The lifeblood of countries' economies is draining away - with grim consequences for us all, writes Ambrose Evans-Pritchard
The money supply data from the US, Britain, and now Europe, has begun to flash warning signals of a potential crunch. Monetarists are increasingly worried that the entire economic system of the North Atlantic could tip into debt deflation over the next two years if the authorities misjudge the risk.
The key measures of US cash, checking accounts, and time deposits - M1 and M2 - have been contracting in real terms for several months. A dramatic slowdown in Britain's broader M4 aggregates is setting off alarm bells here.
Money data - a leading indicator - is telling a very different story from the daily headlines on inflation, now 4.1pc in the US, 3.7pc in Europe, and 3.3pc in Britain.
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Paul Kasriel, chief economist at Northern Trust, says lending by US commercial banks contracted at an annual rate of 9.14pc in the 13 weeks to June 18, the most violent reversal since the data series began in 1973. M2 money fell at a rate of 0.37pc.
"The money supply is crumbling in the US. There was a very sharp lending contraction in the second quarter lending. If the Federal Reserve is forced to raise rates now to defend the dollar, it would be checkmate for the US economy," he said.
Leigh Skene from Lombard Street Research said the lending conditions in the US were now the worst since the Great Depression. "Credit liquidation has begun," he said.
The Fed's awful predicament does indeed have echoes of the early 1930s when the bank felt constrained to tighten into the Slump in order to halt bullion loss under the Gold Standard. Investors - notably foreigners - dictated a perverse policy. Over 4,000 US banks collapsed. This time a de facto "Oil Standard" is boxing in Ben Bernanke. Benign neglect of the dollar has started to backfire. It is pushing up crude, with multiple leverage.
The monetary picture is highly complex. The different measures - M1, M2, M3, M4 - have all given false signals in the past. Each tells a different tale, and monetarists fight like alley cats among themselves.
The Federal Reserve stopped paying much attention to the data a long time ago. It has abolished M3 altogether. The US economic consensus is New-Keynesian (dynamic stochastic general equilibrium model). Delving into the money entrails is derided as little better than soothsaying.
That attitude, retort monetarists, is the root cause of the credit bubble. The money supply almost always gives advance warning of big economic shifts. Those who track the data are now calling on central banks to move with extreme caution. If the rate-setters overreact to an inflation spike caused by oil and food - or confuse today's climate with the early 1970s - they may set off an ugly chain of events.
"The data is pretty worrying," said Paul Ashworth, US economist at Capital Economics. "US lending is shrinking dramatically in real terms, and we know from the Fed's survey that banks want to tighten further. People are clamouring for higher rates but we think deflation is now the biggest threat. The idea that the Fed should tighten with unemployment soaring is preposterous," he said. The jobless rate jumped from 5pc to 5.5pc in May.
advertisementIn Britain, the Shadow Monetary Policy Committee - hosted by the Institute for Economic Affairs, and a refuge for UK monetarists - issued its own alert this week. The focus is on "adjusted M4", which covers loans to "private non-financial corporations" and may offer the best insight into the health of British business.
The growth rate has dropped from 16.1pc a year ago to minus 0.5pc in April. It is the suddenness of the decline that matters most. The data reeks of recession. Professor Patrick Minford from Cardiff Business School called for an immediate rate cut, arguing that the credit crunch is a more powerful and long-lasting force than the oil inflation.
Professor Tim Congdon from the London School of Economics said the UK was lurching from boom to bust. "Real money growth is virtually nil. The British economy is taking a thrashing and it is going to get worse. Corporate money balances have contracted 3pc over the last three months, which is double digits on an annualised basis. This is a serious squeeze for companies," he said.
Mr Congdon warned three years ago that surging M4 would lead to a "dangerous" bubble, which is what occurred. He now fears the MPC will react too late as the process goes into reverse.
Roger Bootle from Capital Economics said Britain could be facing a "real economic crisis and a financial collapse. The MPC does not have the luxury of waiting until all is absolutely crystal clear. By that time the bird will have flown."
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