Liar, Liar

By Howard Katz    Jun 15 2009 10:14AM

The Federal Reserve is lying about the nation’s money supply (M1). The current figure for money supply is being given as $1.6 trillion. The actual number is $2.34 trillion.  The reported number is equivalent to an increase of 16% over the past year. The actual number is equivalent to an increase of 70% over the past year. This compares with the nation’s high money supply increase of 16.9% in 1986.

The implications for gold are astounding!

Astute observers of the Federal Reserve have noticed that since the large infusion of money of last autumn, the monetary base has exceeded the money supply:

reported monetary base ($1.8 trillion)

reported money supply ($1.6 trillion)

These figures are from Federal Reserve releases H-6 and H-3.

However, the monetary base is a part of the money supply. How can the part exceed the whole?  (Money is created in 2 basic steps. First, the Federal Reserve prints up paper money. This is called special money and is usable by private banks as reserves. It is treated in the system in the way gold used to be. This money is measured by Federal Reserve Credit, or Reserve Bank Credit. With a few adjustments, this becomes the Monetary Base, which can be thought of as the special money that is available to the banking system for the second step. In the second step, the private banks create money in the form of demand, and other checkable, deposits. They do this in the process of making loans. Essentially, the nation’s money supply is cash [the special money] plus bank deposits.)

In pursuit of the answer to how the monetary base got to be bigger than the money supply itself, I called the St. Louis Federal Reserve, and they were good enough to send me the following reply:

“Half of all transaction deposits do not appear in M1 [the money supply]  due to retail deposit sweeping. Adding these back into M1 causes M1 to be larger than the monetary base. (In retail deposit sweeping, banks reclassify checkable deposits as savings deposits so as to reduce statutory reserve requirements. Within certain legal bounds, such behavior is acceptable to the Fed.  Bank customers are unaware that such reclassification is occurring.)

“Plus the FOMC has increased the Fed balance sheet to levels never before seen. Banks are holding deposits at the Fed and not making a great deal of new loans (they are making some, but it is a recession after all). If the banks made new loans, that would generate more deposits to be included in M1.”

Transactions deposits are simply demand deposits plus other checkable deposits. That is, they are total bank deposits and, as such, are an important part of the money supply. Immediately prior to the crisis of last autumn and the massive creation of over one trillion dollars out of nothing by the Federal Reserve, total bank deposits were about 40% of the money supply, with the Monetary Base as the other 60%. According to the St. Louis memo half of these deposits are “swept,” that is they are reclassified as time deposits.  (The memo did not say, but probably it is done overnight or over the weekend.)

This process of reclassifying bank demand deposits as time deposits is the fraudulent part of the new procedure. Despite the fact that both are called deposits, time deposits are fundamentally different from demand deposits as follows:

• A demand deposit is money given to a (banking) institution which does not earn interest and can be withdrawn by the person who gives it (the depositor) whenever he wants (on demand).
• A time deposit is money given to a (banking) institution which earns interest but cannot be withdrawn except after giving notice for a defined period of time (usually 90 days). A time deposit at a bank should be thought of as similar to a certificate of deposit. You can’t get your money out for a certain period of time, but while it is there, it earns you interest.

Because of these differences, economists, for many centuries, have classified demand deposits as money but have said that time deposits are not money. A simple example will illustrate the point.  Money is that economic good which can be used to buy things. Suppose you go to the store and see an item that you want. If you pull out your checkbook, which is a demand deposit, it will be accepted as money. But if you pull out your passbook to the savings account, then you will politely be told to take the passbook to the bank and get money for it. The passbook is not money (because of the time restriction on it), and you cannot buy things with it.

Notice that the St. Louis memo tiptoes around the question of telling a depositor that he has a demand deposit while telling the rest of the country that he has a time deposit.  It states, “Within certain legal bounds, such behavior is acceptable to the Fed.”  Well, since the Fed is trying to lie to the American people, I imagine that it certainly would be acceptable. The question is not whether the banks’ behavior is acceptable to the Fed; the question is whether the Fed’s behavior is acceptable to the nation. At least the memo is candid when it concludes, “Bank customers are unaware that such reclassification is occurring.”

According to the June 1, 2009 Federal Reserve release H-6 (table 3), demand deposits plus other checkable deposits are equal to $740 billion. But according to the memo this reported figure is only half of the real deposits. Thus the true number for bank deposits is $1480 billion. Adding back the missing $740 billion gives us a money supply of $2.34 trillion (1.6 + .74).

Calculating from end May 2008 to end May 2009, the U.S. money supply has grown from $1.73 trillion to $2.34 trillion. This is an increase of 70%.

To put this figure into context, the previous high one-year growth in U.S. money supply was 16.9% in 1986. The money supply figures for the late ‘70s, which gave us a 13.3% rise in the Consumer Price Index, were in the range of 8%-9% per year.

Here is what this means for the price of gold.

My previous calculation for the price of gold was $3500/oz.  And this was calculated as follows: We are now in an economic phenomenon I call the commodity pendulum.  This means that, when the Fed creates money, it has an immediate (1-2 year) effect on consumer goods but a long term (10-20 year) effect on commodities. The commodity pendulum started in 1963 with the Kennedy tax cut and printing of money. Over the next 8 years, commodities did not go up and thus became undervalued in real terms.  By 1971, commodities were very undervalued, and began a 9 year rise from 100 to 337 on the CRB index. This was the first upswing of the commodity pendulum, and during this time the rising commodity prices passed through into consumer prices. Thus for this period (1971-80) the Consumer Price Index rose faster than the money supply. Then came the second downswing in the pendulum (1980-1999), in which commodities got even more undervalued than in 1971. This was why Reagan and Bush, Sr. were able to print so much money with only a small effect on consumer prices. The decline in commodities was undercutting the rise in consumer prices and making it smaller. Now we are in the second upswing in the commodity pendulum.  It started in 1999/2001 and I estimate that it will run for about 20 years.

To get a conservative estimate of the price of gold at the end of the second upswing of the commodity pendulum, I started with the price at the end of the first upswing ($875).  I calculated that consumer prices had doubled from 1980-1999 and guestimated that it would double again on the second upswing (because that is what happened in the first upswing). This meant that prices at the end of the second upswing of the commodity pendulum should be (at least) 4 times what they were in 1980.  Multiplying 4 x $875, we get $3500, and this was my original projection.

But it is now clear that this was far too conservative. Barack Obama has projected a budget deficit for the coming year of $1.8 trillion. (To be honest, it seems strange to me to be using the T-word.) There is something that is not understood about budget deficits. We are always told that this is bad because it is borrowing from the future and that our children will be responsible for our debts. This, however, is an earlier-day lie. No government in history has ever been able to borrow the money for any sizable spending program from the people. The government’s deficits are simply too big and would overwhelm the credit markets of the nation. What every government has done when it faces sizable deficits is to simply print the money. If America is facing a $1.8 trillion deficit later this year, then it will probably print (another) trillion dollars to finance this. And then, as a political reality, it will be impossible to significantly cut the deficit for the next year, and the year after, etc., etc., etc.  In this way, our children do not get poorer in the future. We get poorer, here and now. But we get poorer by having our dollars worth less. We have a bigger quantity of dollars but a smaller quantity of goods.

This means printing of money (the Fed prints the money and then “lends” it to the Treasury) of $500 billion to $1 trillion addition to the money supply, each year for the next several years.  A few years down the road we could easily be looking at a money supply of $4 trillion to $5 trillion.. This is 3-4 times the level of a year ago.

What then can we project for the gold price at the end of the second upswing of the commodity pendulum?   It might make sense to take the original $3500 and multiply it by a factor of 4.  This would give a gold price of $14,000.

I am not saying that these are accurate projections, but I am saying that they are reasonable projections. And they make the point that the current price of gold is absurdly low. We are living in a time when the United States of America is collapsing.  It is similar to Britain in 1948 when she gave up her empire and her currency collapsed. Britain is still a nice country, but it is not the great country it was in the first half of the 20th century.

We are living during the collapse of the United States of America.  We have failed to prevent it, and now our society is falling around our heads. Last year practically every newspaper in the country was telling you that the problem we faced was “deflation.”  That was a gigantic piece of propaganda designed to frighten you into holding cash.  Remember the flight to “safety” into T-bills and T-bonds?  Most people fled from hard assets. These are the victims. They believed the propaganda of the establishment.  When the debris of our collapsing society starts to come down, they will be its victims. Their assets will be “safe” in the U.S. dollar as it loses its place as the world’s reserve currency.

For more specific analysis of this type, you may be interested in my newsletter, the One-handed Economist ($300/year). For more of my writing, visit www.thegoldbug.net

Thank you for your interest.

Howard S. Katz

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Howard S. Katz was one of the early gold bugs of the late ‘60s and ‘70s, turning bullish on gold in 1965.  His favorite gold stock, Lake Shore Mines, went from $3/share to $39/share over the course of the seventies (sold at $31).  Katz turned increasingly skeptical about gold as it mounted its final rise in 1979, and he called the top after the close on Jan. 21, 1980 (with gold at $825.50/oz.).  Katz traded gold in and out during the ‘80s and ‘90s and once again turned long term bullish in Dec. 2002.  His thoughts on commodities, stocks, bonds and real estate are available in a letter entitled The One-handed Economist and published every two weeks giving specific advice on trades in stocks and futures.  This letter is available (both electronic and paper copy) for $300/year with a 3-month trial for $100.  Send to: The One-handed Economist, 614 Nashua St. #122, Milford, N.H. 03055.  (Include both electronic and mailing address.)