover rate of money has fallen.

I don’t under­stand why the Fed­eral Reserve is push­ing an increased money sup­ply when we are in the mid­dle of a liq­uid­ity trap. Right now more money will only result in more hoard­ing. I under­stand why the Fed­eral Reserve needs to make sure that money sup­ply doesn’t fall, but dra­matic increases in money sup­ply aren’t going to help. Increas­ing money sup­ply doesn’t address the fall off in veloc­ity and it doesn’t unclog the liq­uid­ity trap.

Fis­cal stim­u­lus is a cure for a liq­uid­ity trap. The gov­ern­ment sec­tor can, by itself, increase veloc­ity through increased spend­ing. And, sooner or later, fis­cal stim­u­lus will get the global econ­omy mov­ing again. But, because of cur­rent Fed­eral Reserve actions, when the econ­omy starts to expand, money sup­ply will be ele­vated and an asset bub­ble and infla­tion will result.

TARP is a form of fis­cal stim­u­lus and once the money from TARP starts to flow the turnover rate of money will accel­er­ate. After the elec­tion I also expect an addi­tional fis­cal stim­u­lus pack­age to make its way through Con­gress and that will also have a stim­u­la­tive effect on the econ­omy and velocity.

Other eco­nomic data

There is no good news in the other eco­nomic data. Unem­ploy­ment is head­ing up and the Grinch is going to steal Christ­mas. Until the effects of TARP are felt and the Gov­ern­ment set­tles on a new fis­cal stim­u­lus pack­age don’t look for things to get a lot better.

Posted in: BANKS, Bernanke, Credit Crisis, Deflation, Economic Statistics, economy, Federal Funds Rate, Federal Reserve, Finance, Fiscal Policy, GDP, Inflation, Liquidity Trap, M2, monetary policy, Money Supply

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