Swimming In Camp W’s Pool: M1 Multiplier Suggests Economic Stagnation In The US

Every other Thursday evening is filled with anticipation at the Kanundrum offices as the Fed releases data on monetary aggregates and reserve balances. Prior to the economic meltdown these numbers toiled away in the back alley of economic obscurity, now they are front page news. Despite their sudden popularity, the fame has not gone to their head and they remain as potent as ever. Let us dispense with the verbal machinations and get right to the numbers.

The M1 multiplier barely climbed from the prior fortnight to a reading of 0.996. While still below the critical 1 level, this is the highest reading since the beginning of July.

Because the M1 multiplier has such a high correlation to future industrial production (96% at the 6 month time frame) we can safely say that the economy has stabilized. However, the stagnation of the M1 multiplier below 1 since November has us concerned that the economy may not grow.

Further evidence of a stagnating economy can be found in both M1 and M2. M1 has declined from its peak and M2 is now below its 4 week moving average.

In theory, as monetary base is increased, the money flows into the economy and produces profits. These profits are then deposited in bank accounts, money markets and other demand deposits.
However, what is occurring is the currency component of M1 has steadily increased, while demand deposits remain below their peak.

The micro breakdown of M1 mirrors the macro implications of the M1 multiplier, i.e., there is plenty of currency in the system but it is not creating profits. Part of the reason for this development is the excess reserves held by banks at the Federal Reserve.

Banks are still finding that holding excess reserves and receiving a minimal interest rate is still the superior investment option. This implies there are few suitable investment alternatives, likely due the deteriorating credit worthiness of the American consumer.

We have dipped our toe in Camp W’s pool and the preceding analysis adds to our conviction that economic stagnation may occur in 2010. If excess reserves begin to decline and the money finds its way into demand deposits in the form of profits, then we may declare Camp W’s pool closed for the season. Until then we shall wade in the shallow end and keep a close eye on the lifeguard.

Disclosures: none

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