Money Supply and the Price of Treasury Bills

Nima — Sun, 23 Nov 2008 09:03:59 +0000

It is very important to understand the effects of the central bank inflation do not all appear at once on the market. Since the money needs to be injected through certain assets first, the prices of those assets will rise before it trickles through to other assets as the people who receive the money begin spending it. Different asset types see changes in their prices at different times. Have a look at a chart that shows the development of the money supply and the price of 13 week treasury bills:

Click on image to enlarge.

As can be seen in the chart above, a significant rise of the price of US Treasury Bills always preceeds a monetary expansion beyond 3%. This is simply due to the fact that before the money supply appears on the bank accounts, the Federal Reserve Bank, through its FOMC, needs to begin bidding for these bills on the market. Alternatively the Fed might inject the money into banks by other means upon which the banks will initially park it in Treasuries, mostly T-Bills.

Thus there is no better immediate indicator of an impending inflationary credit expansion than the price of Treasury Bills and Bonds. This is why Mike Shedlock is wrong when he expounds the issue of deflation. He has been right over the past year when he said that we were in a deflation. But he says that an increase in the price of Treasury Bills is a sign of deflation. This is of course a fallacy. An increase in the price of treasury bills is, to the contrary, the very first indicator of a new inflation. It is the sign that the past deflation has come to an end and that we are entering a new monetary expansion. There is not one single point on the chart above that would corroborate the opposing view.

I agree with Mike that gold has bottomed out, albeit for a different reason. The new money inflation has begun. Treasuries are once again the first assets to soar. In about 1-2 years from now the current Wall Street bear market will bottom out and then start a new primary rally. Gold will pick up steam from now on and stage a major rally once the aforementioned stock market rally comes to an end.

I, too, don’t like too see inflation raise its ugly head again. We need a deflation, badly, to save us from complete financial havoc. But the government is at the very least slowing it down significantly. Whether we like it or not, we have to observe the data in an unbiased fashion. This is not to say that the numbers may not swing back with a resumption of the deflationary trend. But we should not just cast them aside just because we don’t like what they tell us.

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Money Supply and the Price of Treasury Bills