Money Supply’s Surge Triggers Debate Over Cause, Effect

A long, long time ago--as in before the 1990s bull market--economists and many investors had an obsession with the nation’s money supply statistics. Wall Street waited with great trepidation for the data each week, then reacted maniacally.

Well, look who’s back.

The money supply has again become a hot issue among many economists, thanks to what some contend has been explosive growth recently in key measures of that economic barometer.

The money supply simply measures the sum of liquid assets sloshing around in the U.S. financial system--in checking accounts, money market funds, etc.

Money may not make the world go ‘round (contrary to the song), but it does make the economy go. The more liquid assets in the system, the more money is available for spending on real things.

And that’s what is disturbing some economists: Two of the most-watched measures of money supply have soared since July.

So-called M2, which includes the totals of currency in circulation, bank checking accounts, savings accounts, bank savings certificates of less than $100,000, money market funds and a few other important money measures, surged at a 7.5% annualized rate between Aug. 4 and Nov. 3, to nearly $4 trillion, seasonally adjusted.

That was far above M2’s annualized rate of growth of 3.6% between Feb. 3 and Aug. 4, and well above the real growth rate of the economy.

M3, an even broader money supply measure, grew in the third quarter at the fastest inflation-adjusted rate since 1984, says Paul Kasriel, economist at Northern Trust Co. in Chicago.

To die-hard monetarists--people who believe that the money supply is the only determinant of economic growth, and inflation, long-term--rapid growth of M2 and M3 implies a much stronger economy ahead and, potentially, higher inflation.

Which is why the Fed is being skewered by some analysts for allowing money growth to expand so significantly at a time when the U.S. economy already is in fine shape and hardly appears to need further stimulation.

“We have no intelligent explanation for why the Fed is pumping money like a depression was underway,” opined the Overpriced Stock Service newsletter in its November issue.

While the Fed may be worried about the financial trauma in Asia, analysts note that the money supply’s liftoff began in early August, well before the Asian mess began to grab headlines and stoke real concern in October.

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What gives? Some economists think the Fed is getting a bad rap. In fact, the Fed hasn’t loosened credit at all, at least judging by its benchmark short-term interest rates.

The money supply may be expanding briskly merely for technical reasons that won’t be long-lasting, some experts argue.

For example, the sum of cash in money market mutual funds and in bank savings accounts has risen markedly since early August. Why? Economists figure that many investors have been taking money out of stocks amid Wall Street’s gyrations and stashing it, temporarily, in safer places.

Bank savings deposits have grown by $34 billion since early August, to $1.36 trillion. Those deposits had shown little net growth since April.

“I think this is purely related to the stock market,” said James Glassman, economist at Chase Securities in New York.

If that bank money is earmarked to go back into stocks at some point, it may never get into the “real economy”--that is, it won’t be used to buy goods or services, which means it won’t add to inflation pressures in an already tight economy.

Others aren’t so sure that the increased liquidity won’t find its way into the economy. With bond yields at 21-month lows, dragging mortgage rates down as well, it’s conceivable that more people are piling up funds in short-term accounts to use for home purchases--a major economic stimulant.

Some experts believe that the money supply is ballooning because banks are trying to lure more cash in the form of CDs and other accounts to fund the growing hunger of corporate borrowers.

And indeed, banks’ sum of commercial and industrial loans outstanding jumped from $815 billion in late July to $844 billion by Oct. 15. The total had grown by $7 billion from May through July.

“Businesses have been borrowing a lot,” says Kasriel, who figures corporate America is financing its ongoing takeover boom, higher inventories and perhaps, stock buybacks.

Glassman, however, still thinks this is “much ado about nothing.” Relative to U.S. Treasury yields, most companies would have to pay more to borrow via bonds than a few months ago, because the market is demanding more of a “risk premium” in the wake of the Asian financial mess.

Thus, Glassman says, more companies are just opting to borrow from banks in the short run, rather than issue bonds or short-term IOUs.

Still, Kasriel argues, “When banks lend money, somebody’s going to buy something,” spurring the real economy.

If they can’t agree on why money growth is soaring, most economists at least agree on this: That growth would have been another good reason for inflation-wary Greenspan and the Fed to tighten credit at their meeting last week--if only Asia’s market debacle hadn’t gotten in the way.