Failure of U.S. Money Supply to Grow Points to Economic Stagnation and Monetization of Debt

By: Ned_W_Schmidt

Investors should be taking some clues from the thinking of American voters. Their view, as documented by the respected Rasmusen polling organization, is rejection of the growth killing policies of the Obama Regime. Per Rasmusen, a mere 46% of voters approve of Obama Regime while 53% disapprove. The vote is in on the economic prospects for the U.S. due to policies of the failing and fading Obama Regime, and it is in the negative column.

The currency of a nation where the citizens are rejecting the policies of their government cannot be considered a viable long-term investment. With higher taxes coming in the new year and spending policies that do not encourage economic growth, little if any reason can be found to invest in the U.S. or the U.S. dollar. The model for the future, rather than being the U.S., can be found in China where wealth creating policies continue to be the preferred.

While the long-term prospects for the U.S. dollar are dismal due to policies of the Obama Regime, investors must live in the short-term. In that short-term, we find a relative shortage of U.S. dollars which is bolstering its value. Our first chart this week, above, is of the cumulative growth in the U.S. money supply, M-2 NSA, since August of last year. That starting date is used as that is when the Federal Reserve devoted its energies to fighting the recession that it had created.

Readily evident in that chart is that the U.S. money supply has not been growing. The U.S. money supply has been stagnant since February. Two implications arise from this situation. First, the dollar's relative value in the short-term has been enhanced as quantity of dollars is not expanding. Second, economic growth will stagnate, despite the current economic noise. If the money supply is not expanding, unlikely that economic activity will expand. Most important concern is why the U.S. money supply is not growing, and how the Federal Reserve will respond to this situation.

Three primary factors, or forces, are involved in money supply growth. Why are those forces not causing money supply growth? Remember, the Federal Reserve does not normally directly create money. It normally only provides excess reserves to banks which are then lent out. That process of lending is what creates money. At present, the Federal Reserve is not increasing the availability of bank reserves which retards money supply growth.

Other two factors that must come together to create money relate to bank lending. Banks must make loans to people that want to borrow money. If banks do not make loans, money supply does not grow. If people do not come into the bank to borrow, then loans cannot be made. Neither people nor banks are interested in loans, apparently. Since May, U.S. bank lending has fallen by $2.5 trillion due to the combination of these forces. That reduction in bank lending reduces the U.S. money supply.

So, all three primary factors are preventing the U.S. money supply from expanding. Federal Reserve is not supplying reserves. Banks do not want to make loans. People do not want to borrow money. What are the ramifications of this situation for Gold investors? Will this situation persist?

Our second chart above, updated since we last visited, brings together U.S. money supply growth and the $Gold price. This chart may be the most important one for Gold investors. If the quantity of dollars does not expand, the dollar price of Gold should not rise. Now, is this situation a longer term cap on the price of $Gold as it has been for some months? No, and politics is the reason.

In our introductory comments we noted the dismal polling numbers for the Obama Regime. Negative views also dominate when Congress is the subject of the poll. In particular, some key races are suggesting that the current majority party may take some serious hits in November 2010, if current trends continue. Since staying in power is the goal of all politicians and with only14 months to that election, spending and debt monetization will be high on the agenda in Washington. Japanese election of past weekend is a possible omen for their future that will not be ignored.

Recently, the forecast for the U.S. government deficit for the next decade was raised to $9 trillion. That, however, is the rosy scenario! Reality means adding about 50% to that number to get closer to the actual number. Spending is the first tool to which politicians turn when the polls go south. We can expect the Obama Regime and Congress to spend with enthusiasm in the coming year.

With Bernanke to be reappointed as Chairman of the Federal Reserve in January, we can safely assume he is now a monetary tool of the U.S. government. We can expect the Federal Reserve to monetize a significant portion of the U.S. deficit. As the Federal Reserve readily provides funds to finance the deficit, we will have the equivalent of trucks delivering cash to the U.S. Treasury. As that happens, the "other" means of increasing the U.S. money supply comes into play.

The "printing press," now fully under control of a troubled political machine, will begin spewing out dollars. We can expect that stagnant U.S. money supply, which has capped $Gold, to again begin to grow. U.S. money supply growth should begin to increase as the calendar turns to Fall. When U.S. money supply breaks out of the current lateral pattern to the upside, $Gold will advance to new highs.

The current top of the trading range for $Gold will then become the floor. Investors with a longer term view should be using price weakness in $Gold during this period of the "U.S. money supply cap" to add to their holdings. Politicians will always be politicians, and that is why Gold in your portfolio is essential.

By Ned W Schmidt CFA, CEBS

Copyright © 2009 Ned W. Schmidt - All Rights Reserved

GOLD THOUGHTS come from Ned W. Schmidt,CFA,CEBS, publisher of The Value View Gold Report , monthly, and Trading Thoughts , weekly. To receive copies of recent reports, go to http://home.att.net/~nwschmidt/Order_Gold_GETVVGR.html

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