Economy in Brief

China's manufacturing and nonmanufacturing PMIs have improved in January; each of them rising significantly. The manufacturing PMI is up to 50.1 from 47.0 in December; the nonmanufacturing PMI has jumped to 54.4 from 41.6. Both were on a string of declines; January signals expansion for the first time in four months. In the case of each one of these readings, it's just an increase for one month in a row and, while it is only one month both the diffusion indexes - on top of improving - (for the first time since September in manufacturing and for the first time since June for nonmanufacturing) are above 50, indicating growth. In the case of manufacturing, it's barely any growth because the index is only at 50.1.

Optimism grows… Still, there is growing optimism in China because it has ended its zero COVID policies and that appears to be having an almost instantaneous impact on growth. These improvements are expected to continue. However, China is coming off a period of weakness as the 12-month, 6-month, and 3-month manufacturing and nonmanufacturing PMI averages show slippages over that time sequence.

Ranked on data since January 2019 the manufacturing and nonmanufacturing gauges are above their medians for the period, both have rankings above 50. Manufacturing has a ranking-reading barely above 50 at 51.0. For nonmanufacturing it's a much more substantial position above 50 at a 75.5 percentile standing. But both sectors are responding quite quickly which isn't surprising given the nature of the zero COVID policy and this tendency for that policy to hammer at nonmanufacturing and services sectors much harder than at the manufacturing sectors as demonstrated by the large gain in nonmanufacturing in January… as the policy was abandoned.

EMU- Long slow slog of recovery? EU Commission indexes for January 2023 show continuing rebound for the European Monetary Union as it continues to climb from its October low. The January index for the Monetary Union rises to 99.9 in January from 97.1 in December. There are month-to-month improvements in all the components except for construction. The reading for construction falls to 1 in January from 4 in December. However, the industrial index rises to 1 from -1, the consumer confidence index reduces its negative reading to -20.9 from -22.1, retailing does the same, rising to -1 from -3 in December. The all-important services sector advances to a reading of 11 in January from 8 in December. These EMU indexes are net diffusion indexes that are the result of subtracting negative responses from positive responses to create the net diffusion reading. The headline sentiment reading is a different animal; it's an index.

Money and credit growth in December took a turn lower for the most part on a global basis. In the European Monetary Union, M2 fell by 0.4% month-to-month; total credit fell by 0.4% and private credit fell by 0.5%. In the U.S. the M2 money stock fell by 0.7%, in the UK (the November figures are the most up to date, and in November) the money stock fell by 1.6%. In Japan, in December, M2-plus CDs was flat.

Money supply…back in the limelight? Different economists pay different amounts of attention to the behavior of the money stock. In recent years, money supplies haven't been written about as much as they were certainly back in the 1980s when the Fed was using monetarist techniques to try to gain control of inflation. The focus on money has gradually waned as central banks adopted inflation targeting and ‘black-box-methods’ to reach these targets. (‘Black-box methods’ refers to the fact that central banks give us no idea what process they will use to reach the target, they simply commit to the target.)

In for a penny, in for a pound…or a euro, or a yen However, I don't know anyone who thinks that money supply is irrelevant. We are currently coming out of a very unusual period in history where money supplies boomed and have since busted. And this transition in money supply growth from boom to bust is usually believed to confer some amount of instability to the economy. It certainly makes forecasting anything much more difficult because to the extent that economic activity engages lags; there are the lags from this incredible boom period now beginning to interact with the lags from the bust. And how that interaction works out is complicated and may even be unknown.

The current cycle defined: In this cycle, from January 2020 to date money supply in the European Monetary Union posted its greatest year-over-year growth rate at 11.4%; in the U.S. it was 26.9%; in the U.K. it was 13.7%; in Japan it was 9.6%. The lowest growth rates in the period were 4.1% for the Monetary Union, -1.3% for the U.S., 2.5% for the U.K., and 2.7% for Japan. If we take the current year-over-year growth rate of money in each country/region and express it as a percentage of these high and low readings for growth, the U.S., the U.K., and the European Monetary Union are currently experiencing their lowest money growth of the whole period. Japan’s money growth is in the lower three percentile of this range. In the case of the U.S., money supply growth is contracting at a -1.3% rate of ‘growth’ and it's the first contraction in nominal money supply growth for the U.S. in over 61 years. Certainly, that can't be a good thing. It does not seem to plow a path to a soft landing to me…

Most do not focus on money supply… While many of us, I'm certainly one of them, tend to describe monetary policy more in terms of interest rates or in terms of real interest rates when inflation rates begin to perk up. But it's also important to keep an eye on what's going on with money growth. We remind you here this idea of lagged behavior. People may have a harder time attaching the notion of lagged behavior to real interest rate levels. But the idea that money supply booms and busts work through the economy with varying lags is more appealing to people and easier to explain. So the problem we have in the U.S. is that money supply growth boomed, peaking at a 27% annual rate in February 2021 about two years ago so if there are lags in this process it makes sense to think that we are still experiencing the lags from the boom and money supply rather than from the bust which is only now being recorded and will have its effects in the period ahead. One year ago, money supply growth was still strong: 7% in the EMU, 12.4% in the U.S., 6.9% in the U.K. and 3.7% in Japan. These growth rates place money growth in the 40th percentile of its (high-low) range in the EMU, nearly at the mid-point for the U.S. (48.5%), at the 39% mark in the U.K., and much lower for Japan at its 14th percentile. Japan should be receiving much less monetary stimulus ‘today’ from past actions compared to these other money center areas because of that low ranking. Monetary stimulus globally saw year-on-year money growth rates slow the most from their pace of one year ago around January 2022 (one year ago). More recently, the U.S. began to see growth slow sharply after July 2022; for the U.K. and the EMU, the sharper declines have been even more recent. Japan has not experienced any recent sharp changes only ongoing erosion. All four countries/regions have ongoing decelerations in 12-month money growth rates from the pace of 12-months ago tracing back to at least June 2021.

Market focus is on interest rates However, the discussion in financial markets is all about the Fed's clustering of rapid interest rate increases and people have moved ahead to worry about the restricting effect from those increases and the increases for other central banks. Looking at money supply growth and remembering that there are lags involved, it's easy to see that whatever effect we're going to have from having raised interest rates those are going to be on the same timeline as this contraction in the money stock and they lie ahead.

What is the Fed weighing? All of this makes the Fed’s behavior a little bit more curious since the Fed already seems to be bracing for a slowdown and wants to pause policy. But interest rates run below or at where the inflation rates currently reside. Certainly, the Fed is aware of these lag processes and realizes that there's some degree of slowdown coming ahead and may in fact be looking substantially at money growth rates. The money growth rates send more of a chill up your spine than real interest rates since real interest rates aren't yet restrictive because nominal interest rates have not moved up above the inflation rate. But the nominal U.S. money stock is declining for the first time in over 60 years, and slowing globally – be afraid, be very afraid...

Net-net money growth has been TOO-strong You'll notice, looking at the data in the table, that the U.S., the European Monetary Union, the U.K., and Japan all have synchronized periods of slowing and weak money supply growth. Over the last three years even with the developing slowdown in money growth, the three-year annualized growth rate in money for the EMU was 7.3%, in the U.S., 11.5%, in the U.K., 7% and in Japan, 5.3%. All of these are more than the 4% it would have taken to accommodate 2% inflation and 2% growth on a steady basis. Even with its sharp deceleration, money growth over this entire span remains excessive relative to the growth these countries/regions are capable of and their inflation targets of 2%.

The table shows that there are negative nominal growth rates for money supply in Europe and in the U.S. as well as contractions in both European credit measures. So far Japan and the U.K. have simply experienced the slowdown in money growth - in some cases a relatively sharp slowdown.

Real money growth weakness is… unreal… However, looking at the bottom panel in the table: growth rates of the real money stocks - money supplies adjusted for the effects of inflation- show that money growth has been contracting on all these measures on all time horizons from two years and in. In the case of the European Monetary Union, credit has been contracting even longer. The only exception here is that Japan's M2 plus CD's measure shows positive growth over two years but then that does transition to a contraction for real M2-plus CDs over 12 months.