Saturday, 10 January 2009

UK money supply growing at 16 percent

Since August, the UK money supply increased by almost 2 percent a month. During the 12 months up to November, it increased by over 16 percent.

It is hard to reconcile these numbers with the undoubted credit crunch going on in the housing market and the small business sector. The UK economy is seeing both rapid monetary growth and contracting credit.

M4 measures the growth of bank balance sheets. Since the banks aren't giving credit to the real economy, then who is getting all this new money? Yes, the banks are handing out huge amounts of credit to non-bank financial institutions. This is the unregulated shadow banking system which is at the epicentre of today's credit crisis.

Something tells me that this financial crisis is far from over.


Anonymous said...

very odd!!!

Anonymous said...

Credit crunch today, inflation in 18 months time.

Anonymous said...

The UK definitely has a whiff of Zimbabwe about it.

AC said...

all my money is in gold,

I'd like to see Gordon Mugabe try and print that !

Anonymous said...

I've recently read New Monetarism by David Roche - which, while spectacularly badly written, says something relevant on this topic.

A central thesis of "New Monetarism" is (as far as I understand) that the money supply is very difficult to measure. The author introduces a number of inverted pyramids that illustrate this point... the liquidity pyramid being the most interesting. It assumes a universe of 'money-like' instruments and classifies it:

~1% - "Power money" (Bank capital & cash in circulation)
~9% - Fractional reserve debt (Roughly M4, I presume)
~10% - Securitized debt.
~80% - Derivative contracts.

To me this is significant. It illustrates first that, in all likelihood, a vast majority of the derivative contracts are going to cancel out. Next it suggests that Securitized debt is extremely significant. If our central banks support it (Ref: TARP in the USA and the SLS in the UK - and similar schemes at the ECB... coupled with plummeting base rates) then securitised debt is, effectively, equivalent and convertible to fractional reserve.

Any leak from Securitized debt into fractional reserve debt will play havoc with any statistics which, hitherto, had ignored securitized debt - assuming it to be managed outside the banking system. I imagine not a leak but a torrent... given the size of schemes targeting securitized debt - which already exceed $1tn.

In my opinion, we are now in a situation in which M4, like M3 is almost entirely irrelevant... as it now measures ringfenced moneys that were never previously considered relevant to the metric. Unless we re-think how such metrics are established - then construct comparable historic data sets, we are doomed to be grievously mislead.

Another major problem with M4 is that is considers moneys of up-to 5 years maturity. The £20 I have in my pocket in cash is likely to have a far greater impact on the economy than £100 that I'm due to receive in 2014... and this is especially the case if the £100 asset is offset by a current £100 debt - planned to be settled in 2014.

A major effect of the "credit crunch" has been to make it extremely difficult to estimate the "velocity of money" - which, previously, was approximated by maturities - on the assumption that people would invest for as long a term as their plans permitted - as that would be a good way to maximise income. In the credit crunch, even capital required for the extreme long term has been liquidated in order to avoid undue risk. This means that there is a massive unknown in all the financial models: how much money tagged for 'instant access' is actually money destined for long-term investment?

I agree whole heartedly that this financial crisis is far from over. The principle angle at present is political. The government are promising to spend on a spectacular scale - at a time of diminishing tax returns and a rapidly growing trade deficit. Right now there is substantial demand for sovereign debt - but, I wonder, how long will that last? One year; two, three? Surely not 5 or 10? Unfortunately, if our government is going to to go ahead with its spending plans, it is likely to need to manage its debt for a considerable term... which is the exact opposite of what investors want... unless, of course, they're confident that we're heading for a spiralling deflationary depression that makes the 1930s look like it was a walk in the park.

Right now industry is experiencing a massive economic shock that is precipitating a recession on a scale in excess of living memory. This will bring the "tough times" that everyone expects - but it is not the final act in this tragic play. Inflation will return - after a deflationary period - and when it does, there will (almost inevitably) be a bond crisis. Investors who've piled into short term sovereign debt at near-zero interest rates (which made sense during a deflationary period) will, once the economy has stabilised, start to demand sensible rates of return... which will, in turn, cripple government plans both to borrow and spend and tax and spend.

There's plenty more of this story to come.

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