Money Supply Data and Inflation
Yesterday I looked at several differing and important interpretations about defining and measuring inflation. I promised to take a deeper look at the Fed and the money supply.
You might think that considering money supply data would be easy and non-controversial. You would be wrong!
The Case of Michael Pento
Michael Pento, most recently affiliated with Euro Pacific, is well known as an aggressive advocate in both print and broadcast media. That is probably an understatement given his controversial nature and style of engagement. Most people would view him as an aggressive advocate for the viewpoint that inflation is spiraling and the Fed is responsible.
Here at "A Dash" we'll just stick to the data and Pento's presentation. While he says the same things in many places, let us focus on his article in Advisor Perspectives on February 4th, 2011.
To set the stage, he compares the US Dollar to Enron shares in 2001. Readers should check out the article to see how persuasive this might be. As I said, we'll stick to the actual data.
The Monetary Base
Here is Pento's chart for the Fed monetary base.
Pento's conclusion: "No doubt here. The supply of high-powered money has exploded."
He ignores two facts. Most of the explosion came at the depth of the recession. Nothing much has happened in a more than a year.
There is really no fresh news here, despite his enthusiasm for making a story out of nothing.
Pento next looks at the M2 measure of money supply.
Pento's note: Since the recession began in December, 2007, the M2 money supply has increased by over 18%.
Obviously the intent is that we should all be alarmed by this. The chart seems to support his conlcusion.
An Alternative View of the Data
There are two problems with the Pento presentation — the chart and the interpretation.
The chart takes a very long time period without using a log scale. This is often a problem. The 80's era change in the base from two trillion to three trillion is 50%. From eight trillion to nine trillion in the last few years is only 12.5%. Objective researchers routinely use log scales to help in this interpretation. The St. Louis Fed provides the same chart Pento uses in a log form — you need only to check a box in choosing your preferred chart. Here is that view:
Instead of the alarming spike, this view shows a rather normal rate of growth for many years, although perhaps a little too slow in the last year.
The correct chart also shows the error in Pento's statement about 17% growth since the end of the recession. The normal M2 growth rate is in line with the nominal growth in GDP — about 6% per year. The scary phrase he throws out is actually a lower number than we would expect for a period exceeding three years. You would never have known this from his data display.
The Missing Measure
It is always interesting to check out the past work of advocates like Pento. Has he changed his position with changing times? Has he consistently used the same measures and indicators?
A Google search on his work in the 2007-08 era (different firm, same story) showed that he usually wrote about broader monetary measures including MZM (money of zero maturity) and M3 (dropped by the Fed as adding little predictive value, and thus becoming an instant favorite of the conspiracy crowd).
Since Pento was such a fan of these measures a few years ago, usually pointing out that the rate of growth was exploding, I was curious about why he omitted his favorites from the current article. Here is the reason:
Well that explains it! MZM has been unchanged for two years, so it does not support Pento's current argument.
There are many different reasons for the negative spin on the Fed and inflation. Some of these are strictly political. Other people object to the Fed as an institution. Some analysts merely disagree with Fed policy choices. Most people engaged in the debate about monetary policy are focused on data.
Consumers of data must be aware of the motivations and biases. This article does not do any sophisticated analysis. It is merely a second look, with a slightly different perspective. I'll bet that 95% of the Pento readers and viewers did not take this small second look, and were therefore seriously misled.
Reader Note: Here is a great resource for anyone wanting to learn more about how to measure the money supply — http://www.ny.frb.org/aboutthefed/fedpoint/fed49.html
The Bonddad Blog, one of our featured sources, also has very objective weekly coverage of money supply data.