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By New_Deal_democrat March 2, 2017 10:36 am
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Real money supply nears the caution zone
In my last "Weekly Indicators" installment, I noted that real M2 money supply has decelerated enough that it is close to being downgraded from a positive to neutral. I wanted to follow up on why that is, and relating that to the "Kasriel indicator."

The "Kasriel indicator" is a simple method that Paul Kasriel used to determine if a recession was near.  It consists of real M1 and the yield curve.  If both real M1 is negative and the yield curve is inverted, then a recession is on its way (at least since 1960).  Otherwise it is clear sailing.

One problem with the indicator is that is does not work for deflationary recessions. In particular, because the yield curve never inverted between 1929 and 1954, it misses the 1938, 1945, 1948, and 1950 recessions.  But as Milton Friedman pointed out back in his academic days, in "A Monetary History of the United States," M1 and M2 did decline during all those recessions.

For a while, real M2 was part of the Index of Leading Indicators.  But it was dropped from the index after it failed to decline before or during either the 2001 or 2008 recessions, and it was far too positive in 2009-10.

But it is true that real M1 has declined before each of those recessions, and real M2 decelerated to less than +2.5%:

So that real M2 has decelerated sharply recently, to +3.8% as of last week, puts it closer to that mark:

which is why I've indicated that if it declines below +3.0%, I will designate it a neutral.

Another useful way to look at real M1 and real M2 is their quarter over quarter change: 

Even before they turn negative YoY, typically M1 and M2 will decline q/q.  If real M1 declines q/q, and real M2 is up less than +0.6%, usually although not always that means trouble.
As of last week, real M2 was up +0.7% q/q, and real M1 is up less than +0.5%:
  Of course, for all I know, M1 and M2 could start zooming higher when they are reported late today.  But if the recent decelerating trend continues much longer, while it isn't a red flag, it is close to the zone that warrants concern.
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