November 16, 2005
DOES M3 MATTER?
Conspiracy theories shadow the Federal Reserve like moths to a flame. That's the price an institution pays for life at the top of the monetary feeding chain, or so one might conclude after reading William Greider's Secrets of the Temple: How the Federal Reserve Runs the Country, a dense tome that does the central bank no favors on downplaying the notion of conspiracies and the Fed.
True to form, the conspiracy minded were inspired to vent after last week's announcement that the Federal Reserve would cease publishing its broadest measure of money supply numbers, otherwise known as the M3 series. The official reason is that M3 is a dud. That is, M3 offers little information above and beyond M2. Dave Skidmore, a spokesperson for the Fed, told CS today. M3 adds sparse, if any insight to monetary trends that's not available in M2, a narrower definition of money supply, he continued. Skidmore also said that there's a cost to compiling M3 data. (Yes, he really did say that.) As a result, eliminating the broadest measure of money supply seems to be reasonable, or so went the drift. As Skidmore explained, "The cost of collecting [M2 data] outweighs the benefits of publishing it."
In fact, there's no shortage of agreement among mainstream economists, investors and other consumers of money supply data that M3's death will be a yawn. The demise of M3 is no great loss, Michael Cosgrove, an economist who runs The Econoclast, a Dallas-based consultancy, told CS today. "The fact that the Fed will not report M3 any more probably won't make much difference." The M2 series is an able substitute, he added.
In any case, when it comes to monitoring the Fed on matters of monetary policy, Cosgrove said that he prefers the monetary base numbers published by the central bank, which is a narrow measure that's even more constrained than M1. As a result, the monetary base figures provide a much better reading of the Fed's monetary activities because it's more directly influenced by the central bank compared to M1, M2 or M3.
Concurrence comes from Wrightson ICAP, an independent research outfit that monitors the Fed for clients. On its website earlier this week, Wrightson advised that M3 had become "increasingly irrelevant."
But step outside the mainstream of economic thinking and you'll get a spicier dose of opinion on the M3 announcement, namely, one laced with conspiracy implications. For example, James Turk of the Free Market Gold & Money Report smells a monetary rat, as noted by MarketWatch via ResourceInvestor.com: "Why does the Fed no longer want to report the total quantity of dollars in circulation?" Turk asks. "They know what's coming -- massive amounts of dollar creation to fund the worsening trade and federal government budget deficits. The Fed is just doing what other government agencies already do when they don't like the result of their statistical calculations. Like children, they play ‘make believe."
One George J. Parrish Jr. also sees nefarious reasons for killing M3. Writing on his blog, he asserted:
If an increase in the money supply is the cause of a rise in the general price level then M3 is an important measure of price inflation simply because it is considered to be the broadest measure of money and, hence, the best measure of price inflation. With M3 crossing the $10 trillion level the Fed has decided to stop publication of this important data. The Fed by nature is an inflation machine built to support limitless spending by the government. Yet the Fed also enjoys the reputation of being an inflation fighter. In order to protect its image the Fed has found it necessary to cease publication of M3 data.
With all the back and forth, we decided to take a look at the numbers for what we hope might approximate objectivity. As such, we compared the monetary base with M2 and M3, courtesy of data on the Federal Reserve's web site. Using the latest data releases for the series, the monetary base has rose 3% for the year through November 9. In fact, looking at rolling 52-week percentage changes for the monetary base on a weekly basis reveals that the rate of change has been steadily falling for several years, and 3% represents the lowest pace of increase in recent history.
M2 is rising at a faster pace (4% over the past year through October 26), but the general trend mirrors that of the monetary base, i.e., the pace of increase has been falling for some time.
Then we come to M3, and here's where it gets interesting or, conspiratorial, if you will. M3 money supply rose 7% for the 52 weeks through October 31. Not only is that rate of advance dramatically higher than M2 or the monetary base, the pace of increase is heading upward as well. Indeed, a year ago, M3 was consistently increasing at around 4% a year.
Superficially, at least, it looks a bit suspicious when the Fed says it'll soon bury a series of money supply numbers that contradicts the central bank's public relations effort to convince the world that it's squeezing the monetary system and thereby taking a hawkish view on fighting any and all future inflation. Of course, as Cosgrove observed, the Fed has relatively lesser influence on M3 vs. M2, or certainly the monetary base. Nonetheless, the Fed's only explanation for the planned demise for M3 boils down to sparse interest in the series and the allure of saving money by discontinuing its publication. The former is a reasonable, but ultimately unpersuasive point. After all, the Fed publishes a massive amount of data, and much of it is obscure for all but a few economics geeks. As for the bit about saving money, well, that one just rings hollow from the outset. How much could the termination of M3 save the Fed? Measured against its annual budget, it's barely a rounding error, if that.
All of which convinces some that there's a conspiracy afoot. Proving conspiracies, unfortunately, is notoriously difficult, and the M3 caper promises to be no less immune to definitive conclusions, short of a confession from Alan Greenspan that he's intent on cooking the books. (Don't hold your breath.)
Nonetheless, some in the marketplace have already made up their mind, or so one could argue. Gold, to cite the obvious barometer of doubt, fear and conspiracy talk on matters tied to paper currencies, is doing well these days. The precious metal jumped sharply today, for instance, rising to around $479 at one point, a level last seen more than a month ago. Not bad, considering that the monetary doves received a fresh dose of optimism with today's release of consumer prices for October--the government's unofficial gauge of inflation. The CPI advanced just 0.2% last month, down from September's hurricane-induced surge of 1.2%.
But it'll take more than a docile CPI report to convince the conspiracy theorists that the Fed's being straight with Mr. Market. By that logic, M3 does matter after all.
Indeed, for an institution that prides itself on managing perceptions, as Ben Bernanke explained so persausively yesterday in his Senate testimony, it's odd that the central bank is blind to potential for conspiracy mischief that inevitably accompanies the killing of M3. Managing expectations about inflation, the designated successor to Greenspan said, is at the core of the Fed's job. A little bit of that sprinkled elsewhere in the central bank couldn't hurt.
Posted by jp at November 16, 2005 2:25 PM
All money is based on some kind of social agreement. Barter is, too, for that matter. Precious metals happen to have a longer span of agreement.
Part of what I'm getting at is that to understand money, you need to understand individual and social psychology. Unfortunately, like economics, there are a few competing and partially incompatible psychological theories floating about.
The remark "show me a fiat currency that has survived more than a human's lifespan before some zeros were cut off" means that the socal agreement will show wear and tear.
Any kind of money arrangement, metal, unbacked greenbacks, shells, wampum, etc., will favor some people at the expense of others. One of the things I liked about Greider's book is that it made much of this explicit and detailed.
Another book about money I liked was philospher Jacob Needleman's "Money and the Meaning of Life." But even more so than Greider's book, it won't give you any investment ideas.
Posted by: Hal at November 22, 2005 9:30 AM
Thomas Jefferson warned us a hundred years ago that a private central bank issuingthe public currency was a greater menace to the liberties of the people than a standing army."
Posted by: Rothschilds at November 21, 2005 1:36 AM
Prudent Investor, you said: "Compare the performance of gold and the S&P since Nixon closed the gold window. Gold wins every long-term comparison in real terms."
Can you link to data for this please. Thanks.
Posted by: Jack at November 17, 2005 11:27 AM
Your exactly right - in fact any precious metal should hold its value better than a fiat, because you can't print precious metal and then fuel up the helicopter.
To temper that thought, precious metals supply is not finite. If the price gets high enough, people start melting grandma's old jewelry and tea set, and when that hits the market the prices tank - look at the Hunt scenario when they tried to corner the market for silver.
But in general, precious metal should hold its value better.
Posted by: pww214 at November 17, 2005 9:00 AM
It is not about conspiracies I worry. They would require all participants to be highly intelligent. One can't say that about a couple of members of this government, starting right at the top, with the Treasury literally just a stone throw away. But show me a fiat currency that has survived more than a human's lifespan before some zeros were cut off. How good is a central banker's job done when the currency loses "only" half its value every 20 years? Compare the performance of gold and the S&P since Nixon closed the gold window. Gold wins every long-term comparison in real terms.
Posted by: The Prudent Investor at November 16, 2005 4:01 PM