British M2 and Dollar Daze

August 12, 2011
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The Economist had an interesting note last week on M2 (bold emphasis mine):

In monetarism’s heyday, central banks tried to steer the economy by controlling the money supply, which has a loose relationship with spending and inflation. Indicators like M2, which includes notes and coins and some deposits, then fell out of fashion. But central bankers are paying renewed attention to monetary measures as one gauge of the impact of “quantitative easing” (QE): printing money to buy longer-term securities. In America and Britain M2 grew quickly in the thick of the crisis, as firms and households made a dash for cash. It then began to slow in both countries, despite repeated bouts of QE. The money supply is now shrinking in Britain, suggesting its uncomfortably high inflation will pass.

Britain embraced “austerity measures” roughly a year ago — a bold move by the new conservative government. (Some think the London riots are a lag-time result of that decision.)

The British pound (GBPUSD) has been strong versus the dollar on a combination of government spending cuts, Bank of England (BOE) rate hike expectations due to inflation, and general weakness in the $USD.

How quickly that could change, though, if it becomes more apparent the global economy is headed toward recession. Against a backdrop where the money supply is shrinking, commodity prices are falling, and economic growth is stalling, the BOE could be forced back into a Quantitative Easing / emergency stimulus stance rather forcefully.

Everyone still hates the dollar, of course, but that leaves us wondering just who is left to hate it.

The Federal Reserve has been well ahead of the curve in terms of trashing the greenback (thus bidding up corporate profits for U.S. multinationals). And in various trader circles, the next leg of $USD collapse is a frequent topic du jour.

If we head into a true global downturn, though — with subsequent reflation trade collapse and “risk off” $USD boost –  it may become apparent that the Fed’s powers are tapped out, with other countries just getting started in their austerity-to-stimulus transition.

Shrinking M2 could grease the wheels of this sea change, and the pound could make for a hell of a great short in result.

JS


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