Shrinking money supply and collapsing housing market

"By allowing persistent declines in the money supply and in the price level, the Federal Reserve of the late 1920s and 1930s greatly destabilized the U.S. economy and the economies of many other nations as well.
- Federal Reserve Governor, Ben Bernanke, 2004

Ben Bernanke, Nobel Prize winner Milton Friedman, and most other economists out there agree that the reason the Great Depression was so deep and destructive was that the Federal Reserve failed to keep the money supply from shrinking. I'm a little more skeptical, but I agree that it would be impossible for an economy to grow without a growing supply of money in a debt-based monetary system.
That's why this news article should be extremely distressing.

The stock of money fell from $14.2 trillion to $13.9 trillion in the three months to April, amounting to an annual rate of contraction of 9.6pc. The assets of insitutional money market funds fell at a 37pc rate, the sharpest drop ever.
"It’s frightening," said Professor Tim Congdon from International Monetary Research. "The plunge in M3 has no precedent since the Great Depression. The dominant reason for this is that regulators across the world are pressing banks to raise capital asset ratios and to shrink their risk assets. This is why the US is not recovering properly," he said.

As our political and financial leaders are using every tool at their disposal to jump-start the economy, there are fewer and fewer dollars in circulation. That's not a prescription for a growing economy. It's a prescription for economic disaster.

Image Hosted by ImageShack.us

David Rosenberg from Gluskin Sheff said the White House appears to have reversed course just weeks after Mr Obama vowed to rein in a budget deficit of $1.5 trillion (9.4pc of GDP) this year and set up a commission to target cuts. "You truly cannot make this stuff up. The US governnment is freaked out about the prospect of a double-dip," he said...
Mr Congdon said the Obama policy risks repeating the strategic errors of Japan, which pushed debt to dangerously high levels with one fiscal boost after another during its Lost Decade, instead of resorting to full-blown "Friedmanite" monetary stimulus.
"Fiscal policy does not work. The US has just tried the biggest fiscal experiment in history and it has failed. What matters is the quantity of money and in extremis that can be increased easily by quantititave easing. If the Fed doesn’t act, a double-dip recession is a virtual certainty," he said.

America's M3 isn't the only indicator of trouble ahead. Europe's M3 is giving the exact same warning signals, right along with Europe bank lending.

Image Hosted by ImageShack.us

Along with the money supply we are seeing a dramatic drawback in liquidity. The commercial paper market is cutting back. This is happening at the same time that the Libor is rising.

Image Hosted by ImageShack.us

Image Hosted by ImageShack.us

Those economic geeks out there might remember that the M3, commercial paper, and the Libor were the early indicators of the current recession. They flashed warning signs before most economists even acknowledged we were entering a recession.
Another coincidence indicator to watch is global forex reserves.

Image Hosted by ImageShack.us

The key driver of the global credit bubble of the past decade was growing economic imbalances. This can be measured by the building up of massive currency reserves in surplus countries such as China and Japan. It is the foundation of Bretton Woods II - a now busted and defunct global monetary system.
Bretton Woods II failed when the Great American Consumer's credit card got maxed out. This is reflected in China's trade numbers.

Image Hosted by ImageShack.us

So what should you do with this news? Well, hedge fund manager Hugh Hendry has interesting advice.

"I would recommend you panic."
"Banks today are refusing to lend to each other. Bank share prices are collapsing. We have no ability to gauge the credit-worthiness of the banking system."

Of course, being a hedge fund manager, Hendry might be "talking his book", but he does have a few good points.

The reason why the credit-worthiness of banking systems are in question is the same reason why liquidity is drying up, and is the same reason why the M3 is shrinking, and is the same reason why we entered the Great Recession in the first place - the collapsing housing market.

T2 Partners has a great presentation of the condition of the housing market. I would like to share just a couple of the slides.

Image Hosted by ImageShack.us

The current troubles in the real estate market are not because the federal government hasn't taken unprecedented efforts to keep the housing bubble from deflating. The entire multi-trillion dollar mortgage market has been nationalized, and yet even that has failed to keep home prices from sliding. This has left the big mortgage providers swimming in debt.

Image Hosted by ImageShack.us

Foreclosures are still near record highs, despite the best government efforts to stall and delay the foreclosure process. The government's mortgage modification programs have been accused of doing more harm than good.

“I don’t think there’s any way for Treasury to tweak their plan, or to cajole, pressure or entice servicers to do more to address the crisis,” said Mark Zandi, chief economist at Moody’s Economy.com. “For some folks, it is doing more harm than good, because ultimately, at the end of the day, they are going back into the foreclosure morass.”

Image Hosted by ImageShack.us

Image Hosted by ImageShack.us

All the government has managed to accomplish is to create this massive overhang of properties that must one day be foreclosed on and brought to market.

Image Hosted by ImageShack.us

Image Hosted by ImageShack.us

The number of people living in homes for months on end, and have absolutely no hope of ever paying again, without having been foreclosed on is simply staggering.

Image Hosted by ImageShack.us

In the end the banks are going to have to write off all these losses in their mortgage holdings. To cover these losses, to avoid going bankrupt, the banks have to build up cash reserves. That means cutting back on loans, both business and consumer.

Image Hosted by ImageShack.us
Image Hosted by ImageShack.us

The recovery cheerleaders like to talk about recent numbers and charts, but they don't spend much time talking about the fundamentals of the economy. The fundamentals start with the amount of money and credit in the system.
It's possible to get a temporary bounce in the economy based on massive government stimulus and intervention, but you can't get a sustained recovery under any circumstances without an expanding money and credit supply. Unless that changes, we are going into a double-dip.

Meta: 

Comments

5 points for Midtowng

There use to be a rating system that one could rate the article from 1 to 5. I see that this article has a 2 point rating but I don't see how to assign a number. Sooo just let me say this a 5+. Midtowng is always a must read. But this this time he out did himself.
Midtowng - "you da man!"

You must have Javascript enabled to use this form.

but the reward is so much greater than your typical pt system

uprating a post puts it first on the front page. Those arrows actually move content around the site, controlled by registered users.

See the admin forum, under the promote/demote system topic.

You must have Javascript enabled to use this form.

double dip proclamation

Writing up so many EI reports, my overall analysis is that results are mixed at best to date. I sure do not see anything to really jump start the job markets, (supposedly the Obama administration is claiming the Stimulus saved up to 2.8 million jobs but I haven't looked at that in detail), keywords being "up to" assuredly, but I don't see the "real" economy which generates job growth having enough "umph" to it to kick in. There is some good news in auto manufacturing and they are hiring in Detroit and even opening up, revamping some plants.

That said, I believe a double dip is going to happen because the Stimulus effect wanes at the 2nd half of this year, we have an ongoing European crisis and the biggest impetus is the gulf oil spill. If NOAA is right and we're going to have that many hurricanes, the gulf would have to be evacuated as they showed up there, which one can bet some will. Top waves can hit 100 feet high. I don't know how far turbulence goes to the sea floor in a hurricane but all of that oil is not tethered to it either.

3.0% GDP where over half is inventories and we need a good 2.5% to maintain the status quo, even if GDP does not go negative, it's still nowhere near what kind of economic growth the nation needs. Then, while some people believe, magically, there will be better reforms in conference committee, I do not think so. In other words, they still have not reined in the Banksters and thus it can all happen again.

You must have Javascript enabled to use this form.

Great post, great graphs, but to be expected...

...we are still in the Great Deleveraging, to make up for all those debt-financed billionaires who profited from their ill-gotten gains to the extreme aggro to the rest of us.

Nope, there is no economy, with the top five banks making up 63% of the GDP, and with the Fantasy Finance Sector, all told, making up over 80% of the GDP, where's the frigging economy?

No economy.....no media.....what's up with that, huh?

Onward marches the Neofeudalism Movement.....

You must have Javascript enabled to use this form.

Admin, EPers - consider using the share buttons

Putting on my EP admin hat on for a moment.

You might also notice that share button. Since EP is a niche site, all econ 24/7, a lot of posts get read because someone reads something and shares it on another site or through those buttons. It's weird but that's what goes on, instead of writing a comment on this site, they write a comment on some other site which has picked up on the article, even though it is read on this one. The site feeds also go out and are aggregated by some other sites who like us as well as news sites, which is another way people read the articles posted here.

I'm working to get more people to join us in the comments, discussion section and I'm working on the software to make that happen more, but in terms of getting really good posts read, so far this seems to be how it's all happening.

Bottom line if you think an article/post is awesome, you might try those buttons in addition to comments.

You must have Javascript enabled to use this form.

Effort to Support Housing Makes Things Worse

IMO this is just perpetuating a failed system and keeping home prices from reaching affordable levels.

We have oodles of government support for housing prices from tax deductions of interest to credits to mortgage programs etc. All this does is create an artificially high priced market that pushes home ownership further and further away from the average earner and pads the pockets of the banks and the wealthy.

Reinstating mark to market for bank held assets is the first step in deleveraging the US housing market and hence the economy. Within a year of that we'll see whether the new reforms allow for another round of bank bailouts etc.although the Fed will bail them out anyway since we have no control there in all reality making financial reform a complete joke.

Remember China is still moving away from long term US investments and even stuck to the Euro investments rather than return to US as its main investment. What does that tell us?

Let the housing market fall and deleverage the dollar. Housing will fall for awhile while wages will rise naturally and our debt as a percentage of GDP will fall. Pizzas may end up costing $50 but we'll have the money to pay for them and making oil $300 a barrel is the best thing we could do for alternate energy.

You must have Javascript enabled to use this form.

In an ideal and honest universe....

sure, but the underlying reason for propping up Freddie Mac and Fannie Mae is to service and keep solvent (if anthing about them is really solvent) JP Morgan Chase, Goldman Sachs and Morgan Stanley.

Therefore, as others far more intelligent than I have pointed out, the US Dollar today is based upon mortgage loans.

Housing will fall for awhile while wages will rise naturally and our debt as a percentage of GDP will fall.

But I fundamentally agree with your idealistic assessment of what would happen in an honest economy -- assuming the US economy is anything other than a colossal criminal enterprise today.

You must have Javascript enabled to use this form.

Agreed Criminal Enterprise

Wait till the Fannie/Freddie bailout costs come to light. They will dump all their bad CDO investments (as you say the crap that the banks sold them rated AAA by the corrupt ratings agencies filled with junk) on the taxpayers rather than default and the taxpayer will pay the banks yet again further perpetuating the system in place.

Cue the markets to fall. Cue Libor and TED back to 2008 levels. Cue the Fed to return to QE priming the pump. Cue hyper inflation hidden by fake stats as consumers here buy everything made by Chinese prison labor. Cue worse and worse unemployment. Cue the FHA plus a newly rejuvenated F&F to more sully support a housing market already on government life support to maintain high housing prices to further support the banks. I mean housing sales are way off so what we want is different mechanisms for people to borrow there way into bankruptcy not allow more affordable homes right? This will of course also inflate our way out of debt but with all the benefits going to the banks and the wealthy where as my solution most goes to regular people.

We won't have to wait long for all this to play out though. The FASB wants to reverse their change in bank asset valuations back to mark to market and F&F will bubble to the surface by the end of summer. Look for action to block the FASB move and to put off F&F till after midterm elections.

As the money supply contracts and the Fed keeps printing the Congress keeps borrowing to spend cue hyper inflation as the Fed will unleash the printing presses and Congress will spend us into the proverbial poor house weakening the dollar till its wallpaper. As long as a house remains essentially pegged where it is though since thats the status quo.

The scary thing is that we have to see US M3 stats coming from Europe because the Fed no longer publishes them.

When this started many people including Roubini, Taleb, Marc Faber and a few others including Bernankes MIT economics professor Stanley Fischer said that they are just doing the same thing that got us here in order to maintain the status quo.

Fischer put it best though at the Central Banking get together in Jackson Hole, WY last year:

"At this stage, we seem to be taking it for granted that we should go back to the structure of the financial system as it was on the eve of the crisis," Fischer said. "But we need to be thinking more broadly, including the possibility that some radical restructuring is needed.

We are solving a private debt crisis by exacerbating an already bad sovereign debt crisis and our children and grandchildren will be paying for all this.

You must have Javascript enabled to use this form.

M3 is Decreasing Now

M3 is falling as of the end of Q1. Bernanke is doing this deliberately because he does not want to deal with the reality of business loans, credit cards, consumer loans being paid off and no new loans take out.

The effect is profound deflation. A near repeat of 1930 and Hoover's Treasury and Fed. There is a slight
but important difference between now and 1930: M1 and M2 are still growing but the rate of growth of M2
is slowing.

If Bernanke is blind to M3, cash, demand deposits,
money market funds, some commercial paper are created, but no real consumer or business loans.

Daily Telegraph reports that M3 is actually falling.
http://www.telegraph.co.uk/finance/economics/7769126/US-money-supply-plu....

You must have Javascript enabled to use this form.

Burton Leed