Tuesday, November 21, 2006

The Fall and Rise (and continued increase) of M3

Anyone with an interest in conspiracy theories and the geekier aspects of economics, and with a instinctive distrust of anything the government does (especially during the Bush administration) will just *love* this item. Last year the Federal Reserve nonchalantly announced that as of March, 2006, it would no longer report the broadest measure of the nation's money supply, known as M3. Certain economists were appalled, and suspicious, that the Fed would suddenly end reporting of a useful economic statistic with a lengthy historical baseline. Coincidently, M3 also happens to be the fastest growing component of the money supply, and, we have recently learned, the Treasury Department has been quietly circumventing the Fed's public attempts to tighten the money supply. As John Crudele of the NY Post explained,

Last Thursday [Nov. 2], for example, the Fed executed $2.5 billion in overnight repos and $8 billion in 14-day repurchase agreements. These were reported on the financial wires. // The Treasury completed a $5.5 billion repo operation on the same day under what it calls the Term Investment Option. There was no mention of the Treasury operation on the wires. In the Fed's repo deals, the banks temporarily turn over securities to the central bank in exchange for cash.

The result of these agreements is to increase the money supply, even as the Fed steps up interest rates, keeping financial institutions flush with credit to loan. Even more so since the Fed stopped reporting M3. Thanks to new sources of M3 reporting, Barry Ritholtz of The Big Picture can tell us that
M3 is growing quite rapidly, with the annual rate of change now over 10%. Prior to the announcement of M3's demise, its growth was in the range of 3 - 7%. // Anytime a government agency stops reporting about their goings on, it should raise a few eyebrows. Now we see what happened once the reporting of M3 was killed -- that measure of money supply spiked much higher -- a rate of change that's even greater than 10%+.

I'm not knowledgeable enough about the nation's banking system to hazard much of a guess at what's up here, but it looks like the Treasury has been stimulating an economy already floating on a credit bubble. Was this an election year gambit to stave off a recession until after the mid-terms? Is it a less cynical attempt to engineer a soft landing? Or is it just a way for people at the treasury to shovel more money towards the financial sector? I don't know, and it could, of course, have a more benign explanation as well. But it seems pretty fishy to me.


Rob said...

Me thinks the combination of deficit spending and selectively turning on the money spigot means some severe inflation may be on the away. We used to hear that globalization made inflation a thing of the past. Well it's already happening as people can vouch from their grocery bills of late. It's going to get worse in the next couple years and the poor and middle class will be hit the hardest. Hopefully the Democratic congress can restore some fiscal sanity but I don't think they'll be able to do enough in time - Bush will veto anything that makes sense.

christian_left said...

When I took economics in college (not that long ago!), we only learned about M1 and M2. But life is one great continuing education, I guess. I've been reading a little about this M3 conundrum you mention, and it is hard for me to understand why the gov't would stop reporting M3 and then keep taking deliberate actions to increase it--especially considering the magnitude of the increases and how they trend against the flat-line of M2 (and indeed the actual decrease in M1!) Unless of course, they wanted to have a way to quietly inject liquidity into the economy behind the scenes without getting too much attention. Oops! I guess people are starting to notice.

Beyond the issue of soft-landing (with respect to GDP growth rather than inflation, which this action exacerbates) vs. short-term political gain, it seems like a case of BOTH AND rather than EITHER OR to me. And I'm glad to Rob points out that the combination of deficit spending--shamefully, this includes throwing a huge amount of our tax money down the blood-soaked pit of US-occupied Iraq--and increasing the money supply poses a risk of worsening inflation. (Stagflation in the offing?) So I wonder, has this combination of events made some plausible prognistications about possible deflation a few years ago less likely? Then again, there's the housing market... On the whole, my opinion is still that oil prices will play the key role in how fast the economy unravels, and in what specific way it happens.