Monetary Base Indicates Recession

You can view the short-term adjusted monetary base here:

You can view a longer term chart of the monetary base here:

You can view the excess reserves held by commercial banks here:

The adjusted monetary base is indicating that a recession is ahead.  The Austrian Business Cycle Theory tells us that an artificial boom will turn into a bust when the there is a deceleration in the money supply.  There does not have to be a contraction in the money supply.  It just has to be a reduction in the rate of increase.  If the money supply is growing at 10% per year and then it slows down to 5% per year, this could be enough to cause a bust.

In our current situation, there is actually a slight decrease in the adjusted monetary base since the end of QE2 back in June of this year.  Although we have not really seen a boom, the large increase in the money supply in the last 3 years indicates that things may have seemed better that they otherwise would have been without the large monetary increase.  Regardless, the monetary inflation of the last 3 years has misallocated resources and this will need to adjust at some point.  The bigger problem is that the original large misallocation that took place prior to 2008 was never allowed to correct.

So in just looking at the chart of the monetary base, it looks like we should see a recession coming.  However, there is a big "but" here.  Starting in late 2008, we saw something that we had never really seen before.  The excess reserves held by commercial banks increased dramatically as shown in the link above.

Typically, banks will lend almost all of their money and keep just enough to stay within the reserve requirements.  If they fall below the reserve requirements, then they can borrow money from the Fed on an overnight basis, which is the Fed funds rate that the Fed controls directly (except now because banks don't need overnight borrowing, which is why the Fed funds rate is so low).

In 2008, the Fed started paying banks interest to keep their excess reserves with the Fed.  However, I have never really believed that this is the reason that banks have dramatically increased their reserves.  The Fed is only paying a quarter of a percent interest.  I think the reason the banks have increased their reserves as never before is because of their bad financial positions and their fear of what is still looming in the economy.

Regardless of the reasoning, the increase in the excess reserves has just about imitated the dramatic increase in the monetary base since the fall of 2008.  This has kept price inflation in check.

So while the monetary base is indicating a recession, the excess reserves are not.  If we see a drop in the monetary base with an increase of reserves (or at least no change), then a recession is more likely.  On the other hand, if the Fed keeps the monetary base steady and we see a big drop in excess reserves by the banks, then you should prepare for severe price inflation.

Right now, it is still a tug-of-war.  I would not be surprised to a see a mini-boom cycle with the stock market and commodities continuing to go up in price.  I also would not be surprised to see a recession.  There are a lot of factors out there.  Right now, we should be in asset protection mode and we should keep watching the charts above.  If there is any big change, I will be sure to let you know.