Investment Commentary No. 272 Page 3The figure below makes the situation abundantlyplain. The money supply M3 in the USA, whichis no longer calculated by the Fed (why not?) butis still tracked by intelligent people, continues toplummet, while the Fed’s excess reserves remainat the highest level.
02004006008001,0001,2001,400Jan 08Apr 08Jul 08Oct 08Jan 09Apr 09Jul 09Oct 09Jan 10Apr 10Jul 1011,70012,30012,90013,50014,10014,70015,30015,900
Commercial bank reserves with the Fed(left-hand scale)Money supply M3(right-hand scale)
Source: Federal Reserve, shadowstats.comNote: Figures in USD billion; M3 = Cash + savings + timedeposits
Of course, blame can be laid at the door of thereal economy, which is obviously generating toolittle demand for credit: “You can lead the horseto water, but you can’t make it drink”. The lackof enthusiasm for investment is probably themirror-image of the lack of risk appetite on thebanking side. With interest rates very low nomi-nally, and possibly negative in real terms, suchbehaviour on both sides is extremely strange, if not indeed off-putting. Something must be radi-cally wrong somewhere: otherwise an investmentand credit boom would be in full swing!Low interest rates, record liquidity supplies,“quantitative easing” (which can be equatedwith the direct supply of capital to the system bythe central banks), a farewell to the concept of an “exit strategy” (i.e. to an end to “quantitativeeasing”): according to current economic theorywe should long have been feeling inflationarypressure. Hence the perplexity of the monetaristCassandras: inflation has fallen to an all-timelow on both sides of the Atlantic; there is no signof any constraint on the supply of goods, onaccount of the productivity gains both in theemerging markets and in the domestic econo-mies. It almost looks as if J. K. Galbraith, thatveteran Keynesian, was right after all. He re-cently utterly dismissed any warnings about thenegative impact of the extremely stimulatingmonetary and fiscal policy (
,12.8.2010, p. 60). By way of reminder: TARP,the American government’s stimulation pro-gramme, amounted to USD 700 billion. Further,for fiscal 2009, the ARRA (American Recoveryand Reinvestment Act of 2009) was created withUSD 800 billion. The Fed’s balance sheet wasexpanded from USD 943 billion (2008) to USD2,368 billion (2010) for the purpose of buying updomestic debt. The European and Japanesetotals look little different.However, and here’s another source of perplex-ity, Keynesian economics throws up more ques-tion marks than anything else – never mindabout success stories. For even if it really is thecase that an extremely stimulatory monetary andfiscal policy does no damage with regard to infla-tion, it has sadly also become clear in the mean-while that it doesn’t actually do much goodeither. Unemployment in the USA seems stuckat the high level of 9.5 percent (including thoseworking part-time who would be happy to workfull-time, it’s almost 20 percent), the US realestate market has been at best stabilised, and therallying cry of “Yes, we can!” now generates atbest a weary shrug of the shoulders. Despiterecord low interest rates, average Americans aresaving, while the state piles deficit on deficit.Having been close to zero for many years, thesavings rate for American households is now 6.2percent. The US government’s debt has risen by28.4 percent since the end of 2008. Put differ-ently: one side provides stimulation as neverbefore, but on the other side, this stimulationobviously achieves little or nothing.Perplexity over monetary policy too. By now,the extreme stimulation of the system by practi-cally all the relevant central banks has comeunder criticism not only from academic circles,but also from insiders, so to speak. The annualreport of the Bank for International Settlements(BIS) devotes a whole chapter to the potentialnegative impact of the low-interest-rate policy(BIS 80th Annual Report, Basle, June 2010, p.36ff). It discusses microeconomic misallocationsby companies, as well as global distortions; thefear is expressed that the increasingly desperatesearch for returns will result in dangerous risk-taking by investors, and there’s more in a similarvein. However, not one of the critics has everindicated where the right – or at least an appro-priate – interest rate might lie when there ispractically no inflation, and the fear is rather of deflation. Criticism is cheap when there’s noneed to comment on the alternatives and theirrelative advantages and disadvantages.
A lonely student in a sea of flames
Perplexity in the markets, in all the institutionsand at all levels: this cries out for some effort atexplanation. Pictures are sometimes worth athousand words – if they are the right ones. Let’stry. With the burning steppes and smoulderingtundra, with the Kremlin swathed in acrid