M3: The Sucker's Statistic. Why Inflationists and Deflationists Have Repeatedly Been Sucked In.
Match 31, 2010
The Bible speaks of a dog returning to its vomit. The vomit in question here is M3.
I warned inflation predictors against paying any attention to M3 years ago. You can read my report.
About two years ago, it began turning down. Rick Ackmerman finally jumped on board. He has spent two decades predicting price deflation. He has never been correct. He had always ignored M3, because it pointed to serious price inflation. He was correct to ignore it. Then he got the M3 religion. He wrote this.
There was good news yesterday for all those who mistakenly think inflation is worth worrying about: The U.S. money supply experienced its sharpest contraction in modern history. For the rest of us, this can only spell one thing: ruinous D-E-F-L-A-T-I-O-N. The money supply story was reported yesterday by Ambrose Evans-Pritchard, the London Telegraph's man-on-the-scene in America. The news is likely to have been reported by the U.S. media as well, although we couldn't find it anywhere else, even on Google's business page.
Why all the fuss? He had read an article by Ambrose Evans-Pritchard, the perennial deflation-predicting Keynesian. Ackerman linked to this article.
The US money supply has experienced the sharpest contraction in modern history, heightening the risk of a Wall Street crunch and a severe economic slowdown in coming months.Data compiled by Lombard Street Research shows that the M3 'broad money" aggregates fell by almost $50bn (£26.8bn) in July, the biggest one-month fall since modern records began in 1959.
On a three-month basis, the M3 growth rate has fallen from almost 19pc earlier this year to just 2.1pc (annualised) for the period from May to July. This is below the rate of inflation, implying a shrinkage in real terms. . . .
The M3 data measures both cash and a wide range of bank instruments. It tends to provide an early warning signal of major shifts in the economy, although the US Federal Reserve took the controversial decision to stop reporting the statistics in 2005 on the grounds that the modern financial system had rendered the data obsolete.
Monetarists insist that shifts in M3 are a lead indicator of asset prices moves, typically six months or so ahead. If so, the latest collapse points to a grim autumn for Wall Street and for the American property market. As a rule of thumb, the data gives a one-year advance signal on economic growth, and a two-year signal on future inflation.
"There are always short-term blips but over the long run M3 has repeatedly shown itself good leading indicator," said Mr Stein.
Evans-Pritchard neglected to mention that in March 2006, the Federal Reserve had quit reporting on M3. The statistic is useless, the FED said.
M3 does not appear to convey any additional information about economic activity that is not already embodied in M2 and has not played a role in the monetary policy process for many years. Consequently, the Board judged that the costs of collecting the underlying data and publishing M3 outweigh the benefits.
The FED was correct. Yet inflation-predictors screamed "Foul!" There had to be some sort of conspiracy to conceal the real rate of monetary inflation. But the rate of change in consumer prices did not jump in 2007. It did in the first half of 2008; then it went negative. Overall, no big change.
So, did America's consumer price index go negative, year to year in 2008 or 2009? No. It went flat in 2009. It is still close to flat.
M3 is useless at best and a liability for anyone who uses it to forecast the the consumer price index.
Evans-Pritchard is at it again. In a May 26 article, he was screaming doom, doom, doom.
The M3 money supply in the United States is contracting at an accelerating rate that now matches the average decline seen from 1929 to 1933, despite near zero interest rates and the biggest fiscal blitz in history. The stock of money in the US 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 which include broad range of bank accounts and are tracked by British and European monetarists for warning signals about the direction of the US economy a year or so in advance - began shrinking last summer. The pace has since quickened.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 institutional money market funds fell at a 37pc rate, the sharpest drop ever.
Yet in 2008, he wrote: "On a three-month basis, the M3 growth rate has fallen from almost 19pc earlier this year to just 2.1pc (annualised) for the period from May to July." Result? Nothing much. But he skips over this inconvenient fact.
Bad news: we're back to 1931. Good news: it's not 1933 yet. "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.
Wait a minute. What do "regulators around the world" have to do with American banks? Nothing. These unnamed regulators have zero authority, here or anywhere else.
We don't need M3 to tell us there is monetary deflation. We only need the adjusted monetary base.
If you want a quick review of the various M's, Jesse's Cafe offers one. Click here.
On that site is a response to Evans-Pritchard. Here is the bottom line: no one knows what M3 is. Anyone who says he does is faking it. What is missing is Eurodollars, which was part of the FED's M3. There is now a lag time on the reporting of Eurodollars.
As for M2, there is no major decline. The same for M1. The decline is in the M1 money multiplier.
Jesse and I agree: the increase in bank reserves is driving the economy. Prices are flat because excess reserves have offset the increase in the monetary base.
For a set of charts on recent money supply measures, click here. Savings accounts have fallen. Retail money market accounts have fallen. Nothing else has. When people pull money out of a money market fund and deposit it in a checking account at a bank, M3 falls. The bank then puts the money in its account as excess reserves. M3 falls. M1 doesn't. So what?
M1 has fallen this year. Its decline parallels the decline in the adjusted monetary base.
If you want an opinion on why M3 has dropped, ask the person who is publishing his pseudo-M3 statistics. Whatever M3 used to be statistically, it isn't today. What it was before -- useless as a forecasting tool -- the pseudo-M3 statistics will be, but worse.
If your source of M3 is the Shadow Statistics site, be forewarned: these are not anything remotely like the Federal Reserve's version. John Williams modifies the statistics, but calls the result M3. I don't think most of his readers understand this. This from his April 2010 report. His M3 is something called "real M3." This is exclusively his invention.
Signal Deepens for Intensified Economic Downturn. As discussed in recent Commentaries (see Commentary No. 277, for example), declining year-to-year change in real (inflation-adjusted) M3 signals a pending economic downturn or pending intensification of an existing economic contraction. The following updated graph reflects both the annual payroll change and the approximate annual real contraction in the SGS Ongoing M3 Estimate as of March 2010. The M3 plot is shifted forward on the time scale by six months so as to show its leading relationship to payrolls. The March real M3 estimate is based on approximations of 4.0% annual nominal M3 contraction and 2.1% annual CPI-U, for a total 6.1% contraction, versus a 5.2% contraction in February. Assuming the March estimate holds, such would be the sharpest annual decline of real M3 in modern reporting.
What is CPI-U? How does that have anything to do with monetary statistics?
As I wrote on May 20, he does not tell us how he calculates his price index. It does not correspond the the CPI. I trust the CPI more than I trust his version.
He needs to produce a detailed series of reports on how he uses Federal data to calculate M3 as well as CPI-U. He also needs to publish a treatise on the theory that requires that we mix separate categories. Finally, he needs to publish a book on how his combined series has predicted the move of the CPI more accurately than M1 or M2 did. Until he does all three, I shall state simply: "Highly implausible case not yet proven."
How have his predictions gone recently?
In 2008, he predicted hyperinflation for 2010.
In late 2009, he revised this prediction. It will hit no later than 2014. Oops!
I regard these predictions as completely wrongheaded. I regard his statistics as unverifiable by third parties. So far, they have led him to make preposterous predictions about prices.
If your pseudo-M3 statistics come from his site, you have another reason to ignore them. They were useless in 2006 when the FED ceased posting them. Modified and unverified, they are far more useless today.
For more on the weakness of M3 as a statistic, click here. The author is an Austrian School economist.
If you decide that you still must return to this useless statistic, now modified by a promoter, ask him any questions you may have about what is happening to M3. See if he can explain it. Feel free to post his answer on a forum.