Gary North

Feb. 18, 2008

The FED is deflating.

I define the noun deflation as "a decrease in the money supply." When the FED deflates, this refers to a decrease in the monetary base.

The monetary base reversed in recent days. It is headed lower.

The crisis began on August 11. If we compare the adjusted monetary base on August 15 with the most recent figure, February 13, it is down by 0.4% on an annual basis.

This is incredible. With all talk about the FED inflating in order to reduce the FedFunds rate, in fact it has sold T-bills and other assets, net, thereby reducing the monetary base.

Look at the chart for M1. It does not precisely reflect the monetary base, but it comes close. The figure for February 18, 2008 is below the figure for the first week of January, 2007. There was a spike upward in August. Then it fell back in late August, bounced around, but headed generally lower. It fell like a stone in the first week of January.

Note: I have written a detailed report on M1 as the most reliable monetary indicator of price inflation over the following year. Click here.

This is confirmed by a report released last week by the New York FED, Domestic Open Market Operations During 2007. Chart 9 on page 16 tells the story.

The FED has been deflating!

This is not what the public is being told by the financial media, including the "hard money" media.

Then why is the FedFunds rate in the 3% range? Because the T-bill rate is at 2.2%. Short rates are falling because there is a move to safety. It is the fear of recession, not the FED's non-existent policy of inflation, that is driving the credit markets.

Why is the FED deflating? There is no public explanation. I don't think the general investing public knows that the FED is deflating. So, the FED offers no explanation.

My guess: fear of a falling dollar internationally. If it is not this, then I do not understand the policy.

Those who expect near-term price inflation to continue at 3% or higher will be disappointed.

Those who think that the precious metals are rising because of a looming threat of price inflation in the United States are mistaken.

All is not what is seems. But, then again, it rarely is.

Do not be stampeded by warnings of imminent price inflation. Those warnings will be valid one of these days, or years, but not in 2008.

Pay no attention to the little bearded man behind the curtain, who told the Senate Banking Committee on February 14, "At present, my baseline outlook involves a period of sluggish growth, followed by a somewhat stronger pace of growth starting later this year as the effects of monetary and fiscal stimulus begin to be felt." There has been no monetary stimulus so far.