The Monetary Base (as-of week ending 1/21/10)

This is the most recent graph of the adjusted monetary base, which is produced by the St. Louis Federal Reserve Bank.

What is evident is the pace of growth has moderated, and most recently, has declined. Should this continue, an sharp fall in the real and stock market is inevitable. However, if the Central Bank ramps up money creation, it risks making the forthcoming price inflation worse. Price inflation has not reared its ugly head because banks have not lent the money provided by the FED. Banks are not lending because not only there are fewer worthy borrowers but also because their balance sheets are still weak. As a result, excess reserves--the amount of money exceeding the legal requirement--are still elevated. If these reserves were disbursed into the economy, then fractional reserve banking would multiply money many times over. Price inflation is envitable in this environment.

There are only two feasible options going forward: 1) reduce the monetary base, thereby reducing the money supply. This will cause yields to increase, markets to fall, and creating a severe economic slump. 2) Increase the monetary base, thereby stocking inflation, and potentially killing the currency. What is always difficult to assess is the severity of either outcome.

Stay tuned...