15 November 2014

Is a financial market crash in the offing?

Many commentators have expressed concern that a financial market crash could be coming soon. Others have said the US economy is chugging along nicely and there is nothing that can go wrong in the near future.

The graph below showing Year-on-Year growth of Corrected Money Supply offers insights into what could happen.

It suggests that the danger point for financial markets is when the Y-o-Y growth of CMS approaches the zero mark or falls below it. Right now the Y-o-Y growth is around 14%, so there is still some way to go before a major crash.

It is important to understand what the graph is not saying. It does not say that the instantaneous growth rate of CMS is 14% right now. In fact, as the graph below showing Corrected Money Supply from January 2011 to September 2014 reveals, CMS growth has levelled off. What the first graph suggests is that when CMS remains flat or contracts for a year or more nasty things happen in financial markets.

A natural question springs to mind. If money growth is flat why are the financial markets booming? The explanation is simple. When we say that financial markets are booming we usually mean that stockmarkets are booming as they are now or were from 2006 until the beginning of 2008. But the stockmarket is not the only financial market. We know now with the benefit of hindsight that from 2006 to 2008 the housing market was contracting and that it eventually brought down all other markets.

We can be sure that during the past six months, with money growth flat and the stockmarkets booming, some other financial asset market is contracting. What that market is we can do no more than guess.

For those familiar with the history of the US economy and financial markets the graph below showing Y-o-Y CMS growth from 1961 to 2000 may be interesting.

An especially interesting episode is around 1994 when the sharp monetary contraction resulted in the bond massacre of 1994. If the monetary contraction now under way results in a bond market crash a reasonable guess will be that it will not result in a recession.

Category: Economics

Philip George
Understanding Keynes to go beyond him

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