The above chart shows that money supply as measured by M3 is soaring. I suppose one could nitpick about the latest drop from +12% annual rate of growth to +10% annual rate of growth but seriously that would be just nitpicking.

So money supply is soaring … Right? Not so fast. Let’s take a look at M Prime. I first talked about M Prime in Money Supply and Recessions. M Prime is based on Austrian economic theory that distinguishes money from credit. Those interested in the details can click on the previous link, but essentially M Prime approximates M1 with sweeps added back in.

Sweeps are automated processes whereby banks clear (sweep) excess funds from checking account nightly into other accounts so that it can be lent out. Sweeps originated in 1994 and with sweeps the last semblance of any sort of reserves went right out the window.

With the minor exception of things like travelers checks accounting, M Prime is pretty much a reconstitution of what M1 looked like prior to 1994. Here are a few charts.

Long Term M Prime

Real (CPI Adjusted) M Prime

Note: The latest sweeps data we have is from March. That data was extrapolated forward through the first week in May. A quick look at the above charts will show this is likely to be a minor consequence. Thanks to economist Frank Shostak for the idea behind M Prime. Thanks to Bart at NowAndFutures for reconstructing M3 and for the charts in this post.

Hmmm. M3 is soaring while M Prime is contracting… So what’s it all mean?

What does it mean?

  • Credit is expanding rapidly but with fractional reserve lending via sweeps and other mechanisms such as GSE debt creation and various carry trades, actual money itself is now contracting.
  • This is further proof that the Fed has now totally lost control. What else can it mean when credit is soaring in the face of what otherwise appears to be rather tight monetary policy?
  • The distinction between money and credit is significant. A huge expansion in money supply leads to hyperinflation like the Weimar Republic or Zimbabwe.
  • A huge expansion in credit eventually leads to things like the tulip mania implosion, the railroad bust, and the great depression.
  • The Fed will fight this tooth and nail but right now their hands are tied. When the Fed starts lowering rates to combat this malaise, look for gold to soar.
  • Long term, there is no way out. The policies of Greenspan and Bernanke will be repudiated.

Many eyes are focused on M3 but my eyes are also watching M Prime. And while I still think M3 will eventually implode, the contraction in M Prime right now tells two stories.

  1. How the Fed that has totally lost control of credit
  2. How much credit expansion it takes to grow jobs and the GDP at very anemic rates

The kicker to this mess is that the current round of leveraged buyouts will soon lead to a contraction in jobs. Those LBOs are being funded by reckless increases in debt (the same thing that fueled subprime lending and the housing bust). To pay back that debt will require a cutback in expenses. A cutback in expenses invariably means a cutback in jobs and expansion. Look for many of these deals to default and for various pension plans chasing yield to be left holding the bag.

This post originally appeared in Minyanville. Jeffrey Cooper on Minyanville is writing about Hoofy in La La Land. You may wish to check it out.

Mike Shedlock / Mish/