Broad money less supportive of asset prices in 2018

  •  Broad money growth in all four large advanced economies is healthy, but slowing
  • Crucially, the growth of non-bank financial institutions’ money holdings is subdued
  • Money data point to continued but somewhat less support for assets

As we enter into 2018, broad money growth in all major advanced economies is presenting a divided picture. On the one hand, actual broad money growth rates remain healthy. But, on the other, there has been a modest easing of growth (more than that in the UK). Moreover, higher inflation is eroding real broad money growth.

In the US, broad money (our own recreation of the M3 measure abolished by the Federal Reserve in 2006) grew by 6.7% in the year to November, slightly above the 6.5% average for the first eleven months of the year. Euro Area, M3 grew by 4.9% in the year to November, bang on its average since January 2017, and broadly in line with M3 growth since. In the UK, the growth of M4x (M4 excluding holdings of Other Financial Institutions) was 4.8% in the year to October, down from a high of 7.3% in April, but still healthy, with an average 2017 growth rate of 5.8%. Finally, in Japan, M3 has been growing at 3.4% since July; this is also the average for the first eleven months of the year.

However, real broad money (nominal broad money deflated with the CPI) is less buoyant. This is even clearer when looking at six-month annualised numbers, which give a better picture of recent trends. Of the four major advanced economies, real broad money growth is weakening somewhat in the USA, Japan and the UK. Only in the EA do we see real broad money growth broadly holding up.

The appropriate (nominal) broad money growth rate for each country varies, depending as it does on trend growth and current as well as desired inflation and the trend of the velocity of money. In the case of the USA, this adds up to about 5-7% per annum; for the EA to about 4-6%; and so on. Importantly, in spite of recent weaker data, therefore, broad money growth in the large advanced economies is currently at rates implying output growth at or above trend in 2018.

That is of course good. But with regards to asset prices, some further detail is important. The bulk of money (more than 90%) in any advanced economy consists of bank accounts held by the non-bank private sector. These can be divided into deposits held by households; by non-financial companies; and by other financial institutions/companies (OFCs). Tim Congdon has repeatedly shown that money holdings by households and by non-financial companies tend to be relatively stable.[1] By contrast, OFC money holdings not only vary much more, but also bear a closer relationship with asset prices. This is partly because OFCs tend to want to or have to hold most of their assets in something else than cash and usually have small desired cash/asset ratios.

Central banks don’t always publish data on the breakdown of deposits by holder. The Federal Reserve only does so quarterly, in the Financial Flows data, most recently Q3 2017, (although there is a helpful weekly and monthly series, see below), while the ECB and the BoE do so on a monthly basis. The BoJ, by contrast, only reports household and corporate (financial and non-financial combined) deposits. But this still gives us data for three of the four advanced economy large financial centres.

For the US, although the data is erratic and the very latest quarter shows a weaker OFC deposit growth rate, the medium-term trend is nevertheless still gently, if erratically, up. Moreover, there is another leading monetary indicator of US asset prices. This is large (i.e., in excess of $100,000) savings deposits. These are not included in the Fed’s broadest money measure M2, although they used to be part of M3. However, it stands to reason that the actions and deposits of households and companies that can afford to have in excess of $100,000 in a bank account, are likely to be more relevant for asset prices than holdings of those who cannot command such sums. As it happens, data on large time and savings deposits is published weekly and monthly.  Recent figures show another surge in large time and savings deposits, implying further support for US equity prices.

Euro Area data is much less positive, with the deposits of both insurance companies and OFIs still contracting on a twelve-month basis. In both cases, there has been something of an upturn since the spring of 2017. However, if the message from US money trends for asset price developments in 2018 is relatively buoyant, in the EA, the message is quite pessimistic. As against, that, the continuation of ECB asset purchases (QE) until at least September, should act to underpin asset prices.

In the UK, finally, although OFC deposits growth has trended down since April, more recent data show a pick-up in the very last few months, which may imply a trend change. Overall, however, the monetary message for UK asset prices is also at best somewhat subdued.

Hence, the monetary message for asset prices in 2018 is some continued support, but less than in 2017. The question is now whether there is anything that could offset this in 2018? Leaving aside the ever-present possibility of a Black Swan event, there seem to be four possible threats:

  • A sharp fall in business and household confidence. Of course, this begs the question of what would trigger such a fall, but, occasionally, there is no obvious trigger. Hence, it is worth mentioning in its own right.
  • A collapse in the crypto-currency market. We have previously made our view on Bitcoin et al clear, that it’s a bubble. This is not a unique or unusual view. Nevertheless, a precipitate fall in crypto-currency prices (taking Bitcoin below $5,000, for instance, or even lower), could be a loss of confidence trigger in a marginal section of markets that then spreads more widely.
  • An earlier-than-expected end to ECB quantitative easing. The ECB is taking great pains to convince markets that its asset purchases will continue at least until September 2018. But it is no secret that the combination of quantitative easing with above-trend growth is causing unease in a number of countries, notably Germany. It is possible that further strong growth in the spring will force the ECB to taper and perhaps end its purchases sooner than currently expected. Although coming as a result of economic strength, it would still most likely hit confidence, while the end to QE would remove monetary support for asset prices.
  • Accelerated monetary policy tightening. The world economy should see another year of healthy growth in 2018. However, there is a possibility that central banks, under the influence of strong economic activity and (likely but still modest) accelerating inflation move more rapidly towards ‘normalising’ interest rates.

To repeat, these are the threats, the downside risks. The overall monetary message for asset prices in 2018 remains moderately positive. Moreover (and to quote Old Turkey, the character from Reminiscences of a Stock Market Operator), “After all, this is a bull market.” These tend to run on, powered by their own momentum, until something suddenly snaps.


[1] See, e.g., Tim Congdon, Money and Asset Prices in Boom and Bust, IEA Hobart Paper 152, 2005; Money in a Free Society, Encounter Books 2011; and Money in the Great Recession, Edward Elgar, 2017