March 9, 2010
Implications for the future
The data for M3 reinforce Williams’ broader thesis that the US is headed for a severe and prolonged economic contraction that will ultimately result in hyperinflation – possibly within the next year, a forecast we have written about previously.
“You are going to see an intensified economic downturn in the next couple of months,” Williams said, “that will show up in the statistics.”
The banks are largely insolvent, he said.
Williams said the Fed, in its recent Beige Book, recognized the fragility of the banking system. It attributed lack of credit to tightened lending standards and to the inability of mid-sized and regional banks to lend because of their impaired balance sheets. “These problems are the same as at the beginning of the crisis,” Williams said. “Until the banking system gets healthy enough to resume lending into the flow of commerce, you are not going to have positive economic growth.”
The Fed’s primary function is to maintain the solvency of the banking system, not to control inflation, Williams said. “All the programs thus far have been aimed at that goal,” he said. “The Fed is in an impossible situation without a robust economy.”
Williams expects the Fed to “debase” the dollar as much as necessary, by decreasing the interest rate on reserves held by banks, for instance, in order to stimulate bank lending. Such actions would be designed to increase M3, but they would carry with them the risk of inflation.
So far, the Fed has been successful in stabilizing the system without causing inflation.
“The Fed will talk one game to keep the dollar stable,” he said, “but will act otherwise to keep the system stable.”
Without growing M3 the system “will implode on itself,” Williams said.
A weak economy will create additional funding needs for the Treasury. Insufficient auction demand for Treasury securities will force the Fed to step in to buy to keep rates down. In doing so, it will be monetizing the debt and increasing the money supply
The contraction in M3 has been deflationary and runs contrary to Williams’ larger theme of a hyperinflationary threat. Williams is convinced that contraction is temporary, and he believes Fed actions to fight deflation will eventually grow the money supply and lead to uncontrollable inflation.
If that were happen, it would require a movement out of the dollar, reflected in lower dollar exchange rates. The sale of dollar-denominated assets, such as Treasury securities, could cause this.
“The thing to watch for is the dollar,” Williams said. “If there is fundamental or panicked selling of the dollar, the system will freeze and rates will skyrocket, or the Fed will be forced to flood the system with liquidity, which will be very inflationary.”
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