The Very, Very Confused Mainstream Economics Profession

I am using Bill Conerly as a proxy for mainstream economists, as they attempt to understand the current economy. He thinks he has found what is wrong with the economy. He writes:

Take a look at the money supply. The monetary base (the raw material out of which money is made) rose very sharply in late 2008. The money supply rose at a fast pace, but not nearly as fast as the typical relationship would show. That was fine, because there was enough money supply growth to get the economy growing again late in 2009 and early 2010. However, the economy has slowed down to about zero, which I believe is due to the Fed dialing down money supply growth. Over the past 12 months, the money supply has grown by about the rate of inflation, leaving no further growth for real expansion of the economy.

The Fed had gotten used to thinking of monetary policy as working through interest rates. When the Fed Funds rate drops near zero, one view says they are out of ammunition.

First, he is absolutely correct that the current downturn is the result of slowed money growth. You could have seen this coming for months. And by March, it was obvious. I wrote on March 28:

The above chart (the chart showed collapsing money growth) is extremely important.

The information that it imparts explains why the dollar has been so strong against the euro and most other currencies. It explains the weakness in gold. And, I believe it signals an eminent crash in the U.S. stock market--which will lead to the second leg of the double dip recession.

How does the chart signal all this? Simple supply and demand. There are fewer dollars entering the system. Fewer dollars changes the supply structure that existed when the Fed was aggressively printing.

Specifically, fewer dollars means that its price will go up in terms of most other currencies and gold. There will also be fewer dollars to support the current structure of the stock market.

Here are specifics:

The M2 growth rate on an annual basis fell in the week ending March 15 to 0.85%, the lowest money growth rate since May 1995.

In each of the last 10 weeks, M2 growth has been below 2.5%.

Mark Perry details a lot of these specifics at his blog. His focus, though, is on the lack of price inflation that will exist because of this collapsing growth. He is correct, but I think he is missing the much bigger picture of the impact this will have on foreign currencies vis a vis the dollar, the impact on gold, and most important the stock market and overall economy.

In other words, all hell is about to break loose, again. And few are ready.

We can now look at the next step in Conerly's thinking. The slowed money growth and its relation to rate of inflation has nothing to do with the slowed economy, as Conerly tries to indicate. It is simply about no money growth resulting in the collapse of the previous distorted consumer/capital structure. And this is not a bad thing! If the economy were allowed to readjust, the crisis would be gone in six months.
But the government will monkey, this way and that, and prolong the downturn for, quite possibly, years.

Most interesting, Conerly, is among the first of mainstream economists to figure out that mainstream economists (including Bernanke) have been looking at low interest rates and not money growth as a signal that they have been pumping money into the system:

The Fed had gotten used to thinking of monetary policy as working through interest rates. When the Fed Funds rate drops near zero, one view says they are out of ammunition.

It's not, though, that the Fed is out of bullets, but that the Fed has been keeping rates above the real rate. This is also something that could have been detected months ago. I wrote in January:

What we are experiencing now is a period of huge demand to hold cash balances (The huge excess reserves is one piece of evidence of this). Thus, very short term rates are low, not as much because there is easy money available from the Fed, but because no one wants to lend out long-term, including banks... Banks are not using the short term rates to borrow funds and lend them out further on the yield curve. They are keeping reserves safe and sound at the Fed (where they remain out of the monetary system). Thus, no money creation.

Bottom line, we have a very, very confused mainstream economics profession. Conerly is really ahead of the pack. First, most think the Fed has been "stimulating" the economy through its "monetary policy". When in fact, and Conerly gets this, there has been no money growth.

Second, boosting money growth does not help the economy, it simply boosts the distorted structure. Conerly does not get this part, along with other mainstream economists.

Third, the Fed thinks they have been boosting the economy because they have been watching rates go down. But because, as I have pointed out umpteen times, the real rate (non-manipulated rate) appears to be below the Fed Funds rate and below the IOER, the Fed is not pumping any funds into the system. Conerly gets most of this, but most of mainstream does not. And it appears that Bernanke doesn't get it either.

Eventually, the readjustment phase will panic these so-called professionals that Bernanke will open up the floodgates and pump at double digit rates. This will be highly inflationary, but until this occurs, the stock market, overall economy  will be in a significant downtrend that could, short-term, take gold gown with it. Buckle your seat belts.