The U.S. economy has a long way to go before the economic recovery will be either sustainable or robust. Monetary indicators don’t look good and are once again getting worse. I am concerned that the financial system hasn’t recovered enough for the Federal Reserve to withdraw from its program of quantitative easing.
While most of the large financial institutions seem to be currently stable, abet with hundreds of billions of dollars of government investment and support, they aren’t strong enough to service the needs of Main Street. Almost all of the monetary and financial indicators point to shrinking lending and constrained credit. The part of the banking sector that supports business and consumer isn’t working and, in many ways, is getting worse. And, the shadow banking system is continuing to disappear and can’t be counted on to pick up the slack of banks.
Until the charts presented below start to point up, I don’t think there is going to be a real economic recovery (as contrasted with technical bounces from inventory adjustments and changes in population).
All of the data suggests that the U.S. remains in the grips of a liquidity trap, i.e., a period of time when interest rates are at or near 0% but yet traditional monetary policy is ineffective. The Obama administration needs to reexamine its cautious approach to the big banks and think about whether or not the largest banks are sapping the economic strength of the rest of the economy.
Money Supply and Bank Lending Charts — Important Note — Each chart is a link to a full page view of the chart. Sorry I am not better at presenting graphics.
The below chart indicates that, contrary to popular belief, money supply is somewhere between stagnant to shrinking. A growing economy requires an increasing money supply and an increasing money supply is a sign of a growing economy.
The velocity of money, i.e., the number of times a year money is spent and re-spent, continues to fall (which is very bad). Sustainable economic recovery can’t happen until the velocity of money starts to rise. The current velocity of money is signaling money hoarding by banks, businesses and individuals. Hoarding is a type of savings in cash and cash equivalents that is motivated by fear rather normal savings that signifies a desire to invest in the future because tomorrow will be better than today.
The money multiplier is below 1x which means that as banking reserves are created, money supply is actually shrinking. I think that this is the first time in my life time that the money multiplier is less than 1x. The money multiplier has fallen below 1x despite the Federal Reserve’s quantitative easing program. One way to think of the money multiplier is as a sort of economic thermometer. As long as the money multiplier is below 1x then the banking system (including the effects of Federal Reserve quantitative easing) is sick. Without Federal Reserve emergency measures the diseased banking system would probably have been sick enough to kill the rest of the economy. Sick banks shrink, deleverage and cut back on loans (which are riskier than owning Treasury securities and cash equivalents). The money multiplier needs to be well above 1x for the banking system to be able to support economic growth.
All of the most commonly watched measures of bank lending are trending down (except for the purchase by banks of investment securities which includes government securities and cash equivalent securities). The lending trends are bad and sustained economic recovery isn’t happening until they start to look better. Moreover, non-financial commercial paper (a measure of the shadow banking system) isn’t looking very healthy either.
For those readers who aren’t conversant in Fed jargon, some of the below charts refer to MZM which is M2 minus small-denomination time deposits plus institutional money market mutual funds.
All of the charts were compiled by the St. Louis Federal Reserve which has a great research web site and series of publications.