The U.S. Fed and China Lead Money-Supply Bull Market

Ever since the creation of fiat money, the expansion of credit has consistently debased the purchasing power of paper currency. Only governments can create paper, and to do so requires growing bank credit. Most governments statistically record broad money-supply growth, except the United States, who decided to stop publishing M3 in 2006. The Federal Reserve, however, continues to publish narrow monetary aggregates, M1 and M2.

Only a few central banks have historically done a good job expanding credit while simultaneously suppressing inflation and protecting the purchasing power of their money. The German Bundesbank and the Swiss National Bank are tops on that list followed by the Austrians and the Dutch. In 1999, the German, Austrian and Dutch central banks became redundant on the heels of the new European Central Bank (ECB), now based in Frankfurt. The ECB remains largely a dominant German-thinking institution even though it’s Chairmen rotate leadership.

Below is a telling chart I’m sourcing from the incredible mind of Richard Russell’s Dow Theory Letters. Russell has been a mentor to me since I first started investing in 1990 and I continue to religiously follow his technical analysis of the market.

The above chart depicts a synthetic creation of M3 since mid-2006 (dark blue line) called the SGS or Shadow Government Statistics. You can get a full view of this chart by right-clicking your mouse on the chart. What we see here is a mind-blowing expansion of credit since 2005 in excess of 15% over the last 12 months – highly inflationary and bearish for the dollar. Basically, the Fed is printing hard and will print even more money over the next 12 months as interest rates ease further amid a deflationary tug from housing and sub-prime credit.

China’s expansion of credit makes the Fed’s M-3 charge look like a minor leaguer.

China is home to the fastest-growing economy in the world over the last decade as foreign direct investments skyrockets while the country logs enormous trade surpluses with the rest of the world. In September, the European Union became the largest destination for Chinese exports, surpassing the United States. China currently holds the largest war-chest of foreign-exchange reserves in the world at $1.4 trillion dollars.

China needs to grow her economy at a high rate. That’s because its huge population requires constant employment growth, especially when migration into the cities is on fire. But to keep the populace employed and its export-machine greased, The People’s Bank of China is growing its broader monetary aggregate, or M2, at a wicked 18.1% annualized clip. What’s especially amazing about that statistic is that it’s down from 22% just 12 months ago as the government slowly tries to curb credit growth in order to quash excessive lending.

For now, bank credit continues to expand in the double-digits across most OECD countries, including several in the European Union. That development should continue to find its way into financial assets as governments print credit; excess supply of that credit must be absorbed by the markets and eventually will result in higher inflation. This relationship, more than any other variable, supports the bullish case for gold in the late 2000s.