more on money supply and velocity, from a historical perspective:take the regular equation of exchange, MV=PY (where M = money supply, V=velocity, and PY = nominal GDP or aggregate demand) and expand the money supply term, M, such that M=Bm where B = monetary base and m = money multiplier. This expanded version of the equation of exchange can be stated as follows:
BmV = PY
In this form, the equation says (1) the monetary base times (2) the money multiplier times (3) velocity equals (4) nominal GDP or total spending (i.e. aggregate demand). The Fed has complete control over the monetary base, B. It has less control over the money multiplier,m, but still can shape it to some degree as it is currently doing by paying banks interest payments to sit on excess reserves. (Imagine what might happen to m if the Fed started charging a penalty for holding excess reserves? We saw how excited the stock market got just at the idea of dropping interest paid on excess reserves.) The Fed can also influence V by setting an explicit nominal target (e.g. inflation, price level or nominal GDP target--the latter being my first choice). In short, the Fed has enough influence that if it really wanted to it could do much to stabilize BmV (or MV). And all of this could happen without resorting to more fiscal
policy.
The Death of Paper Money. Ambrose-Evans Pritchard, Telegraph.
Betting on a bubble, bracing for a fall. John Hussman.
The financial markets are in a bit of a fight here between technicals and fundamentals... suggesting that investors are eager to re-establish a speculative tone to the market. At the same time, fundamentals are bearing down hard on the market. We continue to observe a clear deterioration in leading indicators of economic activity.
Over the short-term, my impression is that the technicals may hold sway for a bit. The economic data points simply do not come out every day, and to the extent that economic news is not perfectly uniform in its implications, the eagerness of investors to speculate can easily dominate briefly.
....
We certainly know of many valuation indicators that suggest that stocks are "cheap" here. Unfortunately, they don't demonstrate any reliability in historical tests. It is almost mind-numbing to observe how many analysts confidently make valuation claims about the market on CNBC, evidently without ever having done any historical research. If you don't require evidence, you can say anything you want.
....
The government has issued trillions of dollars in new debt in the attempt to sustain the previous misallocation of capital - trying to prevent bad loans from failing; to keep elevated home prices from adjusting to normal levels relative to income; to maintain unsustainable consumption habits; and to subsidize purchases of autos, homes and other big-ticket items that have weak intrinsic demand because people already have too much debt. Huge chunks of national savings that should have been available for productive economic activity have been diverted in an effort to maintain an inefficient status quo.
We now have corporations sitting on a mountain of what seems to be "cash." But in fact, they are not holding cash. They are holding a pile of government debt that was issued during this crisis, which somebody has to hold until the debt is retired. Corporations just happen to be "it" in this game of hot potato. Bernanke and Geithner have done nothing but incur public losses in order to defend private interests. This is not skilled leadership - it is misappropriation.
Moreover, we've failed to address the underlying problems - the need to ultimately restructure debt obligations so that they are in line with the cash flows available to pay them; the need for prices and production to shift in a way that reflects a different mix of consumption, investment and financial activity. The markets appear to be crossing their fingers that this won't happen - that the combination of opaque disclosure and massive fiscal deficits will simply make the problem go away; that a big enough "stimulus" package will "jump-start" consumers to their previous habits. The historical evidence on this is not encouraging. In the meantime, we've created yet another mountain of debt. Given the fresh deterioration our Recession Warning Composite and other leading measures of economic activity, our economic challenges seem likely to persist much longer than they should have.
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