Recessions and The True Money Supply

posted by Nima

November 18, 2008 · Posted in Monetary Economics 

Our composition of the money supply, as I have outlined here, is the only logical and consistent measure for the true money supply in the United States.

Having figured out what is and what is not to be included, we can now have a look at how this measure actually helps us assess the true market situation at any given point in time and make predictions as to how markets are going to fare in the near and in the mid-term.

It is not a big surprise that our true money supply is the single best indicator for predicting booms and busts in the US economy.

Below please find the true money supply from 1959 until present:

As the money supply increases, booms are fueled via credit expansion. As outlined in that article, once the credit expansion is over, a credit crunch occurs, accompanied by an adjustment of asset and consumer prices. This correction is commonly referred to as a recession. It is accompanied or precipitated by a slowdown in the money supply growth or an outright drop in the money supply.

Below is a chart of the annual money supply growth from 1970 until now:


Click on image to enlarge.

As can be seen in this chart, drops below below 3% (circled in red) have either preceded or accompanied recessions (red lines on x-axis) in 5 out of 7 times. Drops below 0% have led to a recession in 3 out of 4 instances.

It should also be noted that periods of economic booms and increasing asset prices are preceded by a very high year on year growth of the money supply, such as the periods 1984-1987, 1992-1995, and 1996-2000.

The year-on-year growth of the true money supply will be monitored in this blog on a monthly basis.

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