In early 2006, a friend of mine named Mike wrote to me saying he was worried about the Federal Reserve’s decision to stop publishing M3 money supply statistics. He thought it could be a prelude to inflation and trouble for the stock market.
The M scale is a way of measuring money, proceeding from M0 on the narrow end of cash to M3 on the wide end including foreign deposits. Here’s how they stack up:
- M0: This is the most liquid measure, and looks at just the actual cash sloshing around the economy.
- M1: Includes M0 and checking accounts.
- M2: Includes M1 and small time deposits of less than $100k, savings deposits, and individual money market funds.
- M3: Includes M2 and large time deposits of $100k or more, institutional money market funds, repurchase agreements, and dollars held at banks in Canada and the United Kingdom.
In March 2006, the Federal Reserve stopped publishing M3 data, saying that doing so would save it money and that M3 added no additional useful information about the economy beyond what M2 already showed.
But, is that true? You don’t have to be an economist to see from the list above that M3 is the broadest measure of money in the economy. For more than two years, we’ve had no official data for deposits of more than $100k, institutional money market funds, repurchase agreements, or dollars stashed in Canada or the U.K. The worry voiced by Mike and others was that by hiding the growth of big money, the Fed made it easier for itself to inject billions of digital dollars into the economy without anybody noticing.
They wouldn’t do that, though, would they? Sure they would. Even back when M3 was tracked, the Fed grew it at a rate of 8% per year. A chart showing 8% annual growth jumps off pages to even uneducated eyes, so away went the chart. Growing the money supply by so much is bound to have an impact on inflation, so the consumer price index was replaced in 2000 by “core inflation” as the way the government reports inflation. Core inflation checks the price of everything except energy and food.
Of course, that makes sense, because only people who turn on lights, drive cars, and buy groceries are affected by energy and food prices. Surely you’re not part of that odd bunch.
So, by hiding the rising cost of energy and food, and not reporting the growing supply of dollars each year, the Fed cleared a nice path toward opening the money spigot to full blast. Corporations are all for this recipe because they award salary increases based on the cost of living which now does not include energy or food, so they can freeze or even lower wages. Higher prices for goods and services sold, coupled with lower employee wages equals more profitable companies, which must mean a healthy economy. Ta-da! Just like that, the economy is a gem again, thanks to the working stiff.
As investors, we’re supposed to think like corporate management in the pursuit of all profits all the time. We’re not supposed to care about workers. To hell with them. The less our companies can pay for their productivity, the better. You know the old saying: pay them just enough so they won’t quit.
In theory, then, the rising money level combined with fudged inflation stats to create more profitable companies should lead to higher stock prices. It hasn’t, though.
Since M3 stopped being tracked in March 2006, it has gone parabolic. You can’t get data from the Federal Reserve anymore, but other organizations have pieced it together from weekly Fed reports. For example, the key stats section of nowandfutures.com provides charts showing that M3 was $10.25 trillion in March 2006 and has risen 32% to $13.50 trillion now. That’s a big expansion of the money supply in just 27 months.
By chance, have you noticed anything getting more expensive during those 27 months? You have to look carefully, so let me help.
According to the Energy Information Administration, the average price of a gallon of regular grade gasoline in the U.S. was $2.25 when M3 data disappeared. Today, it’s $4.10 and approaching $4.50 in some areas.
According to the Bureau of Labor Statistics, a pound of white, all-purpose flour cost 33 cents when M3 data died. In May of this year, it was 53 cents. A dozen grade A large eggs went from $1.30 to $1.93.
Inflation is here. Another way to put it is that a dollar is worth less today than it was a couple of years ago. That’s true at gas stations and stores, as shown above, and also at the currency exchange where 27 months ago one euro bought $1.20 and one dollar bought 119 yen. Today the euro buys $1.58 and the dollar buys only 106 yen.
Which might explain what the Federal Reserve was really up to. The dollar is still the world’s reserve currency. We pay for imports with dollars. Those sending us the goods and collecting the dollars as payment, such as China, deposit the dollars in central bank coffers or convert them to local currency. The central banks take the dollars and buy U.S. Treasuries. The U.S. government wants to pay that debt back with dollars as cheap as possible, which has been arranged.
What are the practical implications for individuals?
One is that this financial engineering may mean little to the stock market. On the one hand, rising profits from an inflated money supply and stagnant wages should get stock prices moving higher. On the other, higher energy prices could offset the savings from low wages.
Indeed, when we look back at the history of M3 in America, we see it rising steadily from about $0.80 trillion in 1970 to $4.00 trillion in 1995, then taking off to its current $13.50 trillion. During that time, we’ve seen bear markets, flat markets, and bull markets in stocks. We’ve also seen runaway inflation in the 1970s and benign inflation in the 1990s.
So, while Mike was right about the end of M3 data kicking off a race higher in the money supply, it’s not clear that it’s an automatic stock market killer. What is clear is that the situation is not good for American workers.
