Are We Measuring the Wrong Money Supply … Again?

Posted by John Slater on June 12, 2012

Back in 2008 we wrote that the U. S. was facing a serious credit squeeze in part because we had failed to take into account some important structural changes in the credit markets: i.e. the rapid growth and subsequent collapse of the Shadow Banking system. Since then the Fed and the Treasury have spent enormous resources addressing the impact of that collapse through the purchase of assets from financial institutions, the nationalization of Fannie and Freddie and numerous other actions to prop up the housing market in hopes of repairing shrunken balance sheets throughout the economy.

We may be suffering from a different, but equally portentous, issue today arising from another misreading of what the term money really means. In response to our recent article on Fed tightening since the fall of 2011, John Lounsbury, Managing Editor of, made a very astute observation:

You do not mention it in your article but is it possible that the Fed has not been taking a sufficiently global view and has insufficiently reacted to a recessing Europe and a rapidly slowing Asia? India just dropped to a GDP growth rate below anything seen during the Great Financial Crisis. The manufacturing numbers in China have been flirting with contraction for several months. If the Fed reacts to these factors after they have gained a solid foothold, doesn’t that likely increase the magnitude of the yo-yo swings?

The U.S. dollar is without question the world’s reserve currency and the current problems of the Euro have only served to cement that position. Given the global demand for $100 bills, in many parts of the globe the dollar is not only the reserve currency, but the defacto physical currency as well. Yet we continue to look at money as a national, or in the case of the Euro, regional affair. Wouldn’t it make sense to begin measuring a global money supply?

While I expressed concern about the slowing in money growth rates in the U. S. representing an apparent monetary tightening, a far greater tightening may have been occurring globally as a result of the rapid decline of the Euro. From April 1 to June 1, the Euro declined from 1.33 to the dollar to 1.23 to the dollar or approximately 7.5%. At the end of Q1 2012 Euro M2 was €8.7 Trillion or approximately $11.6 Trillion.

U. S. M2 by comparison was $9.8 Trillion. This placed combined U. S. -Euro M2 at approximately $21.4 Trillion in U. S. dollar terms. Taking into account the 7.5% two month slide in the value of the Euro, combined U. S. – Euro M2 at the first of June had likely declined to something like $20.6 Trillion for a decline of 3.8%. On an annualized basis this represents a rate of decline in the U. S. – Euro combined money supply of approximately 23%, representing a tremendous loss of wealth and certainly enough of a decline to have some fairly material and almost certainly negative impact on economic activity.

It appears that we have witnessed a significant period of global monetary tightening in dollar terms, with the risk of serious unexpected consequences that may overwhelm current efforts to shore up the European banking system. Of course calculation of a global M2 would likely result in a somewhat lower, but still very material decline. Lack of ready access to such global data streams almost guarantees that the impact of U. S. centric monetary policy decisions will fail to adequately take into account the global impact of these necessarily domestic decisions.

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