It may not feel like it, but there is less money in the U.S.A. That’s not good news for stocks.
Economics is a social science and was famously referred to by the Scottish philosopher Thomas Carlyle as “the dismal science.” Well, if general economics is dismal, monetary economics could be considered funereal. It’s the realm of egg-heads and wonks who dive into the intricate detail of money and its role in the economy. Monetary economics can be mind-numbingly boring — but, nevertheless, money and credit are the life-blood of an economy.
Take the St. Louis Adjusted Monetary Base. The definition from the website of the Federal Reserve Bank of St.Louis reads, “The Adjusted Monetary Base is the sum of currency (including coin) in circulation outside Federal Reserve Banks and the U.S. Treasury, plus deposits held by depository institutions at Federal Reserve Banks. These data are adjusted for the effects of changes in statutory reserve requirements on the quantity of base money held by depositories.” See what I mean? Are you still awake?
You’ll be glad to know that this piece is not an article on the various nuances of the St. Louis Adjusted Monetary Base, important though they are, but rather a simple observation of what is happening.
The chart above shows the value of the money base going back 100 years to 1918. We’ve used an arithmetic rather than a logarithmic scale to highlight the dramatic change that occurred in 2008. That was when the Federal Reserve embarked on its Quantitative Easing (QE) policy, increasing the amount of money in the economy. A logarithmic scale would show that the most comparable (peace time) increase was during the Great Depression of the 1930s. Even then, it pales by comparison. Between 1930 and 1936, the monetary base increased by 84%. From 2008 to 2014, it increased by 374%. Clearly, what we have witnessed over the past decade has been unprecedented.
But notice what has been happening recently. The money base actually topped out in 2014 as the pace of QE slowed. In fact, the monetary base has been deflating since March this year, as can be seen from the chart below. The chart shows the 12-month Rate-of-Change (RoC) for the St. Louis Adjusted Monetary Base in the top panel, and the same measurement for the Dow Jones Industrial Average in the lower panel. Note that, for the sake of clarity, we have shortened the scale for the RoC on the monetary base — it topped out in 2009 at 109%!
Up until this year, the monetary base deflated (RoC below zero) eleven times over the past 100 years using this metric. On eight of those occasions (73%), this has been accompanied with declines in the Dow Jones Industrial Average. As the Fed continues its policy of Quantitative Tightening and social mood transitions from positive to negative, the chances of this relationship happening again are high.