Monetary Base Grows 37% in October 2013

I often highlight the Fed funds rate as the earliest leading indicator for durable goods manufacturing. It is an important indicator of how the Federal Reserve is trying to influence the economy. But, an equally, or maybe more, important data point regarding the Federal Reserve's influence over the economy is the St. Louis adjusted monetary base. What does this monetary base measure? Essentially it is total amount of actual dollar bills, the physical money in your wallet, in circulation. It's also representative of the size of the Federal Reserve's balance sheet. And, when you hear of the Federal Reserve buying bonds each month (quantitative easing) the dollars used to buy those bonds show up in the St. Louis adjusted monetary base.

True inflation is defined as a change in the money supply. Based on that definition, the St. Louis adjusted monetary base shows that we have had massive and unprecedented inflation in the U.S. since the financial crisis began in 2008. But, this has not resulted in severe price inflation because the money has generally flowed into assets. Therefore, the price inflation has shown up in the stock market and bond market more than in the prices of goods that we buy every day.

In addition to affecting stock and bond markets, changes in the monetary base, or money supply, have a significant impact on capital equipment sales. As more money flows into the economy, spending on capital equipment goes up. As money is pulled out of the economy (the Federal Reserve selling bonds), spending on capital equipment goes down.

In October 2013, the monetary base was $3.610 trillion dollars. That is 37.1% more than it was in October 2012. This is the fastest rate of month-over-month change in the money supply since November 2009. Over the summer, and especially in August, the Fed began talk of tapering its bond purchases from $85 billion a month to between $45-65 billion a month. But, while the Fed was talking of tapering, it has purchased an average of $99 billion of bonds a month based on the change in the money supply. So, the Fed was doing the exact opposite of what it was saying. So, I've decided to coin this new action by the Fed "bellbottoming." Because the opposite of having pants that taper is having pants that bellbottom.

The following chart shows the adjusted monetary base since 1974 versus machine tool sales. The four vertical moves in the monetary base since 2008 are the four rounds of quantitative easing by the Fed. Based on this chart it is difficult to see any relationship between the monetary base and machine tool sales.

However, if we convert these data series into rate of change curves, the relationship becomes more obvious. The annual rate of change in the money supply is up to 16.8%, which is the fastest rate of growth since July 2012. You can see that the faster growing money supply in late 2011 and early 2012, which was the result of QE3, did not have the usual affect on machine tool sales (or other assets). This is why the Fed started QE4. With the month-over-month rate of change growing at its fastest rate in more than four years, I think we will see the rapid growth in money lead to growth in machine tool sales this time around. It appears that changes in the money supply lead changes in machine tool sales by about 12 to 24 months on average.

Because the annual growth in the monetary base was so extreme in 2009, the impact of previous changes in the monetary supply and the affect on machine tool sales is difficult to see. So, here is the same chart ending with 2009 so that the previous changes in the monetary supply can be more easily seen.