The hedgehog number
The hedgehog knows one big thing, and in my case it's how much money there is
TLDR:
- The Hedgehog number is broad money vs nominal GDP
- Its the one big thing that explains how macroeconomics and finance relate
- Monetary policy was loose in 2019, so it’s hard to loosen it
- Fed and Govt interventions don’t seem to be having an impact
It’s said that the fox knows many things but the hedgehog knows one big thing. People who know me are surprised that I know even one thing - but I do. And what I know is how much money there is compared to how much is spent. I look at this chart almost every day to remind me what has actually happened in the US economy since the modern financial era began in the early 80s. It’s my own personal “2+2 = 4, even if the party says it doesn’t”:
Annual growth rate in zero maturity money minus Annual growth rate of nominal GDP:
Or, to put it another way, the ratio of zero maturity money to nominal GDP:
That’s the hedgehog number, money supply - nominal GDP. There are many important, non obvious things about the last 40 years, and the recent past, that we can take from its progress.
The ratio of money to transactions has been increasing at a steady pace since the start of the modern financial era - and inflation has been persistently low. The link between quantity of money and inflation is nothing like what most people think it is.
There is nothing unusual about the post 2008 period in terms of money growth. QE simply replaced private money growth with a bit of public money, and overall, growth has been normal compared to GDP.
Back in 2018 when everyone was talking about rates going to 5%, the money supply was contracting relative to the economy. It was never going to happen.
If you add the fed funds rate and squint a bit, you can see how monetary policy works:
Cuts in the Fed Funds rate lead to an increase in the ratio of money/transactions. Why rates are heading lower and the ratio is heading higher is a post for another day.
Today, we need to look at the the last year or so and zoom in on the situation the US economy faces today. 2018 saw multiple rate hikes, and the Fed gradually reducing its balance sheet. 2019 saw a reversal of monetary policy - with the Fed cutting rates and growing its balance sheet again in response to a worsening macroeconomic environment, and a money market blowup in the 3rd quarter. This loosening of policy led to a major advance in broad money. Taking out the increase in reserves, broad money grew 12% from the start of 2019 to the start of the Covid19 response. Since the start of the Covid19 response, non-reserve money has not grown at all - whilst the Fed has expanded its balance sheet, and therefore the quantity of reserves (central banks’ superpower is to swap any financial asset for base money) , by $2.5tr - from 4 to 6.5.
That’s the background. In the midst of the biggest stop in economic activity since the end of WW2 though, I’m not interested in whether that means policy is loose or tight. I’m looking for some edge, any edge, in understanding whether the actions of the Fed and Government together are getting money into the hands of people who’ll spend it. And are they managing to do it faster than the private sector contracting balance sheets is taking it away. Luckily, the data we need for this is only two weeks lagged.
Looking at March, it appears there are some grounds for optimism. Banks demand deposits increased by around 400bio (ignore the increase in thrift demand deposits, this is a first week of april thing that I’ve yet to pin down but reverses through the year). Unfortunately, this came before the policy measures by the Fed and the Govt - the most probably explanation is companies drawing down revolving lines of credit and issuing more bonds to shore up their cash positions. Indeed, the 400bio increase is more than matched by a 500bio increase in industrial and commercial loans recorded in the fed’s H8 release.
The picture for April is, so far, not optimistic. Demand deposits are down at banks. Savings deposits are increasing, as are retail money funds. The increase in broad money is being driven by base money and institutional money funds, neither of which can lead to money demand in the real economy. Nothing I’m seeing in the money numbers contradicts my central scenario that the government’s policy response is not big enough. Increases in savings imply that my prediction that much of the government stimulus will be saved and not spent is not groundless.
It’s unfortunate that the Fed presided over a large increase in private balance sheets in the year prior to this crisis. We could really all use the private sector stepping up to replace missing spending by taking on more private debt - but that bolt was at least partially shot in 2019 with the Feds loosening and accompanying credit expansion. I’m not carping from the cheap seats, what they did was reasonable, it just would’ve been nice to face this crisis with plenty of room to expand private balance sheets. We’re not in that position. The fiscal and monetary response is interacting with households and especially firms who’ve already borrowed a lot and likely want to save. In a couple of weeks, I’ll be revisiting these numbers to try and spot the impact of stimulus checks, and see if my pessimistic stance needs revising.
NB: This post is not investment advice and is not a trade recommendation. The views expressed here are my own and do not reflect those of my employer.