Collapsing Money and Credit

I have been focusing om M2 nsa slowdown in money growth, which is at the core of money growth. However, this number is not an isolated declining number in the money/credit sphere.

Professor Tim Congdon from International Monetary Research said US bank loans have fallen at an annual pace of almost 14% in the three months to August (from $7,147bn to $6,886bn), as quoted by Ambrose Evans-Pritchard.

"There has been nothing like this in the USA since the 1930s," he said. "The rapid destruction of money balances is madness."

The M3 "broad" money supply, watched as an early warning signal for the economy a year or so later, has been falling at a 5% annual rate.

Pritchard takes a shot at answering why Bernanke is doing this:

It is unclear why the US Federal Reserve has allowed this to occur.

Chairman Ben Bernanke is an expert on the "credit channel" causes of depressions and has given eloquent speeches about the risks of deflation in the past.

He is not a monetary economist, however, and there are indications that the Fed has had to pare back its policy of quantitative easing (buying bonds) in order to reassure China and other foreign creditors that the US is not trying to devalue its debts by stealth monetisation.

Mr Congdon said a key reason for credit contraction is pressure on banks to raise their capital ratios.

Congdon's thinking is in line with mine:

The current drive to make banks less leveraged and safer is having the perverse consequence of destroying money balances.It strengthens the deflationary forces in the world economy. That increases the risks of a double-dip recession in 2010.

Here's a key stat that is going to really squeeze the economy both in the U.S. and the Eurozone:

US banks are cutting lending by around 1pc a month. A similar process is occurring in the eurozone, where private sector credit has been contracting and M3 has been flat for almost a year.

Congdon predicts that the Federal Reserve and other central banks will be forced to engage in outright monetisation of government debt by next year, whatever they say now.

This is a very likely scenario. The ideal would be for the Fed and other central banks to stop manipulating money supplies, but that is not going to happen. With the second dip of the double dip likely to be severely impacting the economy by early next year (if not sooner), Bernanke is apt to open the monetary floodgates, just like he did in September of 2008.

But, first the crash, and it's going to be ugly.

(Thanks to Brian Erickon)