Will falling commodity prices cause deflation?

Some readers expressed concern about falling commodity prices, especially crude oil, and whether this will cause global deflation. This confuses the cause with the symptom.

Crude

Falling prices are largely benign except where caused by a contraction of the money supply. Commodity prices may fall when there is an excess of supply over demand, but this is soon absorbed by changes in consumer behavior. Discretionary spending will rise in response to the savings, so that aggregate demand is unaffected.

A contraction in the money supply, however, is far more serious. Slow growth in the monetary base (below growth of real GDP) results in less money chasing the same goods, driving down prices. Supply and demand in this case are unchanged, but prices fall because of a contraction in the money supply. Wages, however, are sticky and do not fall in line with prices, leading to falling profits, cuts in production and job layoffs. Falling income from lower profits and fewer jobs leads to a contraction in aggregate demand, causing further cuts to production and income.

Contraction of the money supply also places pressure on banks to reduce lending. This danger was highlighted by Irving Fisher in the 1930s. Contracting credit reduces not only new investment but forces existing borrowers to liquidate some of their assets, mainly stocks and property. The surge of selling, and limited availability of credit, drives down asset prices. A feedback loop results, with falling asset prices prompting banks to further contract lending — in turn causing more price falls. That is the central bankers’ equivalent of a perfect storm. The graph below shows how close we came in 2009 to a deflationary spiral.

Working Monetary Base

Slow growth in the monetary base caused a sharp contraction in bank lending (below zero) in 2009. Only prompt action by the Fed averted a 1930’s-style collapse of the financial system.

The Fed indicated in October that it will curtail QE and no longer expand its balance sheet to support money supply growth. Should we expect another contraction of the money supply as in 2008?

The answer is: NO. When we look at the graph of the Fed balance sheet below, we can see that total asset growth [red] is slowing. But bank deposits at the Fed — excess reserves that earn interest at 0.25% p.a. — are slowing at an even faster rate. That means that the actual amount of money flowing into the banking system is not contracting, but increasing.

Fed Total Assets and Excess Reserves

The following graph shows a net growth rate (of Total Assets minus Excess Reserves on Deposit) of more than 20 percent. Expect growth to slow over time, but the Fed can adjust the interest rate payable on excess reserves to ensure that it remains positive.

Fed Total Assets minus Excess Reserves

Deflation is a far bigger problem for the Euro. After a “whatever it takes” surge in 2012, the ECB attempted to contract its balance sheet far too soon — withdrawing treatment before the patient had fully recovered. They also do not have excess reserves on deposit, like the Fed, which could soften the impact.

ECB Total Assets

The result has been faltering economic growth and price levels falling dangerously close to deflation.

ECB Total Assets

The ECB appears to have recognized its error, indicating that it will expand its balance sheet if necessary to avert a monetary contraction. If they learn from their past mistakes, the ECB should be able to avoid any threat of deflation.

A tale of two economies

Stock markets in Western Europe and Asia are rallying on the strength of falling oil prices, joining the US in a bull trend. But primary producers, largely dependent on commodity exports, are likely to suffer as a result of falling prices. Australia is no exception.

The S&P 500 continues a primary advance. A conservative target would be 2200*. Rising 13-week Twiggs Money Flow indicates medium-term buying support. Reversal below 2000 is unlikely, but would warn of another correction.

S&P 500 Index

* Target calculation: 2000 + ( 2000 – 1800 ) = 2200

CBOE Volatility Index (VIX) indicates low risk typical of a bull market.

S&P 500 VIX

Germany’s DAX is testing resistance at its earlier high of 10000. Recovery of 13-week Twiggs Money Flow above the declining trendline suggests medium-term buying pressure. Breakout above resistance would offer a conservative target of 11000*. Reversal below 9000 is unlikely, but would warn of a primary down-trend.

DAX

* Target calculation: 10000 + ( 10000 – 9000 ) = 11000

The Footsie is also testing long-term resistance on the monthly chart — at 6900/7000. The sharp rise on 13-Week Twiggs Money Flow indicates strong medium-term buying pressure, but resistance at the December 1999 high is likely to be solid. Reversal below 6500 remains unlikely.

FTSE 100

China’s Shanghai Composite Index cleared resistance at 2440/2500, signaling a primary up-trend. 13-Week Twiggs Money Flow respect of its rising trendline confirms (medium-term) buying pressure. I remain wary of China. The recent rate-cut by the PBOC is cause for concern, not jubilation.

Shanghai Composite Index

* Target calculation: 2500 + ( 2500 – 2000 ) = 3000

Japan’s Nikkei 225 Index is headed for long-term resistance at 18000. 13-Week Twiggs Money Flow oscillating above the zero line indicates long-term buying pressure. Reversal below 16500 is unlikely.

Nikkei 225 Index

* Target calculation: 16000 + ( 16000 – 14000 ) = 18000

The ASX 200 is undergoing another correction. Respect of support at 5250/5300 would indicate the primary up-trend is intact — but 13-week Twiggs Money Flow reversal below zero warns of strong selling pressure. Breach of support is likely and would warn of a test of 5000.

ASX 200

* Target calculation: 5650 + ( 5650 – 5300 ) = 6000

Markets rebound except for ASX

  • US stocks continue their bull-trend
  • European stocks strengthen
  • China likewise
  • ASX Energy and Materials sectors under pressure

The S&P 500 broke through the upper border of its broadening wedge formation, signaling a fresh advance with a target of 2300*. Rising 13-week Twiggs Money Flow indicates medium-term buying support. Reversal below 2000 is unlikely, but would warn of another correction.

S&P 500 Index

* Target calculation: 2050 + ( 2050 – 1800 ) = 2300

CBOE Volatility Index (VIX) at 13 continues to reflect low risk typical of a bull market.

S&P 500 VIX

Germany’s DAX broke through resistance at 9400/9500, signaling another test of 10000. Rising 13-week Twiggs Money Flow refllects medium-term buying pressure. Reversal below 9400 is unlikely at present, but would warn of another test of primary support at 9000.

DAX

* Target calculation: 9000 – ( 10000 – 9000 ) = 8000

The Footsie is also headed for a test of its long-term high at 6900/6950. The sharp rise on 13-Week Twiggs Money Flow indicates strong medium-term buying pressure. Reversal below 6500 is unlikely.

FTSE 100

China’s Shanghai Composite Index respected support at its 2013 high of 2440, signaling a fresh advance. 13-Week Twiggs Money Flow respect of its rising trendline confirms (medium-term) buying pressure.

Shanghai Composite Index

* Target calculation: 2400 + ( 2400 – 2300 ) = 2500

The ASX 200 is weaker, undergoing another correction. Respect of support at 5250/5300 would indicate the primary up-trend is intact — as would a 13-week Twiggs Money Flow trough above zero. Penetration of primary support at 5120/5150, however, would signal a primary down-trend.

ASX 200

* Target calculation: 5650 + ( 5650 – 5300 ) = 6000

ASX 200 Materials (15.7%) and Energy (6.0%) sectors have commenced a down-trend. This is in sharp contrast to the Financial (46.2% including REITs) and Health Care (5.2%) sectors which continue in a healthy up-trend. It is possible for the first two sectors, with a combined weighting of 21.7%, to reverse the broad index, but is not likely unless the contagion spreads to the Industrial and Financial sectors. Increased risk-weightings for home mortgages and stronger capital ratios for major banks are likely recommendations of the Murray inquiry. These will improve the long-term strength and growth prospects for Financials, but a negative reaction in the short-term could tip the sector into a down-trend.

ASX 200 sectors

Each generation has its own Berlin Wall | Gary Kasparov

Garry Kasparov is Atlas Network’s 2014 Templeton Leadership Fellow and spoke at the closing ceremonies of Atlas Network’s 2014 Liberty Forum & Freedom Dinner.

November 13, 2014 – New York City

Usually saying “thank you for having me here” is a perfunctory opening, but for me, especially on this occasion, it has a very sincere and personal meaning. The kind of brave people in this room, and a few actual people in this room, share some of the credit for my freedom and the freedom of hundreds of millions of people like me who were born behind the Iron Curtain. I thank you and we all thank you for your efforts and your belief that the right to individual liberty should not be based on where you are born.

Unfortunately, that attitude seems to have fallen along with the Berlin Wall. If people like Obama and Cameron had been in charge instead of Ronald Reagan and Margaret Thatcher in the 1980s I would still be playing chess for the Soviet Union!

But instead, I am truly very happy to be here. If only my die-hard Communist grandfather could see me now!

November 9, 1989, was one of the most glorious days in the known history of the world. Hundreds of millions of people were released from totalitarian Communism after generations of darkness.

There is no shortage of scholarship and opinions about why the Wall came down when it did. I am happy to engage in those endless discussions, but we must recognize that looking for a specific cause at a specific moment misses the point. We do know that without the unity of the free world against a common enemy, without a strong stand based on refusing to negotiate over the value of individual freedom, that the Wall would still be standing today.

Yes, there were alliances and rivalries and realpolitik for decades. Yes, individuals played a part on both sides, from Ronald Reagan and Margaret Thatcher to Lech Walesa and Pope John Paul II, to Mikhail Gorbachev unleashing forces he could not control. The critical theme was as simple as it was true: the Cold War was about good versus evil, and, just as importantly, that this was not just a matter of philosophy, but a real battle worth fighting. Society supported the efforts of those great leaders, society supported the fight and the principles behind it. But as Milton Friedman wrote in 1980, “Society doesn’t have values. People have values.” So we must talk to people about these principles of freedom. We must spread this message far and wide.

In today’s era of globalization and false equivalence it can be hard for many of us to recall that most Cold War leaders had seen true evil up close during World War II. They had no illusions about what dictators were capable of if given the chance. They had witnessed existential threats with their own eyes, seen the horror of the concentration camps and the use of nuclear weapons in war. In some ways it is a shame that today the names of Adolf Hitler and Josef Stalin have become caricatures, as if they are mythological beasts representing an ancient evil that was vanquished long ago.

But evil does not die, just as history does not end. Like a weed, evil can be cut back but almost never entirely uprooted. It waits for its chance to spread through the cracks in our vigilance. It takes root in the fertile soil of our complacency. Like the dragon of Greek myth, whose teeth sprouted from the ground as soldiers, the Berlin Wall fell to pieces, and many of those pieces contained the seeds of evil.

Nor did Communism disappear when the Wall fell. Nearly 1.5 billion human beings still live in Communist dictatorships today. And another billion live in unfree states of different stripes, including, of course, much of the former Soviet Union. The desire of men to exploit and to rule over others by diktat, and by force, did not disappear. What did disappear, or, at least, what faded dramatically, was the willingness of the free world to take a firm stand in support of the oppressed.

The Wall fell and the world exhaled. The long war of generations was over. The threat of nuclear annihilation that hung over all our heads was ending. Victories, however, even great victories, come at a cost.

I have written about what I call “the gravity of past success” in chess. Winning feels great, but it can also inhibit your development. The loser knows that he made a mistake, and that something went wrong, and he will work hard to improve. The happy winner, on the other hand, often assumes he won simply because he is great. It takes tremendous discipline to learn lessons from a victory.

The natural response, the human response, in the aftermath of the Cold War was to embrace the former enemy. Clinton and Yeltsin smiling and laughing. The European Union and NATO welcoming the former Soviet Bloc nations with open arms. The principle was to lead by example, to offer the newly free countries incentives to join as a full partner, with democracy and free market economies. This principle of engagement was a great success in Eastern Europe, despite the bumpy road for many. But this expansive method was also applied in places where the forces of oppression had not been rooted out. They were invited into the club with few demands, with little reciprocity. The prevailing attitude in the West was, “It’s okay, they will come around eventually. Their time has passed. We just have to keep engaging with them and wait.” But the forces of history do not win wars.

It is amazing how quickly the lessons of the Cold War victory were forgotten and abandoned! The strong moral stance and the isolation of evil were rapidly discarded. At the moment of greatest ascendancy of the forces of democracy, they stopped pressing the advantage. With overwhelming military, economic, and moral power on their side, the West changed strategies entirely.

This shift represented the public’s desire to end the tension and the decades of standoffs. Bill Clinton epitomized the mindset that it was time to move beyond the harsh Manichean worldview of the Cold War. Meanwhile, the dragon’s teeth were growing. Belorussian dictator Lukashenko began his lifetime tenure in 1994. His Central Asian dictator colleagues, Nazarbayev and Karimov, will soon celebrate their 25th anniversaries in power. It is no coincidence that the two countries from the former Soviet Union with the greatest potential to break free of this orbit, outside of the Baltics, Georgia and Ukraine, were both attacked by Russia and partially occupied.

There were no truth commissions for Communism, no trials or punishments for the epic crimes of these regimes. The KGB changed its name but it did not change its stripes. And just nine years after the statue of KGB founder Felix Dzerzhinsky was torn down in Moscow, a KGB lieutenant colonel named Vladimir Putin became president of Russia. It was one of many warning signs that went ignored by the free world.

Western soft power had reached its limits and there was no will to bring back the policies of containment. Human rights were treated as an internal issue, especially in places where profitable deals were available.

Engagement cuts both ways, it turns out. Former Soviet nations used money from globalization and their newfound market access to buy companies, politicians, and influence. Having abandoned our standards, we are being dragged down to the lowest common denominator. While destroying civil society in Russia, Putin could hire former Chancellors to lobby for Gazprom, buy the Olympic Games, and beam a global propaganda network into billions of homes around the world. The West boycotted the Moscow Olympic Games over the invasion of Afghanistan. No such threats are made today about the World Cup despite the ongoing Russian invasion of a European country.

Today’s dictatorships have what the Soviets could scarcely dream of: easy access to global markets to fund repression at home. Not just the petro-states like Russia, Iran, and Venezuela, but the manufacturing states as well. The idea that free world would use engagement for leverage against dictators on human rights has been countered by the authoritarian states because they are willing to exploit it without hesitation, while there is no similar will in the free world.

Engagement has provided dictatorships with much more than consumers of the oil they extract and the iPhones they assemble. They have their IPOs and mansions in London and New York; they use Interpol to persecute dissidents abroad; they write op-eds in the New York Times full of hypocritical calls for peace and harmony. And all of this while cracking down harder than ever at home. This is engagement as a one-way street. This is engagement as appeasement. This is a failure of leadership on a tragic scale.

Even the greatest ideals and traditions can lose focus after a radical change in the landscape. Symbols help us find that focus, leaving us vulnerable when those symbols disappear.

America going to the moon was not so remarkable because there was anything of value there. John F. Kennedy understood that it would become a symbol of American progress, of challenge, of difficulty, and of superiority over the USSR. A generation of new technology was developed thanks to the space race, technology that would power American industrial might into the computer age. But not long after this incredible feat was achieved, the space race fizzled significantly. The symbol was gone and no man has walked on the moon since Eugene Cernan in December, 1972. The symbol of challenge, the symbol of progress, was confused with the challenge itself. When the moon was reached, the great quest it represented was quickly forgotten. As with Hitler and Stalin, a man traveling to the moon is mostly remembered today as mythology.

The Berlin Wall was more than a symbol, of course. It literally divided a city and represented the divide between the free and unfree worlds. When it fell, it was easy to forget that those two worlds, the free and the unfree, still existed even though the Wall did not. The symbol was gone and so what it represented was forgotten. Suddenly, evil no longer had a familiar form. As 9/11 taught us, the dangers are real even though the battle lines are hazy. Allies of convenience have replaced alliances based on history and values. This is the natural result of over twenty years of treating everyone like a potential friend, a practice that emboldens enemies and confuses true allies.

But enemies do exist, whether we admit it or not. They are the enemies of what America and the rest of the free world stand for. Whether it is Putin or ISIS, these forces cannot be defeated with engagement. No, to defeat them will require the unity and the resolve and the principles that won the Cold War. In chess terms, our great predecessors left us with a winning position 25 years ago. They gave us the tools to bring down dictators and showed us how to use them. But we have abandoned these tools and forgotten the lessons. It is past time to relearn them.

Each generation has its own Berlin Wall, its own challenges to meet. Without a clear symbol to focus our energies, strong leadership is required.

America, in Margaret Thatcher’s famous phrase, is the only nation built on an idea, the idea of liberty. That idea must now build a global coalition to defend liberty against its enemies, a coalition that is based on principles, not on borders or language or culture.

In a few weeks I will be in Ukraine, and what message can I bring? That it is Ukraine’s poor luck to be so close to Russia? That the destiny of 45 million human beings is to be a besieged buffer state because it is difficult to confront Vladimir Putin? Really? More difficult than Truman standing up to Stalin and protecting West Berlin in 1948? More dangerous than for JFK during the Cuban Missile Crisis in 1962? No. But will the threat Putin represents continue to grow if left unchallenged? History tells us yes. History tells us that no dictator stops until he is stopped.

Soviet propaganda worked hard to portray Communism and the USSR as the side of good, as representing a utopian future. Putin has no interest in this. His propaganda today is all about national superiority and destiny, the fascist messaging so familiar from the Nazi build-up in the 1930s. Putin’s threat grows because the free world is letting it grow. Too many leaders still want to believe that evil was defeated for good on November 9, 1989. What could be called optimism and wishful thinking twenty years ago must now be called out as dangerous delusions.

The world needs a new alliance based on a new Magna Carta, a declaration of rights and practices that all member nations must recognize. Nations that value democracy and individual liberty now control the greater part of the world’s resources as well as its military power. If we band together and refuse to coddle the rogue regimes and sponsors of terror, our authority will be irresistible. Our combined wealth can also fund new technologies to cure our fossil fuel addiction, which currently empowers a majority of the terrorists and dictators.

The goal should not be to build new walls to isolate the millions of people living under authoritarian rule, but to come to their aid. The so-called leaders of the free world talk about promoting democracy while treating the leaders of the world’s most autocratic regimes as equals. A global Magna Carta would forbid this hypocrisy and provide a powerful inducement for reform. The policies of engagement with dictators have failed on every level. It is time to recognize this failure.

As Ronald Reagan said fifty years ago, in 1964, this is not a choice between peace and war, only between fight or surrender. We must choose. We must fight. And it must be a global fight. America must lead, yes, but it is obsolete today to speak only of American values, or even of Western values. Japan and South Korea must act, Australia and Brazil, India and South Africa, and every country that values democracy and liberty. We have every advantage in this fight for freedom. We know it can be done because it has been done before. We must find the courage to do it again. Thank you.

To hear Kasparov’s interview on Voice of America – Russian, click here. (In Russian)

Reproduced with kind permission from the Atlas Network. Atlas Network is a nonprofit organization connecting a global network of more than 400 free-market organizations in over 80 countries to the ideas and resources needed to advance the cause of liberty.

ASX under pressure

The S&P 500 continues to test resistance at 2050, the upper bound of the broadening wedge. Rising 13-week Twiggs Money Flow suggests buying pressure. Breakout would offer a target of 2250*. Reversal below 2000 is less likely, but would warn of another correction.

S&P 500

* Target calculation: 2050 + ( 2050 – 1850 ) = 2250

The CBOE Volatility Index (VIX) indicates low risk typical of a bull market.

S&P 500 VIX

Dow Jones Euro Stoxx 50 is testing resistance at 3140. Breakout would indicate an advance to 3300. 13-Week Twiggs Money Flow oscillating around zero suggests indecision. Respect of 3140 would test primary support at 3000.

Dow Jones Euro Stoxx 50

The Shanghai Composite Index retraced to test support at 2440, while declining 13-week Twiggs Money Flow indicates medium-term selling pressure. Reversal below the rising trendline at 2400 would warn of a correction, while respect would suggest trend strength.

Shanghai Composite

Hong Kong’s Hang Seng Index is weaker. Reversal below 23000 would warn of a test of primary support at 21200/21500. Twiggs Money Flow (13-week) reversal below zero would also be a strong bear signal.

HSI

The ASX 200 is undergoing another correction. Respect of support at 5250/5300 would indicate reasonable trend strength, but declining 21-day Twiggs Money Flow suggests medium-term selling pressure. With both Energy and Metals & Mining sectors under pressure, a test of primary support at 5120/5150 is likely.

ASX 200

The Aussie Dollar is also falling, having reversed below primary support at $0.8650 to signal a decline to $0.80*.

Aussie Dollar

* Target calculation: 0.87 – ( 0.94 – 0.87 ) = 0.80

Monetary Base and deflation

The Monetary Base consists of currency in circulation and commercial bank deposits at the Federal Reserve. Currency in circulation includes notes and coins both in circulation and held in the vaults of commercial banks. Commercial bank deposits at the Fed can be further broken down into required reserves and excess reserves. Excess reserves on deposit have soared — since late 2008 when the Fed started paying interest on reserves — to a level of $2.6 Trillion.

By varying the interest rate payable on excess reserves the Fed can manipulate the amount of currency in circulation. It is no longer reliant solely on Treasury and MBS purchases and sales to increase or decrease the money supply: these are merely one tool in the monetary tool-kit. So announcing that QE (security purchases) have ended does not mean that currency in circulation and the working monetary base (excluding excess reserves) will stop growing or will contract. That would cause deflationary pressure similar to the European experience. Growth, instead, is likely to continue provided that excess reserves are drawn down to compensate for cessation of QE.

US Monetary Base minus Excess Reserves and Currency in Circulation ROC

Deflationary pressures are unlikely to surface provided currency in circulation and the working monetary base continue to grow at above 5% a year. Only if real GDP grew at a faster pace (a problem we would like to have) would we encounter a problem.

Australia has similarly been keeping on the right side of 5% growth since early 2012. Provided this continues we should keep out of trouble.

Australia Monetary Base and Currency in Circulation ROC

A quiet week in the markets

  • US stocks continue their bull-trend
  • European stocks strengthen
  • China likewise
  • ASX retraces to test support

The S&P 500 is testing the upper border of a broadening wedge formation. Retracement that respects support at 2000 would enhance the bull signal and offer a target of 2280*. Rising 13-week Twiggs Money Flow indicates buyers are in control. Reversal below 2000 and the rising trendline is unlikely, but would signal another correction.

S&P 500 Index

* Target calculation: 2040 + ( 2040 – 1820 ) = 2280

Dow Jones Industrial Average has already broken above a similar broadening wedge formation, offering a long-term target of 19000*.

Dow Jones Industrial Average

* Target calculation: 17500 + ( 17500 – 16000 ) = 19000

CBOE Volatility Index (VIX) continues to reflect low risk typical of a bull market.

S&P 500 VIX

Germany’s DAX is testing resistance at 9400/9500, but 13-week Twiggs Money Flow remains weak. Reversal of TMF below zero would warn of another correction. Reversal below 9000 would confirm a primary down-trend. Follow-through above 9500 is less likely, but would suggest another test of 10000.

DAX

* Target calculation: 9000 – ( 10000 – 9000 ) = 8000

The Footsie proved more robust, breaking resistance, at 6500/6560 to signal a test of 6900. 13-Week Twiggs Money Flow is rising strongly, signaling buyers are in control.

FTSE 100

China’s Shanghai Composite Index broke resistance at its 2013 high of 2440, signaling an advance. 13-Week Twiggs Money Flow reversal below its rising trendline, however, would warn of (medium-term) selling pressure.

Shanghai Composite Index

* Target calculation: 2400 + ( 2400 – 2300 ) = 2500

The ASX 200 retraced to test support at 5440/5450. Respect would signal another test of the August high at 5650/5660. Failure of support would indicate a test of 5250/5300 and a weaker up-trend. Reversal below 5250 remains unlikely, but would warn of another test of primary support. A 21-day Twiggs Money Flow trough above zero would signal long-term buying pressure.

ASX 200

* Target calculation: 5650 + ( 5650 – 5300 ) = 6000

Henry Kissinger Looks Back on the Cold War

Henry Kissinger, former U.S. Secretary of State joins CFR President Richard Haass to discuss the Cold War. Kissinger reflects on the events, personalities, and thinking that characterized the United States and Soviet Union’s leadership.

Will the stock market collapse when QE is withdrawn?

This chart in Westpac’s Northern Exposure chart summary implies that US stocks rely on Fed balance sheet expansion (QE) for support.

Fed Securities Held Outright v. S&P 500

The curve shows an almost perfect fit. There are just two things wrong with it. First, the scales on the left and right sides of the chart are not proportionate: the scale on the left compares a 9 times increase to a 3 times increase on the right. Second, while the Fed has expanded its balance sheet to more than $4 Trillion, a large percentage of that money has washed straight back to the Fed — deposited by banks as excess reserves.

Fed Total Assets and Excess Reserves

The impact on the working monetary base (monetary base adjusted for excess reserves) is far smaller: a rise of 66% (or $544 billion) over the past 7 years.

Fed Total Assets minus Excess Reserves compared to Working Monetary Base

A chart since 1985 shows nominal GDP (GDP before adjustment for inflation) normally expanded between 5% and 7.5% a year outside of recessions. But NGDP has not recovered above 5% after 2008. This may be partly attributable to lower inflation, but the Fed would clearly want to see NGDP above 5% — roughly 3% real growth and 2% inflation.

Working Monetary Base Growth compared to NGDP

We can also see that growth of below 5% in the working monetary base is often precursor to a recession, 1995/1996 being one exception. The second is when the Fed took their foot off the gas pedal too early, after QE1 in 2010, but were able to resume in time to head off a major contraction. They have been far more circumspect the second time and are likely to maintain monetary base growth North of 5%. Too sharp a slow-down would be cause for concern.

When we calculate the ratio of total US stock market capitalisation to the working monetary base [blue line] it is apparent that market response to the increase in monetary base is far more cautious than it was in 1998/1999.

Working Monetary Base Growth compared to NGDP

With Forward Price to Earnings Ratios for the S&P 500 and Nasdaq close to their long-term average (Westpac Northern Exposure, Page 118), I consider the likelihood of the QE taper precipitating a major market collapse to be remote.