FLASH UPDATE - August 21, 2008

JOHN WILLIAMS’ SHADOW GOVERNMENT STATISTICS

FLASH UPDATE

August 21, 2008

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July M3 Expanded Month-to-Month, Year-to-Year

Inflationary Recession Continues to Intensify

Broad Outlook Unchanged

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Monthly July M3 Gained $81 billion. In the last several days, I have received a large number of subscriber requests for comment on monthly M3 growth, given a popular-media story of a private estimate out in the U.K. of a $50 billion monthly contraction in July U.S. M3 money supply. Based on my regular estimation of ongoing M3, no such contraction took place in the series as traditionally defined by the Federal Reserve (methodology discussed in the August 2006 SGS Newsletter); to the contrary, monthly M3 increased by roughly $81 billion.

As reported in last week’s newsletter (August 13th, page 31), the Shadow Government Statistics Ongoing M3 estimate for July 2008 increased by roughly $71 billion from June, a number that subsequently has revised to about $81 billion, based on the latest week’s Fed reporting. That estimate is for the month-to-month change in the seasonally-adjusted, monthly-average M3. For the month, the largest M3 component increase was in M2, reported up by $38.9 billion per the Fed. The other M3 component that still is published fully by the Fed — institutional money funds — was shy of flat, with an $800 million monthly contraction. Large time deposits, repos and Eurodollars — all modeled to a certain extent with a backing in other Fed reporting — increased for the month.

While interesting, month-to-month money supply changes can be misleading, given the vagaries of Fed reporting. Year-to-year change, as discussed in the August 3rd Money Supply Special Report, provides more-reliable, long-term indications of monetary trends.

On a year-to-year basis, annual M3 growth slowed to around 15.4% in July, from 15.8% in June and was down from the all-time high annual growth rate of 17.4% seen in April. Nonetheless, the current M3 annual growth remains highly inflationary, rivaled outside the current period only by the events preceding Richard Nixon’s closing the gold window and imposing wage and price controls in August 1971. The current pattern of slowing annual growth appears to be an artifact of the still-deepening banking solvency crisis, which likely will see still further Fed accommodation and liquidity expansion in the near future.

Inflation and Deflation Good for Gold. The purported "collapsing M3," has triggered excitement in the deflationist camp, which is touting a deflation in financial assets and a credit-collapse-induced implosion of the money supply. It would be helpful if deflationist commentaries differentiated between deflation and inflation in terms of financial assets, versus in terms of prices paid by consumers for goods and services. Deflation in financial assets does not require collapsing money growth and has been underway for some time. Indeed, it likely will get much worse (particularly for equities). 

Inflation in goods and services, however, has been picking up and accelerating for some time and also should get much worse. The two deflation/inflation concerns are not inconsistent, and investor nervousness about instabilities in the first case, and the need for protection from the second, feed into both the safe-haven and wealth-preservation demand for gold.

If You Offer Them Money, They Will Borrow. Bank loans are not part of the money supply, although the proceeds from same are in the money supply. Accordingly, loan losses, defaults and such do not contract the money supply, since the cash already has been disbursed and otherwise continues to exist within the system. Slowing loan growth, however, can impact new money supply growth to the extent that the creation of new loans is impaired. Yet, that is what the Fed is fighting in maintaining systemic solvency, and the Fed has no choice but to do everything it has to in order to prevent a systemic collapse, irrespective of the resulting cost in inflation. 

Mr. Bernanke has argued that he always can create money growth and inflation by running the currency printing presses or the electronic equivalent of same. Some argue, though, that loan demand will dry up and that the Fed will not be able to expand credit. Loan demand is as strong, if not greater in recessions than it is in booms; it is just not as healthy in recessions, when banks tend to cut back lending. If the Fed, however, makes available whatever cash is needed for lending, there always will be someone willing to borrow, with the proceeds helping to support money growth.

The inflation/deflation and money supply arguments have been ongoing in the markets for over a year, and I have published two reports intended to address the various issues and related background: Hyperinflation Special Report (April 8, 2008), Money Supply Special Report (August 13, 2008). Ongoing issues also have been addressed in the August 13, 2008 SGS Newsletter. For subscribers with questions in these areas or otherwise, please contact me at johnwilliams@shadowstats.com or through the Contact Us tab on the home page www.shadowstats.com. The referenced Special Reports and newsletters are available on the Archives tab on the home page.

Data Keep Signaling Intensifying Inflationary Recession. I am on the road this week and will publish a further Flash Update over the coming weekend, with greater detail on recent economic reporting and the latest money supply data from the Federal Reserve.

Industrial Production. In terms of general economic activity, seasonally-adjusted July industrial production reportedly rose by 0.2% (0.1% net of revisions), versus a revised 0.4% (previously 0.5%) gain in June.  Symptomatic of a recession, however, year-to-year change turned negative in July, down by 0.1%, after a 0.2% gain in June.

Housing Starts.  The housing recession continues, but the housing starts data remained heavily distorted and misleading due to building code changes in New York a month or two back. The 11.0% seasonally-adjusted monthly July housing starts contraction was overstated, as was the revised June gain of 10.4%. Year-to-year declines of 29.6% and 25.7%, respectively for July and June were understated. An attempt at adjusting these numbers to correct for the distortions will be included in the next newsletter.

Producer Price Index. On the inflation front, continuing a string of upside surprises against consensus forecasts of the popularly followed inflation series, the seasonally-adjusted July PPI rose by 1.2% for the month, following a 1.8% increase in June. July year to-year inflation rose to a 27-year high of 9.8% from 9.2% the month before.

General Outlook Unchanged.Large price swings with high volatility have continued for gold, as well as for the U.S. dollar and domestic equities. It remains unlikely that we have seen the near-term high in oil prices, and neither has gold topped nor the dollar bottomed. All factors considered, the broad outlook remains the same: further intensification of the inflationary recession and a deepening systemic and banking solvency crisis.  Near-term market recognition of these issues and growing global political tensions intensify the risks for unstable market conditions, albeit erratically.

Over the short- to near-term, negative major market displacements likely will follow or be accompanied by intense, broad selling of the U.S. dollar.  An eventual, increasing flight-to-safety outside of the U.S. dollar also should include flight-to-safety into gold.  Despite recent relative softness in oil prices, current levels remain highly inflationary. The gold and currency markets also remain subject to extreme near-term volatility, jawboning and both covert and overt central bank intervention.  Over the longer term, U.S. equities, bonds and the greenback should suffer terribly, while gold and silver prices should boom.