March 28, 2006

The End of M3 – Hiding the Truth About Inflation


Each week the Federal Reserve reports various measures of the US dollar money supply. One of these, M3, is the total quantity of dollars in circulation. Last week the Fed stopped reporting M3, explaining as follows the reason for their decision:

“M3 does not appear to convey any additional information about economic activity that is not already embodied in M2 and has not played a role in the monetary policy process for many years. Consequently, the Board judged that the costs of collecting the underlying data and publishing M3 outweigh the benefits.”

To the casual observer not familiar with the nuances of central banking, the above stated reason may seem plausible. But those with experience know that central bankers only tell you what they want you to hear. Therefore, what is the real reason the Federal Reserve stopped reporting M3?

The answer is very simple. The Federal Reserve wants to hide the truth. They want to hide the fact that they are inflating the dollar.

The Federal Reserve says that M3 is no longer needed, and that M1 and M2, which only measure part of the total quantity of dollars, are sufficient. But look at the following table which I’ve taken from the Federal Reserve’s last money stock report that included M3.

H.6 (508) Table 2
Money Stock Measures
% change at seasonally adjusted annual rates
3-mos from Nov 05 to Feb 06
6-mos from Aug 05 TO Feb 06
12-mos from Feb 05 to Feb 06

Inflation arises from creating too many dollars. Therefore, compare the growth rates of M1 and M2 to that for M3.

Regardless whether you use the 3, 6 or 12-month reporting period, by looking at just M1 or M2 growth rates, one would get the impression that the level of current dollar creation was not unusual and that as a consequence, no inflationary pressures were building within the economy. But M3 reveals the truth, and the truth is that the Fed is pumping up the money supply. The total quantity of dollar currency is soaring, which is also apparent from the following chart which shows the annual growth rates of M3 at each month end since January 1975.

This chart provides a useful roadmap that illustrates the inflationary and disinflationary trends in the US dollar. There was double-digit inflation in the 1970s because M3 was growing at double-digit rates. Paul Volcker was appointed Fed chairman in 1979 and given the mandate to bring inflation under control. He achieved that objective by ushering in a period of disinflation by deliberately implementing a monetary policy that resulted in the declining M3 growth rates clearly visible on the above chart.

After his appointment in 1987, Alan Greenspan continued the same disinflationary policy until September 1992 when the quantity of M3 had actually declined from the prior year. This decline in the money supply was deflation according to its classical definition, but this brush with deflation was brief. The Fed began reflating, and continued to do so until Y2K, in the process creating the greatest stock market bubble of all time. Thereafter, M3 growth rates began to decline along with the US stock market, bringing in another period of disinflation. But look at what is happening now.

I have highlighted with the red circle the recent trend in M3 growth. The rate of dollar creation has begun a new upward path, which I call the “Bernanke Inflation”. It is this new upward trend that the Fed does not want anyone to see.

By not reporting M3, the Federal Reserve thinks they can inflate without consequences. As evidence of this conclusion, please read the following quote from a presentation given on March 13th by Janet Yellen, president of the Federal Reserve Bank of San Francisco. To provide some necessary background information, she first explained in effect that expectations by the public for future inflation have consequences because their expectations cause people to take actions to protect the purchasing power of their dollars. She then goes on to state:

“Over the past two years, wages, core inflation, and long-run inflation expectations have remained well contained despite a dramatic increase in energy prices. With inflation expectations under control, we have avoided a rehash of the 1970s and the need to rein in inflation by engineering a severe recession.”

In other words, if people don’t believe inflation is a problem, the Federal Reserve has more opportunity to intervene, taking actions potentially debasing and inflationary to the dollar and to do this without consequences. Or at least that what’s the Fed thinks. But the Fed is only fooling itself.

First of all, who really believes that inflation is under control? The price of everything is going up, except perhaps computers, but in contrast to food and energy, computers are not an everyday purchase. A poll published by The Wall Street Journal reveals that 75% of those participating believe that the inflation they experience is worse than the inflation rate reported by the federal government’s Consumer Price Index.

So who does the Fed think it is fooling? After the Fed made its initial announcement in November 2005 that it would discontinue M3, I wrote:

“By eliminating its reporting of M3, the Fed is shooting itself in the foot. This misstep will only hasten the rush out of dollars into the safety and security of gold.”

The reason for forecasting as I did a flight from the dollar into gold is that I suspected that the Fed’s decision to discontinue its M3 reporting would be immediately recognized for what it is – something to be expected from a ‘banana-republic’. In other words, if things are that bad that the Fed is no longer going to report the whole story, then, the thinking goes, the sooner one exits the dollar the better. And the best way to hedge oneself against the effects of inflation is to buy gold.

Clearly, the rise in the gold price that has occurred since the Fed announced in November its decision to no longer report M3 must in part be attributable to this gross misstep by the Fed. Given the new upward trend in the M3 growth rate on the above chart, it seems inevitable that the price of gold is going to rise much higher because inflation will continue to worsen, regardless whether the Fed reports it or not.



James Turk is the Founder & Chairman of He writes The Freemarket Gold & Money Report, and his latest book is The Coming Collapse of the Dollar.

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