With sufficient deficit spending private credit isn’t needed at all to sustain growth and employment, so the shift from private sector credit growth (falling M3) to 3% growth sustained by deficits of 10% of gdp is perfectly sustainable.
In fact, I’d prefer, for a given size govt, lower taxes rather than higher private sector credit growth. And a larger trade deficit means we can have taxes that much lower still. And cut out much the military expenditures for Afghanistan and cut taxes that much more, thanks! etc!
Unfortunately 3% growth doesn’t close the output gap, but that’s another (very ugly) story, but with the same answer. Agg demand is about a trillion a year short of potential right now, hence my proposal for a full payroll tax (FICA) holiday to restore private sector sales, output, and employment.
By Ambrose Evans-Pritchard
May 26 (Telegraph) — The M3 money supply in the United States is contracting at an accelerating rate that now matches the average decline seen from 1929 to 1933, despite near zero interest rates and the biggest fiscal blitz in history.
The M3 figures – which include broad range of bank accounts and are tracked by British and European monetarists for warning signals about the direction of the US economy a year or so in advance – began shrinking last summer. The pace has since quickened.
The stock of money fell from $14.2 trillion to $13.9 trillion in the three months to April, amounting to an annual rate of contraction of 9.6pc. The assets of insitutional money market funds fell at a 37pc rate, the sharpest drop ever.
“It’s frightening,” said Professor Tim Congdon from International Monetary Research. “The plunge in M3 has no precedent since the Great Depression. The dominant reason for this is that regulators across the world are pressing banks to raise capital asset ratios and to shrink their risk assets. This is why the US is not recovering properly,” he said.
The US authorities have an entirely different explanation for the failure of stimulus measures to gain full traction. They are opting instead for yet further doses of Keynesian spending, despite warnings from the IMF that the gross public debt of the US will reach 97pc of GDP next year and 110pc by 2015.
Larry Summers, President Barack Obama’s top economic adviser, has asked Congress to “grit its teeth” and approve a fresh fiscal boost of $200bn to keep growth on track. “We are nearly 8m jobs short of normal employment. For millions of Americans the economic emergency grinds on,” he said.
David Rosenberg from Gluskin Sheff said the White House appears to have reversed course just weeks after Mr Obama vowed to rein in a budget deficit of $1.5 trillion (9.4pc of GDP) this year and set up a commission to target cuts. “You truly cannot make this stuff up. The US governnment is freaked out about the prospect of a double-dip,” he said.
The White House request is a tacit admission that the economy is already losing thrust and may stall later this year as stimulus from the original $800bn package starts to fade.
Recent data have been mixed. Durable goods orders jumped 2.9pc in April but house prices have been falling for several months and mortgage applications have dropped to a 13-year low. The ECRI leading index of US economic activity has been sliding continuously since its peak in October, suffering the steepest one-week drop ever recorded in mid-May.
Mr Summers acknowledged in a speech this week that the eurozone crisis had shone a spotlight on the dangers of spiralling public debt. He said deficit spending delays the day of reckoning and leaves the US at the mercy of foreign creditors. Ultimately, “failure begets failure” in fiscal policy as the logic of compound interest does its worst.
However, Mr Summers said it would be “pennywise and pound foolish” to skimp just as the kindling wood of recovery starts to catch fire. He said fiscal policy comes into its own at at time when the economy “faces a liquidity trap” and the Fed is constrained by zero interest rates.
Mr Congdon said the Obama policy risks repeating the strategic errors of Japan, which pushed debt to dangerously high levels with one fiscal boost after another during its Lost Decade, instead of resorting to full-blown “Friedmanite” monetary stimulus.
“Fiscal policy does not work. The US has just tried the biggest fiscal experiment in history and it has failed. What matters is the quantity of money and in extremis that can be increased easily by quantititave easing. If the Fed doesn’t act, a double-dip recession is a virtual certainty,” he said.
Mr Congdon said the dominant voices in US policy-making – Nobel laureates Paul Krugman and Joe Stiglitz, as well as Mr Summers and Fed chair Ben Bernanke – are all Keynesians of different stripes who “despise traditional monetary theory and have a religious aversion to any mention of the quantity of money”. The great opus by Milton Friedman and Anna Schwartz – The Monetary History of the United States – has been left to gather dust.
Mr Bernanke no longer pays attention to the M3 data. The bank stopped publishing the data five years ago, deeming it too erratic to be of much use.
This may have been a serious error since double-digit growth of M3 during the US housing bubble gave clear warnings that the boom was out of control. The sudden slowdown in M3 in early to mid-2008 – just as the Fed talked of raising rates – gave a second warning that the economy was about to go into a nosedive.
Mr Bernanke built his academic reputation on the study of the credit mechanism. This model offers a radically different theory for how the financial system works. While so-called “creditism” has become the new orthodoxy in US central banking, it has not yet been tested over time and may yet prove to be a misadventure.
Paul Ashworth at Capital Economics said the decline in M3 is worrying and points to a growing risk of deflation. “Core inflation is already the lowest since 1966, so we don’t have much margin for error here. Deflation becomes a threat if it goes on long enough to become entrenched,” he said.
However, Mr Ashworth warned against a mechanical interpretation of money supply figures. “You could argue that M3 has been going down because people have been taking their money out of accounts to buy stocks, property and other assets,” he said.
Events may soon tell us whether this is benign or malign. It is certainly remarkable.
On Thu, May 27, 2010 at 12:04 PM, Marshall wrote:
Yes! For some odd reason there is a myth about the Great Depression that could not be more removed from the reality of the time. Most people believe the economy crashed between 1929 and 1932 and then remained depressed until the Second World War which finally mobilized the economy’s idle resources and brought about a full recovery. That’s complete bunk if you calculate the unemployment data correctly. Even leaving aside that fact, it is true that, once the Great Depression hit bottom in early 1933, it embarked on four years of economic expansion that constituted the biggest cyclical boom in U.S. economic history. For four years real GDP grew at a 12% rate and nominal GDP grew at a 14% rate. There was another shorter and shallower depression in 1937 CAUSED BY RENEWED FISCAL TIGHTENING. It was this second depression that has led to the misconception that the central bank was pushing on a string throughout all of the 1930s until the giant fiscal stimulus of the war time effort finally brought the economy up from depression. The financial dynamics of that huge economic recovery between 1933 and 1937 are extremely striking. Despite their insistence that changes in the stock of money were behind all the cyclical ups and downs in U.S. economic history, even Freidman and Schwartz in their “Monetary History of the United States” conceded that the money aggregates did not lead the U.S. economy out of the depression in 1932-1933. More striking, private credit seemingly had nothing to do with the take off of that economy. Industrial production off the 1932 low doubled by 1935. By contrast, bank credit to the private sector fell until the middle of 1935. Because of the collapse in nominal income during the depression, the U.S. private sector was more indebted than ever on the depression lows. Yet, somehow it took off and sustained its takeoff with no growth in private credit whatsoever. The 14% average annual increase in nominal GDP from early 1932 to 1935 resulted in huge private deleveraging because nominal income outran lagging private.
Fiscal policy is going to undergo a complete reversal as the $850 billion fiscal stimulus package wanes and the scheduled tax increases at the Federal level come into play early next year. It may be much worse if financially strapped state and local governments have to cut expenditures and raise taxes over the same time period – which is highly likely, especially as we get to the states’ budget year end which is mainly to June 30th. By then, if they haven’t got to their mandated balanced budgets, they’ll cut more staff off the payroll as that will temporarily get them to balance (from an accounting perspective). That will exacerbate the double dip, which is coming straight on schedule, as Randy predicted last year in his piece with Eric.