Tuesday, August 25, 2009

The Great Federal Reserve Monetary Contraction

MarketWatch economist, Irwin Kellner, gets it:

Guess what? The Federal Reserve has not only stopped depositing copious amounts of liquidity into the economy -- it now appears to be in the process of making a sizable withdrawal.

A close look at quantitative measures of monetary policy reveals a sudden change in trend. After growing at unprecedented rates for well over a year, these aggregates stopped rising several months ago and have since declined, according to data provided by the Federal Reserve Bank of St. Louis.

For example, the monetary base -- the raw material for the money supply -- has fallen at a seasonally adjusted annual rate of 8% from early April of this year through mid-August, after soaring at a 187% pace during the previous eight months.

And after ballooning from $100 billion to nearly $1 trillion between September 2008 and mid-May, adjusted reserves have since declined at a 43% clip, to just over $800 billion.

As a result, the Fed's two measures of the money supply, M2 and MZM, have begun to contract. M2 has shrunk at a 3% pace since the middle of June, while MZM, the St. Louis Fed's measure of liquid money, is down by 2% over the same period.

Both had been rising by rates as much as 15% earlier this year. These are sharp enough changes over a long enough period to suggest that our central bankers are more concerned about inflation developing down the road than you might think, judging by their public statements...

This V-shaped configuration for monetary policy is why I think the recovery will look like a W.

It is also a good reason to take some profits from the recent run up in stocks -- along with the fact that the two worst months for equities, September and October, are just around the corner.
At this point you have to be very wary of any economist talking about all the money the Fed has injected in the system. Not only is the monetary base not growing, it is contracting. Any economist that isn't aware of this is a fraud.

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