May 3, 2007
LIQUIDITY ON THE RISE
The Federal Reserve is scheduled to convene its FOMC meeting next Wednesday to decide on what happens next with the price of money. By most accounts, the assembly promises to be a yawn. Fed fund futures anticipate no change any time soon by predicting that current 5.25% will remain the standard for some time.
Perhaps that's a prudent choice for policy makers, considering that full and clear clarity on the economy remain elusive. As we wrote yesterday, there's a case to be made that the glass is half full as well as half empty. Indeed, economic data in recent months have dispensed conflicting signals.
Yes, that's always true. But the stakes seem especially high at this juncture, with the economic cycle at middle age or later. Meanwhile, the capital markets have been running for some time. Value isn't exactly gushing in abundance when it comes to such metrics as risk spreads and earnings ratios over price. Of course, if you think that the recent past will continue into the foreseeable future, there's nothing much to do but hang on and collect the capital gains.
Enter the Fed, which theoretically must keep inflation at bay while juicing the economy and sidestepping a recession. A thankless task, and one that may be impossible. In short, the central bank must pick one or the other, or so one might assume.
If so, we present evidence that juicing the economy may be the preference these days. M2 money supply, the broadest measure published, has been pushing higher for some time now, as our chart below shows. Based on rolling 52-week percentage changes, M2 rose by nearly 7% for the year through April 9, although it's since slowed to 6.3% That's the fastest rate of printing money in more than three years.
The rise in the annual change in M2 has been fairly consistent this year, suggesting that the central bank is deliberately injecting money into the system in higher absolute and relative quantities. How fast is the recent 6%-plus rate of growth in money supply? More to the point: is it too fast? One might answer "yes," based on the fact that first-quarter GDP advanced by 5.3% in nominal terms (or 1.3% in real terms), according to the Bureau of Economic Analysis.
The fact that the 6% nominal pace of M2 growth is higher should turn a few heads. Those who subscribe to the monetarist view of the world may even suffer a shudder or two.
Of course, no one pays attention to money supply (hardly any one). If an accelerating M2 growth rate suggests inflation risks may be bubbling, it's a risk that the markets seem inclined to dismiss.
Yes, the jury's still out on what it all means. Meanwhile, we can only cite history. On that score, liquidity has powered the bull markets across the asset classes. Everywhere you look, there's money to burn. Whether it's News Corp.'s Rupert Murdoch pricey bid to buy Dow Jones, or private equity shops throwing money around, or the surge in prices in everything from stocks to bonds to commodities to art, it's clear that the liquidity engine is humming quite nicely. The question is whether there's a price to be paid with liquidity, assuming it isn't reined in a timely and prudent manner.
Posted by jp at May 3, 2007 9:31 AM
James. Great blog, interesting post. M2, however, is hardly a 'liquidity' indicator. The chart tells you very little about what really happened over the 2002-2007 period. Personnally, I look at the monetary base or its proxy on the asset side of the Fed's balance sheet, the stock of Treasury securities held by the CB. Then I add the stock of custody holdings as a proxy to the monetary base of countries which use the dollar as their key reserve asset. The result: an unprecedented boom! Regards, Agustin Mackinlay.
Posted by: Agustin Mackinlay at May 4, 2007 10:25 AM
The Monetary base is the best measure of Money Supply and why the Fed dropped M3 (which is easily manipulated by derivatives and Central Banks activities ) .... M2 is barely better than M3
Posted by: jj at May 3, 2007 8:49 PM