The Money Supply and Tea Parties Across the Country

April 15, 2009 Edition, Volume III

Inside Signature Update
- Leading Economic Trends
- A Lesson in Money Supply – M1 and M2
- A Quick Review… Who’s to Blame?
- Tea Parties Across the Country


Leading Economic Trends

This week’s report of a 1.1% decline in March retail sales was a solid reminder that the US economy is not yet out of the woods. Following retails sales increases in both January and February, the retail markets were expected to post a small increase of .2%. The figures reported do not simply represent that consumers purchased less; they also represent that what consumers purchased cost less. March CPI (consumer price index) results were lower by .4%, reflecting an ongoing, though modest, deflationary cycle. The retail sales decline, when adjusted for the CPI decrease, reflects an actual consumer sales activity decrease of .7% - still lower than expected.

Additional deflationary pressures can be seen in the Industrial Production figures released Wednesday morning. Industrial production was down by 1.5% in March reflecting an ongoing decrease in inventory levels and supporting continued unemployment trends. Since December 2007, industrial production has decreased 13.3% while unemployment has increased by approximately 4% to the 8.5% level.

March’s .4% decline in CPI marked the first 12-month decline in CPI since 1955 and was lead by an energy price reduction of some 3%. The ‘Food Price at Home’ index was off by .4% while the prices of some other goods and services actually posted slight price increases.

While these shifts represent additional deflationary pressure in the markets, most economists are not overly concerned about long-term deflation. The increasing money supply, as supported by enormous amounts of government spending will likely curb deflationary pressures as the labor market improves. Most economists are more concerned about inflationary pressures brought on my higher employment levels and increased currency in our economy.

As the stock markets have rallied these last weeks we are reminded that the markets forecast economic activity more than mirror it. Most of the current economic news continues to trend negative while the markets have obviously been on an upward path. This doesn’t represent a disconnect between the markets and the economy, rather it continues a trend that can be seen for the last one hundred plus years of markets leading economic growth and activity.


A Lesson in Money Supply – M1 and M2

The domestic money supply is often reported in terms of M1 and M2, but few people understand what these represent and moreover, what the import is to society.

The money supply is an important aspect of our economy. When the supply tightens, credit is more expensive to get, businesses have a more difficult time expanding, and the economy typically weakens. When the money supply increases, just the opposite effects can be observed. When events threaten the domestic economy, the Federal Reserve and Treasury will most often react by adding to the money supply. This is typically often accomplished by lowering interest rates, altering hypothecation standards (lending ratios), increasing government spending, or simply printing money. While there may be other, yet more complex ways of altering the money supply, these are those that can most immediately provide an impact.

The money supply is measured using various inputs and titled M0, M1, M2, and M3.

- M0 is cash; Federal Reserve notes, and coins (currency in circulation).

- M1 is currency in circulation plus checkable deposits and traveler’s checks. In other words, anything you can use to make payments or purchases without including debt.

- M2 is the M1 supply plus savings deposits, time deposits less than $100,000, and money market deposit accounts for individuals. M2 is most often considered to be the best measurement of money in our economy and is tracked most closely to determine inflationary considerations.

- M3 is the broadest categorization of the monetary supply and consists of M2 plus large time deposits, institutional money-market funds, short-term repurchase agreements, and other larger liquid assets. M3 is no longer published or revealed to the public by the Federal Reserve.

In the last 12 months the M2 money supply has increased by more than 10% and is expected to post increases of another 15-20% in the coming year as the various stimulus plans are put in place and provide an economic boost to our economy. As the US Central Bank no longer publishes M3 data and given that M3 may be the arena that suffers the greatest expansion due to recent Federal Reserve and Treasury efforts, it represents the foundation for economist’s concerns regarding future inflationary trends.


A Quick Review… Who’s to Blame?

As one reviews the sequence of events beginning with the credit market meltdown of September 2008 and the Bush administration’s calls for urgent action, it becomes a simple matter to chart the resulting economic slowdown. There is an entire cause and effect lesson to be viewed here.

Though our economy may have begun to slow modestly we were far from the calamitous events we now survived. As business owners and managers became concerned, their businesses reacted and began to lay off workers and decrease production in anticipation of lower spending; which in turn brought about decreased spending at both the consumer and corporate level; which put yet greater pressure on the labor markets. As the credit markets worsened, the real estate markets, already suffering from overbuilding, began to release inventory through home sales and foreclosures to the point that residential real estate inventory levels became disastrous in many parts of the country. This led to worsening financial ratios for banks, lower valuations for collateralized assets, massive write-downs by banks and other financial institutions, higher unemployment, lower manufacturing and some of the worst domestic consumer confidence levels ever recorded. The slowdown, which may never have reached the level of ‘recession’, quickly escalated and for a time economists feared an outright depression.

Though it isn’t realistic to place the entirety of the blame for our current economic woes on the Bush administration, or those at the helm of the Federal Reserve, it is an interesting study of how quickly problems can get out of hand when fueled by the twin fires of politics and media.

The blame for our current scenario can be floated across at least three presidential administrations and is quickly being owned by yet another. The Obama administration, though having the least direct responsibility in creating the recession is carrying out many of the same measures that got us where we are, primarily excessive spending. Though not an ideological fan of Bill Clinton, I did respect his tone and intent as he addressed the American people and explained that increased taxes and decreased spending would be necessary to balance the federal budget. Today, there is little credible talk of a balanced budget, but there are massive spending plans being pursued. While an increase in spending may stimulate the economy (the Keynesian Theory), wasteful programs and excessive earmarking can undermine even the best efforts; and ultimately, increased taxes follow.


Tea Parties Across the Country

No Presidential administration, House and Senate has never before needed the fiscal backbone those bodies need right now. There is a grass-roots move afoot to bolster those who have the needed strength, alter the mindsets of those who exhibit some measure of promise, or oust those committed to ‘pork’ and excess. Ironically, the Obama administration took to the media on April 15th to defend their position on taxation and discount the credibility of those hosting or attending ‘Tea Parties’ planned across the country. They’ve missed the point entirely.

President Obama and his spokespersons, in an attempt to minimize conservative activists, are speaking to a different issue than that presented by the grass-roots ‘Tea Party’ activists. Rather than address current and future spending, inflation and levels of taxation, they are focused solely on the current tax plans and their proposed benefits to the middle class. Though it may be true that the vast majority of American’s, by some measure as many as 95%, will either see federal income tax reductions or experience no tax increase under the current plan, it is another thing altogether to address the effect of the massive budget deficits being created and the need to deal with them in future years. Most Americans aren’t as bothered by current and proposed tax rates as they are building up a debt that demands payment soon.

Many have commented that we mustn’t waste a good crisis to effect needed changes – very true. But while we’re changing, let’s make sure we look at tightening our belts at home, in business, and in government; and maybe… just maybe we won’t have to hand such enormous problems to the coming generations.





Signature Update is offered by Richard Haskell, Managing Director of Signature Wealth Management and CEO of Signature Management, LLC