Money-supply numbers gain stature as traders look for clues to economy


After years in oblivion, the Federal Reserve's money-suppl figures are gaining new respect.

Bond traders who used to yawn at the weekly money report suddenly have begun monitoring their news wires closely Thursday afternoons -- precisely at 4:30 p.m. EST -- when money-supply numbers are released by the Fed. They say the money statistics may provide valuable clues to where the economy, Fed policy and interest rates are heading.

At a House Budget Committee hearing Jan. 22, Fed Chairman Alan Greenspan said money supply "in this particular environment will give us reasonably good signals relevant to how the economy is emerging." He added, "This is something which I would not have said two years ago."

Less than a decade ago, money-supply analysis was one of Wall Street's biggest growth industries. "Once, there was a period when the sun rose and set on the weekly money-supply statistics," recalls Robert A. Brusca, senior vice president at Nikko Securities Co. International. "Then we had another phase where nobody cared." But now, he says, "it's important once again. Thanks to Chairman Greenspan, the monetary zombies have been brought back from the dead."

Watching the money supply is highly important not only because of its influence on interest rates but also because money and credit represent the basic fuel for economic growth. The Fed, created by Congress in 1913, tries to make sure there is enough money and credit to meet the economy's long-run needs while also keeping inflation under control. Congress decided a central bank was needed after financial panics shook the country in the late 1800s and again in 1907.

If money and credit grow too slowly, that can choke the economy and lead to a recession, or even a depression. But if the money supply expands too rapidly, it can lead to inflation and higher interest rates, which in turn hurt businesses and consumers and can also lead to a recession.

Mr. Greenspan and many other analysts are focusing on money more closely these days, both because of the abrupt slowdown of various money measures in recent months and because of pervasive reports of a credit crunch, or credit-tightening, at commercial banks.

For example, one money-supply gauge, M2, has shown little or no growth during the past several months. Concern about M2 continues even though the measure rose sharply in the week that ended Jan. 21.

The Fed has been reducing short-term interest rates in an attempt to stimulate the sagging economy and accelerate money-supply growth. Therefore, money-supply figures in the months ahead may provide one important clue to monetary policy and the direction of interest rates.

There are several ways to measure the nation's money supply. The narrowest yardstick, known as M1, consists of such items as checking account deposits, traveler's checks and currency held the public. It used to be by far the most closely watched money number. Analysts argued that it was an important economic indicator because it represented money readily available for spending.

When M1's growth rate shot above the Fed's target range, traders often assumed the Fed would react by raising short-term interest rates -- and vice versa. The weekly numbers often jolted not only the bond markets but also the stock, commodity and foreign-exchange markets.

The Fed no longer has a target for M1 growth. It does, however, have "monetary objectives" for several broader measures, known M2 and M3, as well as for growth in debt. Mr. Greenspan recently singled out the M2 measure as the most meaningful now, and that measure therefore is drawing the closest attention. The M2 gauge includes everything in M1 plus certain types of savings such as money-market deposit accounts and most money-market mutual fund accounts.

Mr. Greenspan and some private economists are worried about M2 because its growth rate has been so anemic, which could spell trouble for the economy. The Fed's 1990 target for M2 was 3 percent to 7 percent growth compared with the average in 1989's fourth quarter. M2's growth for the year was 3.7 percent, but M2 growth has slowed to a trickle in recent months. The Fed's preliminary, or "provisional," 1991 target is for 2.5 percent to 6.5 percent growth in M2. That target was set at a meeting of the Fed's policy-making committee in July.

This and other targets were reviewed last week at a meeting of the group, the Federal Open Market Committee. Mr. Greenspan is scheduled to disclose the final targets later this month in his semiannual report to Congress, known as the Humphrey-Hawkins Report.

Even if the Fed does lower rates further soon, as most forecasters expect, the economy and the money supply may be slow to respond. Fears about the war and recession have made many companies and individuals reluctant to borrow. The woes of the banking and financial system also have made matters worse.

Some analysts argue that "velocity," or turnover, of money has slowed, and that this will compound the Fed's job of trying to jump-start the economy. They also warn of long and variable lags in the impact of money-supply changes on the economy. But some economists say the Fed already has done most of what it needs to do to revive the economy. They argue that the Fed's previous credit-easing moves soon will spark faster M2 growth, that the recession will be short and mild and that the Fed won't cut rates much more.

Here are several suggestions for individual investors on what to watch:

* Don't focus on week-to-week money-supply changes. These weekly numbers are highly volatile and loaded with statistical distractions.

* Do focus on longer-term trends. Look, for example, at where the various money-supply measures stand in relation to the Federal Reserve's targets. When money supply falls persistently below target, it could mean the economy is heading for a severe slump that could hurt stocks. But it can be good news for holders of Treasury bonds, because it can mean lower inflation, or possibly even deflation. It also can be a strong signal that the Fed soon will cut short-term interest rates, which would lead to declines in rates on bank certificates of deposit and money-market funds.

* Keep an eye on "bank reserves," which are contained in the weekly Federal Reserve money-supply report. Reserves are the raw material for the money supply. As with the money supply, though, don't focus closely on weekly changes. Look, instead, at monthly and quarterly changes. The Fed now appears to be trying to rev up reserve growth in hopes that will stimulate more lending and investing.

* Look mainly at M2. That's what Fed officials now appear to be watching. Milton Friedman, the Nobel Prize-winning economist and longtime money-supply watcher, also is mainly watching M2 now.

Regardless of how people feel about the reliability of the money numbers, the weekly report is likely to remain important as long as Mr. Greenspan keeps talking about it.

"The chairman has said these numbers now are more reliable, so we all definitely must pay attention to them," says Mr. Brusca of Nikko Securities. "You ignore these numbers at your own peril."

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