ROB Insight is a premium commentary product offering rapid analysis of business and economic news, corporate strategy and policy, published throughout the business day. Visit the ROB Insight homepage for analysis available only to subscribers.
A former hedge fund manager is making a dramatically counterintuitive argument that is sure to enrage gold investors – U.S. Federal Reserve money printing has no effect on overall U.S. money supply. The truly strange thing is that it looks as though he's right, at least for now.
Mark Dow is a former portfolio manager at Pharo Management LLC and MFS Management, and was previously a debt analysis expert at the U.S. Department of Treasury and the IMF. In a blog post Sunday, Mr. Dow was blunt about his beliefs about money supply and inflation:
"There is zero correlation between the Fed printing and the money supply. If you don't believe this, you owe it to yourself to study up on monetary policy until you do."
How can this be? With considerable statistical backing, Mr. Dow is arguing that the traditional relationship between bank deposits and credit creation is now almost completely outdated.
The Fed's "money printing" affects only deposits – chairman Bernanke buys assets and the resulting funds are held as deposits by the major banks. In the past, this would create more lending. But, in the modern financial system, credit creation is far more dependent on the shadow banking market – repo agreements, collateralized debt obligations and other forms of collateral-based lending.
This new form of financial system means that banks can (more or less) create credit out of thin air based on available collateral. They are no longer restricted by deposits, so Fed operations have little effect on the money supply.
If Mr. Dow is correct (and there is significant statistical evidence on his post), the breaking of the link between Fed monetary operations and money supply means the main support for precious metals investing – the Fed is diluting the spending power of the U.S. dollar and creating inflation – no longer applies.
Gold investors will argue that Fed policy makes inflation and a much weaker dollar inevitable in the longer term. In this view, the Fed-to-money supply break is only temporary. Even so, in the present credit environment Mr. Dow's argument appears persuasive.
Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here to read more of his Insights, and follow Scott on Twitter at @SBarlow_ROB.
Scott Barlow