A dispassionate look at the quantities and flows of fiat dollars tells us much about the current state of the US economy, and therefore prospects for the dollar itself.
This is a starting point for understanding the dynamics likely to affect the dollar’s purchasing power after the next credit-induced crisis, which are now beginning to clarify. That is the purpose of this article, which starts by updating the most recent developments in the quantity of fiat money (FMQ), the greatest of all monetary pictures. [i]
Inflation of the fiat money quantity appears to be stalling, as the above graph attests. It has increased just under 3% over the last year to October, compared with 5.8% the previous year. It seems the monetary punch bowl, while not taken away, is lacking its post-crisis drive.
By far the largest component is deposits and savings held at the banks, which total $11,132bn, and have grown a vigorous 7.4% during the last year. The component that has a significantly lower balance is the US Treasury general account, which has reduced from $348.7bn to $160.4bn, knocking FMQ’s overall growth rate. The fact that it is this account that is holding back FMQ inflation tells us that FMQ inflation in public hands is still very much alive.
In recent months, there has been heated debate about whether the US economy is stalling or not, and that perhaps the widely anticipated increase in the Fed funds rate next month will be the last for some time. However, the continuing growth in depositors’ bank balances suggests consumer demand is reasonably robust and interest rate rises are not over.
We are of course skating over an important consideration, the ownership of these deposits. Long-standing experience tells us that when the banks first increase their loans to their customers after a credit crisis, they tend to favor the lower risk accounts. These are the big corporates capable of bringing not only interest income, but fees as well. Additional loans are drawn down through payments to their suppliers, who tend to be large and medium-sized businesses. Thus, deposits are created, and they filter down from the larger to smaller businesses over time. And as these businesses employ extra staff, their personal bank balances benefit as well.
This trickle-down effect conventionally disperses the ownership of bank balances from the large to the less large, and eventually the general public. But today, life is not so simple. The general public is up to its neck in credit card, auto, student, and mortgage debt. The creation of bank deposits is, therefore, the result of consumer debt, more than business loans. This issue is explored further later in this article.
Business finance
It is also clear that we need to dig deeper to see what is going on with American businesses and whether they collectively think trading conditions merit further investment. There is no doubt the Fed is keeping interest rates suppressed below the level indicated by time-preference, the condition required to justify increasing business investment.[ii] This can be measured by seeing what proportion of overall monetary expansion is being applied to business investment, and whether it is increasing or decreasing relative to the total, which is represented by the blue line in the following chart.
The blue line represents business loans as a percentage of broad money (M2). An increasing percentage represents periods, when in aggregate, businesses are investing in production. A decline represents periods when businesses decide returns on business investment are less than the cost of financing. Instead, they pay down their loans, or alternatively, the banks decide to call them in. Before 1980, investment downturns were driven by both these reasons, while after 1980, central bank interest rate policy increasingly became the overriding factor. The correlation between interest rates and the expansion and contraction of business loans, while readily apparent, should be regarded in this light.
There are other factors to consider. Since the last financial crisis, a substantial portion of business debt taken out has been for share buy-backs, so even less investment has been applied to production than the chart implies. Before the last financial crisis, FMQ had been growing at a reasonably constant annual average of 5.9% (the dashed line in the first chart), after which the quantity of fiat money increased with unprecedented rapidity. The chart shows that lending to businesses as a percentage of money supply has been anaemic at best compared with lending to other categories since the crisis, even though it has increased in absolute terms.
Whichever way you cut it, this chart shows the US’s supply-side is now stalling (circled), particularly following the quarter-point increases in the Fed funds rate from December 2015 onwards (also circled). And with only 15.5% of M2 applied to business loans, the other 74.5% is applied to consumer credit and purely financial activities.
This finding is consistent with business surveys that indicate a mixed picture for US production, and supports concerns in the investment community that the economy faces a low-growth future, with a significant risk of a downturn.
The lackluster performance of this, the supply side of the US economy, is in contrast with the pick-up in productive activity elsewhere in the world. Driven by China’s voracious appetite for commodities, the outlook for all commodity exporters is improving. Europe is being linked into the Chinese economy through two-way trade, driving the euro upon improving economic prospects. Japan similarly benefits from the expansion of regional trade with China and all the East Asian nations. The only exception to this positive outlook is for the US and therefore its currency, the dollar.
