Money supply makes world go round
NOT since the 1980s have the Bank of England’s monthly monetary statistics been this closely followed in the City. Yet money has always mattered and has always moved markets – and had economists and investment bankers spent more time monitoring this data in the noughties, it might have been a little more obvious to them that they had all fallen prey to irrational exuberance.
Three facts matter: the amount of money sloshing around in the economy; which classes of economic agents are holding the stuff; and why they would rather hold their wealth in bank accounts rather than yield-bearing assets. Excess liquidity bids up the prices of assets; insufficient liquidity has the opposite effect, as firms sell shares, bonds and property to get hold of more cash. It is a shame many asset allocators still fail to understand this basic truth at the heart of our system.
The Bank of England’s M4 measure of the money supply excluding the holdings of financial intermediaries rose by just 0.2 per cent in May, a much weaker performance than the 1.1 per cent gain enjoyed in April. This is not good news and is the first piece of UK data that has really worried me since the start of the year. Unless the rate of money growth gets back to what it was, we are in trouble.
So what is going on? As Simon Ward, chief economist at Henderson New Star – and one Britain’s top monetary economists – points out, one reason for the slowdown was that a lot of the gilts snapped up by the Bank of England in May were purchased from banks and building societies (rather than from other players), a move which for technical reasons doesn’t increase the money supply unless it leads to more loans.
Money holdings of households and private non-financial companies are up an annualised 3.2 per cent so far this year, which is not very good. Stripping out households, non-financial corporate holdings have risen by just £1bn, or 0.8 per cent annualised, so far this year, despite sterling capital market issuance of £18bn. I suspect the main reason for this is a good one: firms are paying off their foreign currency loans and using cash generated through their operations to reduce bank debt.
Playing with the overall numbers, Ward calculates that the total money supply has risen at a 6.7 per cent annualised rate so far in 2009, which is not too bad. Households and companies have also increased their holdings of ultra-liquid Treasury bills by £18bn this year – equivalent to 1.2 per cent of the total money supply. It makes sense to look at the combined rise in money and Treasury bills to gauge the economy’s real liquidity position – and this reached an annualised growth rate of over 9 per cent in the first five months of 2009.
The mixed nature of these stats suggests that the Bank of England will ask the Treasury for permission to engage in yet more quantitative easing (QE). As Jamie Dannhauser of Lombard Street Research explains, in the last three months the banking system has financed the entirety of the public sector deficit. Net purchases of government debt by the private sector have amounted to exactly zero. We can therefore expect the Treasury to give the Bank the green light for more QE. This will be good for the money supply in the short run – but will make it even harder for the economy to wean itself from state aid.