On September 20, 2010, the National Bureau of Economic Research (NBER), the institution that dates the peaks and troughs of business cycles, pronounced that the US recession ended on June 2009.

The NBER defines recession in this way:

A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough.

We suggest that the NBER’s definition does not provide an explanation of what a recession is all about. Instead it describes the various manifestations of a recession. And this is precisely what is wrong with it.

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According to the British newspaper the Telegraph from 26 of May US money supply M3 (the Fed doesn’t publish this data any longer) displays a visible decline. The yearly rate of growth of this measure of money stood in April at minus 5.3% against minus 4.3% in March and plus 5.2% in April last year.

Economists that follow M3 are alarmed with the sharp fall in this measure of money. They are of the view that this large decline might be pointing to a nasty recession ahead. Most economists that have expressed concern to the Telegraph about the large fall in M3 belong to the monetarist camp, which was formed by the late professor Milton Friedman. Some of them hold that the plunge in M3 is on account of regulators forcing the banks to raise capital asset ratios. It is held that this forces banks to shrink their assets, which is blamed for the shaky economic recovery.

Monetarists, or Friedmanites, are of the view that the Fed is running the risk of repeating the errors that plunged the US economy and the rest of the World into the Great Depression of 1930′s. According to monetarists the Fed then allowed the money supply rate of growth to fall sharply. By July 1932 the yearly rate of growth of M3 stood at minus 14.7% (see chart). From this it follows that the Fed should aim at reversing the current fall in M3 as soon as possible to prevent an economic disaster.

It is quite possible that monetarists are reaching valid conclusions with respect to the economy in the months ahead. We are of the view however, that money M3 is not a valid measure of money.

In order to account correctly for money, one must make a distinction between money that is deposited and money that is loaned out.

When an individual exchanges goods for money he in fact increases his demand for money and when he lends his money he is lowering his demand for money. Individuals can exercise their demand for money in a variety of ways. For example, they can keep money in a jar, or under the mattress, or in their wallets, or place the money in a bank warehouse. From this it follows that the overall amount of money in individual holdings should be the sum of money they hold in bank warehouses also known as demand deposits plus the money they hold outside banks warehouses.

This, in turn, means that the inclusion of various term deposits such as large time deposits and money market mutual funds deposits into the definition of money such as M3 produces an erroneous account of the amount of money in the economy.

For instance, Tom places $1,000 into a long-term saving account with Bank 1. The bank in turn lends this $1,000 to Mike. This type of transaction temporarily transfers the ownership of the $1,000 from Tom to Mike. Consequently, to add $1,000 in Tom’s long term saving deposit into the definition of money will lead to double counting since this money resides either in Mike’s pocket or in Mike’s demand deposit.

Following this line of thinking, one could easily note that, notwithstanding popular practice, money invested with money market mutual funds (MMMFs), which is part of M3 definition must be also excluded from the money supply definition. Investment in a money market mutual fund is, in fact, an investment in various money-market instruments. The quantity of money is not altered as a result of this investment; only the ownership of money has temporarily changed. Including investments in MMMFs in the money definition will only lead to a double counting again.

If one wants to use money supply as a predictor of future economic events one must ascertain what money is all about. This of course means that various credit transactions must be excluded from the definition of money. Once one adjusts for credit transactions one will get a clean monetary measure, which we have labeled AMS (the Austrian School of Economics money supply).

Now contrary to M3 the growth momentum of AMS currently shows a visible bounce. The yearly rate of growth stood at 4.7% so far in May against 3.5% in April. We suggest that a major threat to economic activity, or to be more precise to bubble activities, is the fall in the yearly rate of growth of AMS from 32.9% in November 2008 to minus 10% by November last year. Also note that the yearly rate of growth stood at negative figure during October to December last year.

Contrary to monetarists more pumping by the Fed can make things much worse. It will only weaken the process of real wealth generation further and undermine the pool of real savings — the key for economic growth. Also note that if the pool of real savings is in trouble then banks are likely to encounter difficulties in finding good quality borrowers i.e. wealth generators. In the framework of a declining pool of real savings a lowering of banks capital asset ratios is not going to make banks to expand their lending. Obviously one could try forcing banks to expand lending. This type of lending, given that the pool of real savings is in trouble, would amount to the creation of credit out of “thin air”. So even if this type of credit were to revive the rate of growth of money M3 it will not be able to revive the economy if the pool of real savings is in trouble.

On the contrary such type of lending, which is not backed up by real savings, will only further dilute the pool of real savings. (Also this type of lending will erode further banks quality of assets).

We suggest that it is on account of previously loose monetary policies that the pool of real savings is currently in trouble. It is the fall in the real savings that causes banks to shrink their lending, which is mirrored by the fall in M3. This however, doesn’t imply that the Fed should start pushing more money to reverse the rate of growth of M3. Pushing more money will only make things much worse.

Contrary to monetarists we suggest that in order to lay the foundation for a meaningful economic recovery the Fed should stop the money printing machinery as soon as possible. Printing more money only weakens the pool of real savings and weakens prospects for economic recovery.

Dubai announced last Wednesday that it would ask creditors of Dubai World, the conglomerate behind its rapid expansion (it built the world’s tallest building), and Nakheel, the builder of its palm-shaped islands, to agree to freeze debt repayments for six months.

Some commentators are of the view that banks that have lent money to Dubai World could suffer significant losses if the company were to default on all or part of its $59 billion debt. Duabi’s total debt stands at $80 billion. If creditors were to reject proposals to postpone debt repayments for six months, the Dubai government could be forced to hold a fire sale of its international real estate assets.

Analysts however are of the view that other emirates of the UAE – United Arab Emirates -such as Abu Dhabi are unlikely to be affected by Dubai’s crisis significantly since their funding is derived from exporting oil and gas.

The key factor behind the crisis is the boom-bust policy of the UAE central bank. After closing at 4% in October 2006 the yearly rate of growth of the central bank’s balance sheet (the pace of monetary pumping) climbed to 177% by December 2007. In response to this pumping the yearly rate of growth of UAE’s monetary measure AMS jumped from 6% in October 2006 to 62% by April 2008. This massive pumping has given support to various activities that without the money pumping wouldn’t have emerged. In short these activities cannot stand on their own feet without support from monetary pumping.

Since January 2008 the pace of pumping by the central bank has been trending down. In January this year the yearly rate of growth of the central bank’s balance sheet plunged to minus 36.5%. As a result the yearly rate of growth of money supply fell to minus 12.5% by July this year. It is the fall in monetary pumping that is currently putting pressure on various activities that sprang up on the back of previous massive monetary pumping.

We suggest that other emirates are unlikely to escape the effects of the boom-bust policies of the central bank. Also, in other emirates loose monetary policy set the platform for new activities and the expansion of existing activities. As a result of a decline in monetary pumping by the central bank these activities are currently also under pressure.

Conclusion

A possible debt default by Dubai’s two large government sponsored conglomerates sparked worries in financial markets of another round of global economic turmoil. Dubai has requested a freeze on payments of some of its $80 billion debt for six months. We suggest that the key factor behind the crisis in Dubai is the classical boom-bust policies of the UAE central bank. The phenomenal expansion in various structures in Dubai was mostly on account of massive monetary pumping. Thus in December 2007 the yearly rate of growth of the central bank’s balance sheet stood at 177%. The bursting of the bubble came on account of the strong fall in money pumping. Since January 2008 the pace of pumping by the central bank has been trending down. In January this year the yearly rate of growth of the central bank balance sheet had plunged to minus 36.5%.

Does it make sense that a fall in prices should actually cause people to postpone buying goods? To maintain their life and wellbeing individuals must live at present. FULL ARTICLE

In the popular framework of thinking, which originates in the writings of John Maynard Keynes, economic activity is presented in terms of a circular flow of money. Spending by one individual becomes part of the earnings of another individual, and spending by another individual becomes part of the first individual’s earnings.

Recessions, according to Keynes, are a response to the fact that consumers — for some psychological reasons — have decided to cut down on their expenditures and raise their savings.

For instance, if for some reason people have become less confident about the future, they will cut back on their outlays and hoard more money. So, once an individual spends less, this worsens the situation of some other individual, who in turn also cuts his spending.

Consequently, a vicious circle sets in: the decline in people’s confidence causes them to spend less and to hoard more money, and this lowers economic activity further, thereby causing people to hoard more. FULL ARTICLE

Even former Federal Reserve Chairman Alan Greenspan is alarmed by the massive pumping of the Fed and other central banks. At the same time, a new school has emerged to say that, despite appearances, there is no problem. Who is right? FULL ARTICLE

if printing money can grow the economy, then why not to print plenty of it and cause massive economic growth? By doing that, central banks could have by now created an everlasting prosperity for every individual on the planet. FULL ARTICLE

According to latest US government data, the personal saving rate jumped to 4.6% in June this year after settling at 0.4% in June last year.

According to the National Income and Product Accounts (NIPA), the saving rate is established as the ratio of personal saving to disposable income. Disposable income is defined as the summation of all personal money income, less tax and non-tax money payments to the government. Personal income includes wages and salaries, transfer payments, income from interest and dividends, and rental income.

Once we deduct personal monetary outlays from disposable money income, we get personal saving. Personal saving, then, is determined as a residual.

But is it valid to add all incomes in an economy in order to establish the so-called “national income?” Does the summation of money incomes equate with the true national income? Let us explore this point. FULL ARTICLE

In his speech at the BIS conference in Basel, Switzerland, the president of the New York Federal Reserve, William Dudley, argued that asset bubbles pose a serious threat to real economic activity. He holds the view that the US central bank should develop effective tools to counter this menace. As things stand at present, said Dudley, a monetary policy that relies on short-term interest rates is not well-suited to deal with the emergence of bubbles. FULL ARTICLE

Most experts and commentators are of the view that the worst of the US recession may be over by year’s end. My own prediction is for an illusory recovery of government-constructed economic indicators, but nothing more than that. FULL ARTICLE

Most Fed officials and various economic commentators are of the view that the US economy might be rapidly approaching a stage where it is possible to take out a large chunk of the recently pumped money without causing any harmful side effects. What they don’t tell us is that monetary pumping has given rise to various bubble activities. Hence, contrary to popular thinking, the massive money pumping has actually weakened the economy’s bottom line. If the Fed were to start taking some of the newly pumped money from the economy, it would set in motion an economic bust.

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The whole idea that there is the need for more inflation in order to revive the economy seems preposterous given the fact that the Fed has been aggressively inflating since the end of last year. The yearly rate of growth of monetary pumping as depicted by the Fed’s balance sheet jumped from 3.8% in August last year to 152.8% by December 2008. At the end of April, the yearly rate of growth stood at 138.6%. FULL ARTICLE

We suspect that President Obama has adopted the approach of a patient and his doctor with respect to managing the US economy: deferring to the supposed experts. He is very much influenced by the ideas of Joseph Stiglitz, Larry Summers, and Paul Volcker. During the interview he also expressed his admiration for Robert Reich and Paul Krugman. Although he didn’t say it, we suggest that the US president is also greatly influenced by the ideas of Federal Reserve Chairman Ben Bernanke. FULL ARTICLE

Since the end of February when the S&P 500 closed at 735.09, the index has been pushing strongly ahead, closing on Friday, May 8, at 929.23 — an increase of 26.4%. We suggest that the key driving force behind this strong bounce is a massive increase in liquidity. What is it all about, and how do changes in liquidity drive the stock market? FULL ARTICLE

According to popular thinking an easy interest rate stance and monetary pumping by the Fed encourages borrowings and spending. More spending leads to a stronger economic growth and more employment.

It is however held that this time around an easy interest rate stance and money pumping are not working. Not only bank’s are reluctant to lend but also individuals are clinging to their money thereby weakening the aggregate demand and weakening prospects for economic recovery.

So how could the Fed force people to spend more?

The former White House Chief Economist and currently a Harvard professor of economics Gregory Mankiw offers a solution to this dilemma. (It May Be Time For The Fed To Go Negative — The New York Times April 19,2009).

Mankiw suggests that the US central bank could do the trick by offering negative interest rate.

Why not lower the target interest rate to, say, negative 3 percent? At that interest rate, you could borrow and spend $100 and repay $97 next year. This opportunity would surely generate more borrowing and aggregate demand.

But who is going to lend at negative interest rates?

Our Harvard professor offers the following solution to this dilemma. Mankiw suggests that the Fed could announce that a year from now all money with a serial number, between zero to nine, which is randomly selected, will no longer be legal tender.

Suddenly, the expected return to holding currency would become negative 10 percent. That move would free the Fed to cut interest rates below zero. People would be delighted to lend money at negative 3 percent, since losing 3 percent is better than losing 10. Of course, some people might decide that at those rates, they would rather spend the money — for example, by buying a new car. But because expanding aggregate demand is precisely the goal of the interest rate cut, such an incentive isn’t a flaw — it’s a benefit.

The threat of confiscating people’s money (Mankiw calls it a tax on money) will force them to spend it — precisely what is needed to revive the economy, says Mankiw. He also of the view that a tax on money will also force banks to reduce their excess cash and boost lending.

In the week ending April 15 commercial bank loans stood at $5,996.7 billion — a fall of 1.6% from the end of January and a fall of 2.2% from November last year. (The data is adjusted for large commercial bank acquisitions of non-bank institutions in the week ending October 1 2008).

Banks surplus cash has continued to pile up. In the week ending April 22 banks excess reserves stood at $862.39 billion — an increase of $91.12 billion from the end of March. Note that between January 2000 to August 2007 the average level of excess reserves stood at $1.6 billion.

Another idea to boost spending, according to Mankiw, is that the Fed must commit itself to produce inflation ahead. In this case, borrowing at zero interest rate and repaying the debt with devalued dollars will provide an incentive to borrow and spend.

What however, drives the economy is not demand as such but the production of goods and services. The more goods an individual produces the more of other goods he can secure for himself.

This means that an individual’s effective demand is constrained by his production of goods. Demand, therefore cannot stand by itself and be independent — it is limited by production.

According to James Mill,

When goods are carried to market what is wanted is somebody to buy. But to buy, one must have the wherewithal to pay. It is obviously therefore the collective means of payment which exist in the whole nation constitute the entire market of the nation. But wherein consist the collective means of payment of the whole nation? Do they not consist in its annual produce, in the annual revenue of the general mass of inhabitants? But if a nation’s power of purchasing is exactly measured by its annual produce, as it undoubtedly is; the more you increase the annual produce, the more by that very act you extend the national market, the power of purchasing and the actual purchases of the nation…. Thus it appears that the demand of a nation is always equal to the produce of a nation. This indeed must be so; for what is the demand of a nation? The demand of a nation is exactly its power of purchasing. But what is its power of purchasing? The extent undoubtedly of its annual produce. The extent of its demand therefore and the extent of its supply are always exactly commensurate.[1]

If a population of five individuals produces ten potatoes and five tomatoes — this is all that they can demand and consume. No government tricks can make it possible to increase effective demand. The only way to raise the ability to consume more is to raise the ability to produce more. (Neither printing money nor tax on holding money can strengthen the ability to produce more).

The dependence of demand on the production of goods cannot be removed by means of loose interest rate policy and monetary pumping, or government threat of confiscating people’s money.

On the contrary the loose Fed’s interest rate stance and money printing will only impoverish real wealth generators and weaken their ability to produce goods and services — weaken the effective demand.

If what keeps the economy depressed is too many toxic assets on banks’ balance sheets, then it makes sense to do whatever is necessary to remove those assets from banks’ balance sheets. Equally, it also makes sense to nationalize banks and force them to lend. We suggest, however, that what matters when it comes to economic recovery is the state of real savings. Contrary to popular thinking, it is real savings that fund economic activity and not bank lending. FULL ARTICLE

According to Greenspan, the culprit is the savings glut from emerging economies, such as China. This glut of savings was channeled to long-term US Treasuries and other US financial assets thereby depressing their yields. In fact, the so-called savings glut in emerging economies had nothing to do with the last economic boom or the current economic crisis. The only institution that can set in motion the expansion of money and a false boom is the Fed. FULL ARTICLE

We live in an age of grave economic ignorance, if central-bank policy is an indication of prevailing economic theory. It is apparent that we’ve learned nothing from several millennia of monetary destruction. The persistent demonstration that capital, not paper, is the basis for prosperity has fallen on deaf ears. Daily, we face the sad spectacle of government officials, pundits, and even Nobel laureates telling us that printing money is the answer to an economic downturn. FULL ARTICLE

Reuters

South Korean prosecutors indicted a blogger on Thursday who had warned of financial doom for the country with critics saying he was targeted because his gloomy forecasts upset the government battling an economic downturn.

The blogger, writing under the pseudonym Minerva, became a household name for his predictions of sharp falls in the won and the local stock market and the collapse of U.S. investment bank Lehman Brothers. Prosecutors said he hurt the local currency by posting incorrect information online.

“The suspect in this case was indicted on charges of false information on two occasions,” an official at the prosecutors’ office said by telephone.

As South Korean markets tumbled late last year amid the global downturn, the main financial regulator warned it would crack down on what it considered malicious rumors and some economic analysts say they have come under pressure from authorities not to voice negative views on the economy.

Most economists believe that the US government must sharply increase its spending in order to arrest the economic crisis that could turn into a prolonged slump. They are wrong. The only way fiscal stimulus could “work” is if the flow of real savings (i.e., real funding) is large enough to support (i.e., fund) government activities while still permitting a positive rate of growth in the activities of the private sector. As it is, not only does the increase in government outlays not raise overall output by a positive multiple; but, on the contrary, this leads to the weakening in the process of wealth generation in general. FULL ARTICLE