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Misleading Inflation Data


Prices are headed lower, not higher.

With increasing frequency, charts of MZM and M3 are being touted as evidence of an expansion of money supply that is running out of control. Some even claim the charts show hyperinflation.

Please consider the following charts.

MZM Annualized Growth

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M3 Annualized Growth as of 2008-04-17

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Chart thanks to Bart at NowAndFutures.

Claims that those charts show hyperinflation, or even a rampant increase in money supply is typical of the half-baked analysis spawning all over the web. For starters MZM and M3 contain credit transactions and money equivalents, not money.

And the distinction between money and credit is a crucial issue. A rapid increase in money supply leads to a Weimar Republic or Zimbabwe hyperinflationary scenario, while a rapid increase in credit eventually leads to a Great Depression or Tulip Bubble collapse endgame.

With huge thanks to Austrian economist Frank Shostak please read Money Supply and Recessions for an analysis of why money and credit are not the same thing. You may also want to read that link if you are unfamiliar with a monetary indicator called M Prime, or M'.

I last wrote about M' in Money Supply Trends Are Deflationary.

Here is an updated chart of M Prime, with thanks again to Now And Futures.

Click here to enlarge image

Not much has changed since I last wrote about M' other than screams are getting progressively louder from people who do not understand what M3 and MZM are saying.

Compare the above M' chart to the chart of M3. M' has a clear proven track record corresponding to economic activity and recessions. M3 does not.

True Money Supply

has a new chart of what they call True Money Supply, or TMS.

The True Money Supply was formulated by Murray Rothbard and represents the amount of money in the economy that is available for immediate use in exchange. It has been referred to in the past as the Austrian Money Supply, the Rothbard Money Supply and the True Money Supply.

The benefits of TMS over conventional measures calculated by the Federal Reserve are that it counts only immediately available money for exchange and does not double count. MMMF shares are excluded from TMS precisely because they represent equity shares in a portfolio of highly liquid, short-term investments which must be sold in exchange for money before such shares can be redeemed. For a detailed description and explanation of the TMS aggregate, see Salerno (1987) and Shostak (2000).

True Money Supply

Click here to enlarge image

Click here to create a current chart of TMS.

M Prime is based on that definition. Any differences are unintentional.

TMS, M', Money AMS, are all the same animal. The need for M Prime goes away with the above chart as soon as the Mises site gets the Percent Change From A Year Ago dropdown box unit working.

TMS or M' as stated above has a great correlation to economic activity. Why shouldn't it? After all they represent the amount of money in the economy that is available for immediate use in exchange.

However, TMS does not represent printing, nor was it supposed to. For "printing" we need to look at base money supply.

Base Money Supply

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The above chart courtesy of the St. Louis Fed shows that monetary printing is positive, but barely so. Look at the recession indicators. The chart also shows another phenomenon: Like M3, Base Money Supply is of little use in and of itself of predicting economic activity. Nonetheless it does serve a purpose. That purpose is to disprove all the hyperinflation rants that are so prominent these days.

M3, MZM Do Not Support Hyperinflation Theory

People need to listen to Bart, the person who put M3 back together, rather than spouting hyperinflation from every corner of the blogosphere based on his M3 chart.

Bart writes:

11/30/2007 - Note that much of the large growth in M3 lately has been in flows into CDs and Money Market Funds, a normal occurrence during financial turmoil. See our financial crisis page for more detail, and a picture of the current level of a U.S. financial crisis.

3/31/2008 - Also see our best effort construction of all Fed activities. As of today, it shows that the Fed has been backing off on total money creation activities on a relative basis since about December 2007.

4/4/2008 - As of 3/19/2008, we have added the results of the new Fed TAF, TSLF and PDCF "tools" to our M3 reconstruction, since they are quite similar to temporary repos (repurchase agreements). Temp repos are part of the original definition of M3.

Proof that M3 growth has been on account of money market funds can be found by taking a look at charts of Institutional Money Funds.

Institutional Money Funds Since 1980

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Institutional Money Funds Annualized Growth

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MZM and M3 show recession and bear market phenomena, i.e., liquidity preference or flight to safety, not "printing money". The Fed's Swap-O-Rama is not printing either, although arguably it could lead to it.

The effects of the earlier M&A bubble, large firms tapping lines of credit, hedge funds' sweeps, and so on are reflected in the charts. This mad dash for cash is deflationary, yet ironically it is being used by some as evidence of hyperinflation.
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