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Is M2 The Money Behind Inflation? If Not, What Is (Or Isn’t)?

Milton Friedman was touring India, and while there he shocked his audience by stating, “Inflation is always and everywhere a monetary phenomenon.”…



This article was originally published by Alhambra Investment Market Research

Milton Friedman was touring India, and while there he shocked his audience by stating, “Inflation is always and everywhere a monetary phenomenon.” This was 1963, and the audacity of that statement is today understated. Back then, Keynes didn’t just rule there was hardly any opposition to such accepted orthodox dogma.

Arguing from firmly empirical rather than theoretical grounds, Friedman’s effort was only in getting people to acknowledge the very straightforward implications of these mountains of evidence. For as much of a challenge initially, objections would diminish over the next few years and decade. The Great Inflation became impossible to just ignore from a purely Keynesian perspective.

With excess money, there will be inflation. Without the money, there won’t be. Find the money, find the inflation. What could be easier?

You may have heard recently, most of this year, in fact, that inflation is running rampant.

It isn’t. How do we know? Lack of money, same as before.

Wait, hold up. Some say you need only take a look at M2, that it points out all the money for the CPI’s. After all, this is – by its definition – a monetary aggregate. It might have taken a little longer to flow into the real economy, but there’s absolutely no arguing the excessiveness of M2 since March 2020 and an apparent if delayed correlation to consumer prices.

Therefore, if we’ve found the money in M2 it won’t be just recent CPI’s but many more to come like it.

No. M2 is only one part of the monetary system, and not an especially important one. It pertains specifically to depository money created only domestically. No wholesale; no offshore.

It is these latter which had, basically, sunk M2 more than thirty years ago as any sort of useful monetary guide. And its demise was basically an exact repeat of what happened to M1 just a few decades before, making it pretty easy, too, to chart real world monetary progression.

In the early seventies, the Great Inflation raging, some economists and central bankers began to realize how M1 was misleading (so much so, it justified for President Nixon to undertake doomed and really absurd wage/price control measures). In terms of basic math, M1 growth kept coming up well short of forecast demand and M1 velocity seemed to rise.

The reason was the real economy years before had turned more and more to different forms of money that weren’t included. It doesn’t matter how the government or the Federal Reserve classifies monetary definitions, central bankers don’t decide on what’s money or not, it only matters how real economy participants use whatever might be available; wholesale formats including some like repurchase agreements.

Just as some at the St. Louis Fed realized in 1979:

To the extent that RPs [repurchase agreements, or repo] are used to accumulate liquid balances over a period for some anticipated future outlay, they may be more appropriately classified as time deposits rather than demand deposits; such balances would be more appropriately included in the M2 concept of money which includes liquid savings, rather than the M1 concept which does not. Even if it is concluded that RPs are not money (M1), however, the rapid growth of this highly-liquid asset has almost certainly affected the velocity of demand deposits by permitting corporations to obtain desired liquidity with fewer demand deposits than otherwise.

Outdated M1 was eventually, reluctantly downgraded outwardly in favor of a broader M2 which only made it seem like central bankers were trying to keep pace with this tricky monetary progression(s).

In reality, the Fed by 1982 had already come to realize even this was largely a waste of their time since even a broader definition wouldn’t be able to manage. Officials might refer to M2 occasionally, never really placing much emphasis on it while they turned exclusively to “expectations” management.

In the late eighties and early nineties, M2 did eventually run aground of the same issues which had grounded M1. Velocity spiraled upward, indicating something again very wrong with the data. Alan Greenspan in 1993 went so far as to explicitly state in front of Congress the Fed had given up on the statistic in favor of exclusively interest rate targeting (they would anchor to economic not money aggregates) he told politicians and the public would be a reliable workaround in lieu of any concrete monetary measure or even useful set of definitions.

As I wrote in a bit more detail last Friday:

Interesting, then, how the same problem over a decade later would befall M2! Velocity suddenly rose around 1990 for reasons no one could adequately explain (assuming anyone at the FOMC really wanted to). Policymakers had come to believe they wouldn’t need to – that’s the whole thing behind “discretionary” policy. It was taking the central bank into a realm that wasn’t central banking, at least nothing like what was described traditionally.

The timing of all this wasn’t coincidence, just like it hadn’t been for M1’s demise in the early seventies. But if simpler “wholesale” developments like repo had been “taking” demand away from the M1 components that long ago, it would be far more complex things (“networks of interbank relations”) and more of them offshore which would be responsible for eliminating M2’s practicality.

Evidence for them was all over the place. To begin with, the downfall of the depository:

Commercial banking was an entirely different subset of “banking”, those firms more like securities dealers (and really hedge funds) than anything of an actual bank. With the S&L Crisis reaching its climax late in ’88 – right around when M2 velocity started to go screwy – the “commercial bank” relying more and mostly on wholesale forms of money, including repo, became truly ascendant.

Not just ascending, but essentially replacing depositories and depository money at the margins of growth and for newfound uses all over the world.

This came in other forms, too, like the parallel rise in wholesale off-balance sheet entities, those like ABS Issuers (shown above) which by themselves massively outgrew the traditional bank during the nineties.

Even the Z1 banking data (above) is itself incomplete, not capturing what was even more opaque, ill-defined, as well as even more quickly escalating. I wrote last year:

These enormous figures had ballooned up from Morgan Guaranty’s guess of around $50 billion gross back when nearer the eurodollar’s start in the early sixties. Missing money, indeed. Less than a decade later, each of the M’s had been surpassed by what nobody talked about…The gross eurodollar size was in 1988 a third greater than the entire M2 stock would be three years afterward, while its net size was closing in on two-thirds of it. And this was three decades ago.

Here’s the thing; at least Morgan Guaranty unlike the Fed had made an honest effort for years (going back to the sixties) to try and size up the offshore wholesale component to real world money. Right around the time M2 was coming undone, Morgan Guaranty stopped compiling their eurodollar estimates because the company realized – thirty-three years ago – there was too much going on, so much more yet to be uncovered and thus impossible to document.

All of it outside M2 (and M3).

The entire global economy was using money that might not have looked like money to simple Economics, and far, far more of it outside of M2 than inside. The so-called broad aggregates therefore could only give you a partial monetary picture which was, as I wrote already, a not very important or useful one. They weren’t even close to broad enough. 

These wholesale and shadow money forms, onshore as well as offshore, were the products of commercial not central banks. 

Perhaps the best illustration of just how misleading M2 had become was in how during the worst monetary crisis since the Great Depression, M2 rose substantially. Yep, in the months leading up to Bear Stearns – a period no one should equate with overflowing money – and then even more in the weeks and months which followed Lehman/AIG/et al.

The worst parts of the worst monetary panic (that was global in reach, for another clue) since the early thirties and M2 was suggesting an overflow of money, maybe even an inflationary one – right as the entire monetary and therefore real world was experiencing outright deflation for the first time since around the middle fifties.

Quite simply and obviously, M2 is beyond antiquated to the point of being unhelpful

What are we to do in lieu of any legitimate monetary aggregate? The Fed just gave up on M3 back in early 2006, and despite that whole huge monetary crisis (“somehow” blamed on subprime mortgages), no one’s bothered to take up the task in all the years (and QE failures) since.

Even so, there is a time-tested and reliable monetary indicator widely available nonetheless. You need only listen instead to the commercial banks, those in the shadows producing, or not, these very money forms.

The signals they send out into the public, in real time, are surprisingly easy and straightforward to interpret, requiring no math of any kind nor convoluted theories to explain what should be easy numbers.

Yields. Not only are they produced by these same commercial banks, they are derived from the monetary utility priced into what is essential repo collateral.

Friedman’s “law” remains. While easy to say inflation is a monetary phenomenon, figuring out what that phenomenon is in the modern wholesale, offshore practice takes a step (or several) beyond current Economics (and way beyond M2). Empirically still the same, analytically very different, and, when it comes to inflation post-2007, the money’s still missing.

Best of all, you don’t have to take my word for it. Though I call it shadow money, that’s only because central bankers, Economists, and mainstream monetary aggregates are in the dark. There’s no monetary law requiring you to sit in confusion with them. 


Are These The Charts That Spooked Jerome Powell?

#CKStrong Fed Chair, Jerome Powell finally admitted today there is too much stimulus demand (in the macro context) in the global economy and the Fed will…


Fed Chair, Jerome Powell finally admitted today there is too much stimulus demand (in the macro context) in the global economy and the Fed will have to accelerate its tapering.

The following charts clearly illustrate the U.S. economy is overheating and a major contributing factor to inflation. Nominal retail sales and core capital good shipments remain 15 percent above and years ahead of their pre-COVID trend. Think of the trend line as the supply curve.

In hindsight, it is easy to say the global policymakers overshot with their stimulus, but it is certainly better than the alternative and a deep recession/depression.  Just as you and I, policymakers make decisions with imperfect information.  Counterfactuals don’t go a long way in the political arena.

We think it is about time the FOMC finally starts to focus on the problems caused by the “monetary supply chain,” rather than blaming the economic imbalances on “supply chain issues,” and it appears they have. If demand were not so strong, the supply chain issues would have worked themselves long ago, and the Port of Los Angeles and Long Beach wouldn’t look the 405 freeway during rush hour.   

As reflected in the charts below, the supply chain broke early during the pandemic as upstream suppliers were “bullwhipped” by the massive volatility in point-of-sale or end demand.

We believe the next inflection point, where the Fed keeps tapering and then tightening until something breaks, which leads to reversal and a new monetary regimes, is a long way off.

Stay tuned.

Author: macromon

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Financial Markets and Omicron and Powell

Five year inflation breakeven (unadjusted) down, 10yr-3mo term spread down, VIX and EPU up, and S&P 500 down. Figure 1: Five year inflation breakeven…

Five year inflation breakeven (unadjusted) down, 10yr-3mo term spread down, VIX and EPU up, and S&P 500 down.

Figure 1: Five year inflation breakeven (blue), ten year – three month Treasury spread (red), both %. Source: Treasury via FRED, and author’s calculations.

Ignoring adjustments for inflation risk term and liquidity premia, implied expected 5 year inflation is down to 2.8%, while growth prospects also revert back to September levels.

Figure 2: VIX (blue, left scale), and Economic Policy Uncertainty index (red, right scale).  Source: CBOE via FRED,

Risk and policy uncertainty are also at recent highs, but still are dwarfed by Trump era highs (83 for VIX at 27.2; 862 for EPU at 180 on 11/29).

Figure 3: S&P 500 index (blue, log scale). Source: S&P via FRED. 

Given this backdrop (lower expectations for growth and presumably profits, due to Omicron, and higher interest rates from Powell’s statement re: inflation persistence), it’s not surprising to see a drop in stock indices.

Author: Menzie Chinn

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Retailers Open Pop-Up Container Yards To Bypass Savannah Port Jams

Retailers Open Pop-Up Container Yards To Bypass Savannah Port Jams

By Eric Kulisch of American Shipper,

Overflow lots set up by large retailers…

Retailers Open Pop-Up Container Yards To Bypass Savannah Port Jams

By Eric Kulisch of American Shipper,

Overflow lots set up by large retailers this month as temporary staging areas for imported containers have helped bring down congestion levels at the Port of Savannah, and Georgia officials expect further efficiency gains with this week’s opening of two more port-sponsored pop-up sites.

The Georgia Ports Authority, in partnership with the Norfolk Southern, will start accepting loaded containers on Monday at the freight railroad’s nearby Dillon Yard and later this week will begin routing shipping units to a general aviation airport in Statesboro, located about 60 miles west of Savannah, Chief Operating Officer Ed McCarthy told FreightWaves.

Moving containers to off-port properties is part of the recently announced South Atlantic Supply Chain Relief Program designed to reclaim space at the Garden City Terminal, where container crowding is making it difficult for vessels to unload and for stacking equipment and trucks to maneuver. In October, Savannah handled an all-time record of 504,350 twenty-foot equivalent units for a single month, an increase of 8.7% over October 2020. The volume surpassed the GPA’s previous record of 498,000 TEUs set in March.

Port officials began testing the Dillon Yard and Statesboro locations last week after renting top loaders for stacking and truck transfers, installing computer lines in order to track containers entering the gate with radio frequency identification, and laying extra pavement at the rail facility, McCarthy said. 

Four or five more pop-up container facilities are scheduled to open around Georgia by mid-December and the port authority is talking with freight railroad CSX about an auxiliary storage site in Rocky Mount, North Carolina, the COO said in an interview. 

The sites are mini-versions of inland ports where containers are brought to strategically located sites by intermodal rail, shortening the distance trucks have to travel to collect imports or drop off exports and reducing traffic in and around busy seaports. The concept essentially brings the seaport closer to manufacturing, agriculture and population centers. 

The GPA currently operates a large inland intermodal rail terminal in Murray County, Georgia, as well as an inland dry bulk facility. Construction on a second inland rail link for containerized cargo in northeast Georgia is scheduled to begin in April and be completed by mid- to late 2024, spokesman Robert Morris said. South Carolina also operates two inland ports, Virginia has one in the northwestern part of the state and the Port of Long Beach in California recently launched an effort to quickly flow cargo to Utah for distribution by converting truck traffic to rail.

Several users of the Port of Savannah this month have opened pop-up yards of their own where they can directly flow import containers to avoid waiting for longshoremen to sort through shipping units for their cargo and then retrieve them when space opens at one of their distribution centers. Each of the private spillover yards can accommodate 2,000 to 3,000 containers. 

“We’re starting to see some of our customer base do their own pop-ups. They’re contracting with some folks who have capabilities in the Savannah region and … taking their long-term destiny in their own hands,” McCarthy said in an interview.

The Rocky Mount intermodal facility being discussed with CSX will probably be used as an alternative storage location for empty containers. It could be running by early December, the COO said. Whether containers are diverted from other locations or whether empties are loaded up in Savannah and sent there remains to be determined. 

The Biden administration, which is focused on alleviating a nationwide supply chain crisis that is creating product shortages and contributing to inflation, helped fund the GPA’s emergency storage yards by reallocating $8 million in federal funds. Additional flexibility recently granted by the Department of Transportation allows port authorities to redirect cost savings from previous projects funded by port infrastructure grants toward mitigating truck, rail and terminal delays that are preventing the swift evacuation of containers from ports.

White House port envoy John Porcari, the liaison between industry and the White House Supply Chain Disruptions Task Force, said the government is looking to create more inland ports. 

“We’re encouraging other ports to do the same [thing as Savannah.] I think you’ll see a generation of projects in the short term around the country that will help maximize the existing on-dock capacity through interior pop-up sites,” Porcari said on Bloomberg’s “Odd Lots” podcast last week. 

“The fundamental issue is that the docks themselves are such valuable pieces of real estate that you don’t want the containers dwelling there a second longer than you have to. You want to get them to the interior or back on ships to their target markets overseas,” he said.

Better Fluidity

Improvements in rail handling, a dip in import volumes in line with seasonal patterns and the customer pop-up yards have combined to improve cargo flow and reduce the number of ships waiting for a berth at the Port of Savannah, McCarthy said. 

The port authority released an operations update last week showing the average dwell time for a container moving by rail after vessel unloading is two days, and that the average resting time within the terminal for import and export containers is about eight days, down from 11 and 10 days, respectively. The backlog of empty containers remains a problem, with boxes lingering an average of 17.8 days.

The improved performance is helping personnel work vessels faster and reduce Savannah’s cargo backlog. The number of ships at anchor in the Atlantic Ocean declined to 15 as of Monday morning from 22 two weeks ago, Morris said. There were 24 container vessels at anchor in mid-October. Total containers on the terminal also declined 13% and are down 16% from the peak of 85,000, according to the update.

McCarthy said there are about 225,000 TEUs currently on the water, a 10% to 12% reduction from early November that indicates “we are over the hump of the peak season.”

Last week, ocean carrier CMA CGM said its Liberty Bridge service from northern Europe to the U.S. East Coast would temporarily skip Savannah due to the congestion. According to the revised schedule, seven stops between late December and early February will be omitted. Shippers can send Savannah cargo to the Port of Charleston, South Carolina, until then, it said.

The GPA also noted that providers have increased the supply of chassis, the wheeled frames on which containers rest when pulled by truck, and are increasingly able to repair more chassis to help meet demand for cargo deliveries.

Mason Rail Terminal expansion. (Source: Georgia Ports Authority)

The Port of Savannah increased its near-dock rail capacity by 30% with the commissioning two weeks ago of a second set of nine tracks at the Mason Mega Rail Terminal. The port moved 550,000 containers by rail last year and now has more than 2 million TEUs of capacity with an eye toward future growth. The ability to discharge cargo from a vessel and ship it out by train in less than two days is best in class for the U.S., McCarthy noted.

A huge new container yard will come online in phases starting in December and culminate with about 820,000 TEUs of additional capacity by March. The project includes rubber-tired gantry cranes for sorting, stacking and transferring containers.

Construction of another berth is underway and scheduled to be complete in 2023.

Meanwhile, the federal dredging project to deepen the Savannah River to 47 feet (54 feet at high tide) is expected to be completed in the first quarter of 2022. It has already allowed vessels with deeper drafts to enter the port, McCarthy said. The deepening translates to about 200 extra loaded containers per foot and a total of 1,000 per vessel when the project is finished.

Tyler Durden
Tue, 11/30/2021 – 19:45

Author: Tyler Durden

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