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--- Begin Message ----Caveat Lector- Gary North's REALITY CHECKIssue 309 January 13, 2004 SITTING ON A STRING Something very strange is going on. It has been going on since August. The U.S. money supply is shrinking. I hope you will take a few seconds and click through to the charts published by the Federal Reserve Bank of St. Louis. The St. Louis FED has been diligent for decades in making available charts and tables regarding the money supply, as well as other key statistics. I trust the long-term consistency of this information. If you will see for yourself what is going on, you will be able to understand this report with less confusion, meaning your confusion will stay even with mine. I assure you, what the graphs reveal has confused me. But I think it's better for all concerned if we see the evidence before we start speculating about causes. First, take a look at MZM, "money of zero maturity." This indicator I regard as the most relevant monetary indicator, because it is closest to the characteristic feature of money: instant spendability. Here, the decline is most prominent. http://research.stlouisfed.org/publications/usfd/page6.pdf This is not a minor downward blip. This is a full- scale decline. It has been going on for six months. The free market, through its innumerable transactions, is shrinking the money supply. Second, look at M-2. This is a traditional indicator. I have followed it intermittently for three decades. The monetarist school of economics, once led by Milton Friedman, used to pay more attention to M-2, which includes time deposits (savings accounts), than to M-1 (currency plus checking accounts), although I don't know if this is still true of most monetarists. This statistic tells the same story, but less radically. http://research.stlouisfed.org/publications/usfd/page6.pdf Third, look at the adjusted monetary base. This monetary component is the one that the Federal Reserve System controls. It reveals the FED's holdings of assets, mainly U.S. government debt certificates. The monetary base is what Friedman has called high-powered money. This base supplies the reserves that the commercial banking system uses to create loans, and hence money. Here, things are less clear. Notice that the graph peaked in late October. It had gyrated after late August. As you can see, the general trend was upward, but slowly, until November. Then, it stabilized through December, and has now started down. What is going on? If the monetary base is stable, at least peak to peak, but MZM and M2 are falling, what is causing the disconnect between FED monetary policy and the market's use of monetary reserves? One answer is the rise in the supply of currency, i.e., pieces of paper with dead politicians' pictures on them. There was a steady upward move until late July. Then the rate of increase itself increased. Also note the parallel decline in small time (savings) deposits. http://research.stlouisfed.org/publications/usfd/page14.pdf When currency increases, the ability of the banking system to increase the number of loans decreases. When a depositor goes to his bank and withdraws currency, the bank can no longer use his money to make loans. When he pulls out currency and refuses to deposit it in another bank, the banking system cannot make new loans. It must call in old loans. When the currency supply rises faster than the increase of the monetary base, banks cannot increase the money they lend by the same percentage increase as the monetary base. Since August, the monetary base has stayed almost constant. The currency component of the money supply has increased. So far, this tells us that the non-currency components of the money supply must have fallen. So, I went looking for other statistics that would verify what the logic of money tells us. I did not have to go far. The same chart tells us: the public is pulling currency out of the banking system by cashing in (i.e., cashing out) its savings accounts. While no one is using the terminology, we are witnessing a bank run. This is not a panic-driven bank run, like something out of the Great Depression. This is a steady bank run that is motivated by something other than fear. THRIFT DOESN'T PAY MUCH When the Federal Reserve Board decided in 2001 to fight the recession and then fight the after-effects of 9-11, it pumped money into the economy. Its answer to recession was monetary inflation. This is the FED's usual response. The combination, a rising money supply and falling demand for commercial loans, produced the sharpest decline in the federal funds rate in my lifetime. The federal funds rate is the rate at which commercial banks lend money to each other overnight, in order for lending banks that have temporarily overshot their legal reserve limit to maintain legal reserves for their loans. The fed funds rate has remained in the 1% range for almost two years. As the interest rate on savings accounts has fallen, small, risk-averse savers have been hit hard. Someone with $100,000 in a savings account in 2000 was earning $2,000 to $3,000 a year. For the last two years, he has earned under $1,000 a year, maybe as little as $600. Last May, one survey reported the following: the typical saver was losing money! Bankrate.com's spring 2003 survey of passbook and statement savings interest rates shows that interest rates are continuing to plummet. Once again, rates have reached an all-time low since Bankrate.com began tracking these rates in 1987. The national average interest rate for passbook accounts is 0.60 percent. That's down from 0.80 percent last fall and 0.87 a year ago. Passbook accounts, in which customers track their deposits and withdrawals in a little book, are fairly rare. Traditionally, passbook accounts have paid less than the more modern statement savings account. But in this survey, the results are equally dismal. The national average for statement savings accounts is 0.60 percent, down from 0.82 last fall and 0.92 a year ago. If you put $500 in a savings account and left it there for a year, you'd get $3 interest, since the rate and the yield are the same. If you were in the 27 percent tax bracket, that $3 would be whittled down to $2.19. Subtract 3 percent for inflation and you have about $487 in buying power. That was May. By October, the national average for banks was under 0.4%. http://www.bankrate.com/brm/publ/passbk.asp In July, the rise in currency and the decline in time deposits accelerated. It is understandable why. People who held time deposits were being paid so little for their thrift -- negative, after taxes and price inflation -- that they might as well pull their money out of the bank. A person who has currency can buy and sell without leaving a paper trail. He can pocket any profits. He has his money close at hand. Someone else can send money to relatives abroad. I heard recently that Mexicans sent $14 billion to relatives last year. Most of that money, I suspect, was in currency. I also imagine that more than $14 billion was sent. Immigrants send money home. The paper dollar serves as a second currency in third world nations. The FED decided to stimulate the economy in 2001 by pumping in new money. Lo and behold, this policy is now backfiring. It has produced such low rates of investment return for savers that they are pulling currency out of the banks. This has created an anomaly: a fall in the money supply, or at least a fall in the various money supply statistics. There may be better explanations out there for the anomaly of a falling money supply, however defined, despite a stable monetary base. What amazes me is that there is so little discussion today in the financial press about the existence of this anomaly, let alone its implications for financial markets. --- Advertisement --- The Next Depression Is Closer Than You Think -- Prepare Now! Don't be fooled by stock market rallies. History shows that Wall Street's next stop could be another depression! See the proof for yourself and learn four strategies that could protect your wealth. While the Dow dropped 22% during the severe bear market of 2001-2002, some investors had the chance to enjoy average profits of 26.1%.But if the market begins to collapse in earnest -- and as you'll see, it could happen -- you could enjoy gains of up to 1,000%! Get all the details here... http://www.agora-inc.com/reports/DRI/RealTT/ ----------------------- "PUSHING ON A STRING" This phrase has been used to describe central bank policy in a time of recession. The central bank increases the monetary base, but commercial banks don't respond by lending to the public. They buy government bonds instead. The problem is, this phrase has not generally been applied to an economy that is in a recovery phase. It is always applied to an economy in a recession. The FED today is not pushing on a string. It is sitting on the string. It is not pumping in new money. It is pulling reserves out of the system, though so slowly that this may be a statistical blip. But the money supply is falling, according to standard measures. Yet prices continue to rise, although in the low 2% per annum range (median cpi). http://www.clevelandfed.org/research/data/mcpipr.htm The economy seems to be recovering. The stock market is up. Gold is up. The euro is up. The dollar is down internationally. Yet from the statistics, we learn that the FED is not inflating, the money supply is falling, and prices are rising, but only mildly. Thus, all of the major forecasting systems seem to be stymied. There is no pattern that makes sense, according to the economic models that I am familiar with. I say this as a warning. Be suspicious these days of anyone who has a quick explanation. You now have seen the charts. The charts at present do not seem to conform to any theoretical framework of economic explanation that I see in newsletters or the financial press. Newsletter writers must exude confidence in their systems, but this confidence ought to be related at least loosely to the basics of monetary policy. It is better to point out the anomalies that to conceal them for the sake of preserving an illusion of confidence. Money is not the whole story, but it is a large component of any financial story. What we are seeing is Federal Reserve policy -- monetary stability -- that is being thwarted by individual decision-makers beyond the Beltway and beyond the New York financial district. The FED isn't pushing or pulling on the monetary string, but depositors are making decisions to pull out currency. There may be other factors in the decline of the money supply, but the currency component's direction is the most obvious: upward. This produces a downward move in time deposits. Most time deposits are held by a fairly small percentage of the population -- under 10%. If they are pulling out currency, I wonder why. What else are they doing that is pushing the supply of money downward? I am always open to suggestions. But until I see one that conforms to the existing statistics or adds new ones, I remain skeptical. One thing is clear: the FED is pursuing a stable money policy with the main tool that it has: the monetary base. All discussion of the U.S. economy today should begin here. CONCLUSION What we are seeing is a fall in the dollar internationally that is not based on the FED's pushing on the string by pumping in new money. Right now, FED policy looks neutral. But the fall in the money supply is not neutral. The rise in gold's price is not taking place as an inflation hedge. It is taking place parallel to the decline of the dollar against the euro. There is something more fundamental going on here than traditional inflation hedging, or so it seems to me. There is a move against the dollar that is not based on fear of monetary inflation or price inflation. I am cogitating on this. Who knows? I may come up with an answer and win the Nobel Prize in economics. The question is: Will the Nobel Committee pay me in dollars or euros? I'm hoping for euros. ---------------------------------- Appendix 68 On the disk version of Jay Abraham's case studies -- not available to the public -- #307 is short and sweet. It shows the power of testimonials and referrals. For five years I was the sales manager at a merchant credit card processing firm. . . . We wrote both retail and internet accounts. Prior to using your techniques we were writing a dozen new accounts per month. Our method of lead generation was via telemarketing new business lists and salesman cold calling. Business was slow and steady. Here we have a case study of a business-as-usual operation. It is plugging along. Most businesses are like this. I created our USP [unique selling proposition] based on our honest dealings in a cut throat business. Like so many companies, its decision-makers were not guided by an overall view of the company's unique competitive edge in its market. This is a failing that managers can solve, but rarely do. They rarely even understand the existence of the problem. The company was honest, or so the man says. But the consumer is not going to believe this. After all, isn't the entire industry cut-throat? So, the campaign's designer had to figure out a way to offer proof, or at least a believable perception of proof. All potential clients could call on our existing clients to check us out. Our client list was open to inspection. With nothing to hide potential clients trusted us. He chose to go the testimonial route. Nothing could better illustrate Jay Abraham's approach in posting 300 testimonials on-line. We also started a very aggressive referral system. As sales manager/business development manager I contacted all vendors who worked with new businesses. These included banks, accountants, cash register firms, sign companies, etc. They were in turn paid $100 to $200 for each lead that resulted in a new client. Also new clients were paid the same for other referrals. This referral system involved payment. It was in fact a lead-generation system. But the leads came from third parties that got paid. The third parties converted "unused inventory" -- a list of clients -- into revenue-generating assets. Another avenue was paying our rivals for their turndown accounts. When we moved into internet processing we added web designers, ISP's, etc. With the internet we were able to receive referrals from all over the country. Again, the company paid rivals for "useless" assets -- names of non-buyers -- in the hope of generating income. The company had a better sales approach, based on up-front access to customers. "Our client list was open to inspection." These are only a couple of the "Abraham" methods we employed. Trust me, there were a lot more. As a result our sales went from about 12 per month to over 50 per month. And our profit per sale went way up. Here's the kicker. The system was working. But this led to failure. A year ago our parent company was sold and our division was shut down. "Nothing fails like success." This is one of the oddest economic facts I have encountered in my career, second only to Pareto's 20-80 law. Abraham-like techniques don't get imitated when they work -- and they usually work. If anything, these techniques are deliberately abandoned by successors. Over and over, a genius like Rosser Reeves ("Melts in your mouth, not in your hand") or David Ogilvy comes along, creates huge profits for his clients, builds up a advertising agency, then retires and dies. His discoveries are then ignored by his successors at his own agency. If you have ever seen the movie, "Crazy People," you know what I mean. An advertising executive has a nervous breakdown. He creates one last ad campaign, based on telling the truth. Then he commits himself to a mental hospital. The ads mistakenly get run. They generate huge sales increases for the clients. The head of the ad agency then tries to imitate him. He tells the staff that they must now be rigorously honest in making claims for the clients' products. The entire staff sits there. The result: total confusion. 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