Friday, 17 October 2014

The Short Version of the "Austrian" True Money Supply (TMS), as of 6 October 2014

The short version of the Austrian True Money Supply for the U.S., the measure of the money supply applied in this weekly report, increased 1.02% on last week for the week ending 6 October 2014. At $10.3571 trillion, a new all-time high, the money supply is now up 4.79% year to date.

The 1-year growth rate in the money supply increased to 7.36% for the week, up from 7.06% last week. The growth rate remains lower than the long term 8.30% average and also remains below the 52 week moving average of 7.85%.

In general, the conclusion remains pretty much the same as it's been during the last 14 months: money supply growth is slowing down.


With the Fed having reduced pressure on the monetary pedal during this year, it appears this combined with the slowing money supply growth rate have started spooking the U.S. stock market as the S&P 500 index is down 5.82% this month (the market might not actually be aware that the money supply directly affects stock market prices, it tends to focus on interest rates mostly in my experience). U.S. banks have expanded credit significantly for most of this year, but so far this has not been enough to push the money supply growth rate upwards (represented by the M2 money supply in the chart below).

This stock market drop has already triggered talk and speculation of whether the Fed should and will end tapering and still offer at least some QE on a regular basis going forward. It's important to remember that the U.S. economy is in a right mess with a debt to GDP ratio of around 100% (not including some huge off-balance sheet liabilities) and that budget deficits remain large ($483 bn in the fiscal year ending September 2014). In this sense, the federal government is addicted to the Fed monetizing at least part of its debt.

I see few other "saviours" for the U.S. stock market, bond prices and other asset prices than the Fed again stepping on the pedal. Short term this will help keeping asset prices at elevated, but artificial, levels. Over the medium to longer term however, it can only lead to the creation of more imbalances as pricing mechanisms are put out of action. Or will the Fed be bold, and prudent, and implement full-reserve banking? I don't know, but what I do know is that it is important to focus more on what the Fed actually does rather than speculating at what it might do. As the Fed has actually been tapering all year and as the money supply growth rate has declined combined with bubble level stock market valuations and some other very bearish signs, I've been short the U.S. stock market (and long the U.S. dollar) since the end of June this year.

Visit the "Austrian" True Money Supply archive here. 


I'll end this week's commentary on the Austrian true money supply with my conclusions about the U.S. stock market at the beginning of this year (click here to access the full report):

2013 was a remarkable year for U.S. equities by any standard with the S&P 500 index increasing almost 30% to record the best year for 18 years (1995). This increase was however not driven by an increase in earnings (which increased "only" 6.37% on a 10-year average basis during the year). Nor was it driven by a reduction in the 10-year treasury yield (which increased 69.54%). Rather, the price increase of the S&P 500 index was driven largely by an expansion of the P/E multiple which increased by more than 20% during the year. In addition, the S&P 500 has significantly outpaced any improvement in the real economy. For example, the S&P 500 to GDP ratio is rapidly approaching record territory:
  • The S&P 500 to 10-year average GDP ratio is now approaching the previous high from Q1 2007. 
  • The S&P 500 to 4-quarter average GDP has now surpassed the previous record from Q1 2007 though it is still lagging the all-time record high set in Q2/Q3 2000.

What then caused this expansion in the P/E multiple during the year? In my humble opinion the Fed has managed, again, to create another stock market bubble in the U.S. through flooding the market with freshly minted fiat money (by way of monetizing Federal debt). In 2013 alone, the Fed expanded its balance sheet by more than US$ 1 trillion (yes, trillion!), an increase of more than 38%. Going a bit further back to 2009, the Fed has since expanded its balance sheet by almost US$ 1.8 trillion, or more than 80%!

While the 1994 to 2000 (+185%) and 2003 to 2007 (+64%) S&P 500 stock market rallies were driven by aggressive bank credit growth (with the full support of the Fed of course, read: the taxpayer) the 2009 to 2013 (+110%) rally was driven by the Fed alone (as it is "independent", it does not have to support public spending through monetizing the Federal debt, right?). I say this because Bank Credit outstanding only increased a grand total of only about 8.5% from the end of 2008 to the end of 2013 and by only about 0.4% in 2013. This bank credit growth is very low compared to the longer term average. Since the end of 2008 however,M2 money supply outstanding increased by more than US$ 2.8 trillion, or 34% plus change. The majority of the increase in money supply starting in 2009 was hence generated by public spending monetized by the Fed rather than banks creating credit (and hence money). 

There can be no doubt that a big chunk of this new fiat money orchestrated by the Fed has eventually found its way into the U.S. stock market as reflected in an earnings yield for the S&P 500 index which is now almost 34% lower than the average since 1978. Regular readers of this blog will be familiar with this reasoning. Here's however a quick recap on the subject by professor Jesús Huerta de Soto (Money, Bank Credit, and Economic Cycles, 3rd ed, p. 461-462),
In an economy which shows healthy, sustained growth, voluntary savings flow into the productive structure by two routes: either through the self-financing of companies, or through the stock market. Nevertheless the arrival of savings via the stock market is slow and gradual and does not involve stock market booms or euphoria. 
Only when the banking sector initiates a policy of credit expansion unbacked by a prior increase in voluntary saving do stock market indexes show dramatic and sustained overall growth. In fact newly-created money in the form of bank loans reaches the stock market at once, starting a purely speculative upward trend in market prices which generally affects most securities to some extent. Prices may continue to mount as long as credit expansion is maintained at an accelerated rate. Credit expansion not only causes a sharp, artificial relative drop in interest rates, along with the upward movement in market prices which inevitably follows. It also allows securities with continuously rising prices to be used as collateral for new loan requests in a vicious circle which feeds on continual, speculative stock market booms, and which does not come to an end as long as credit expansion lasts.
When reading the above, please note that money expansion generated through the Fed monetizing government debt ultimately has an indistinguishable effect on the stock market (and other asset prices) compared to money generated through increases in bank credit.
The S&P 500 index is not the only U.S. stock market index to post a huge gain for 2013; all but one of the U.S. stock market indices I follow on a regular basis surged during the year and have climbed way above the record highs from before the collapse of Lehman Brothers in September 2008:

On average, the indices in the table above increased by 32.2% in 2013 with a median increase of 34.1%  (as of week ending 27 December), with the Wilshire US Micro-Cap Total Market Index surging a whopping 50.2%. All indices, except for the Wilshire US REIT index, are also significantly higher than their peaks prior to September 2008. Some of these all-time highs set by major stock market indices in the U.S. has led me to publish a series of "bubble charts" in recent days (e.g. here and here).
As stated above, Fed balance sheet expansion was, in my opinion, the major driver of U.S. stock market euphoria and returns in 2013. For 2014, the Fed balance sheet will increase by about 22% based on the Fed buying US$ 75 billion a month in longer term treasuries and agency mortgage-backed securities. Though a significant increase, it is nonetheless substantially lower than the 38% increase in 2013.

Therefore, unless money supply expansion generated by U.S. commercial banks picks up in 2014, the decrease in the growth rate of the Fed balance sheet combined with a significant slowdown in the growth rate of government debt (at 4.2% in Q3 2013, compared to 8.6% during the same period in 2012) will prove strong headwinds for money supply growth in 2014. And a significant reduction in money supply growth will be decisively bearish for equities. More importantly, such a slow down has been in the making for most of 2013 (e.g. see here) and if it continues the next stock market crash and so-called "financial crisis" is not too far ahead. 

In conclusion, the combination of a high stock market valuation of the S&P 500 index, record increases in all but one of the indices in the table above, the significant increase in the 10-year treasury yield since May, the low personal savings ratefinancial risk indicators hitting record lows, weak U.S. commercial banks equity to total asset ratios and a slowing down of the money supply growth rate which is already underway, means that I am now very bearish for U.S. stocks in 2014. Not to mention the debt crisis in both the U.S. and the EU (yes, they have not magically disappeared). There are simply too many indicators signalling the U.S. stock market is peaking or at least indicating a substantial probability that equities will not perform well over the next few years. In short, there is simply too much risk and too many things that could go wrong to justify being a longer term buy and hold investor in U.S. equities at this stage.

A significantly improving money supply growth rate could prove me wrong, but this would only serve to make the inevitable fall that much heavier. 


Related (my favourite video about the banking crisis and the ongoing debt crisis):

Fraud. Why The Great Recession