Free supply money and growth: III
III. Free supply money and behaviorism
To understand the relations between the free money supply and the GDP growth, it is necessary to understand with what actually correspond, concretely, the variations of the monetary aggregates.
As Americans fear that their situation is degraded in a near future, they spend relatively less and they thus increase their saving, which means that M2-M1 increases and that the growth of the real GDP slows down: saving and growth are inversely proportional.
Conversely, as they anticipate an improvement of their situation, they spend more by decreasing their saving: M2-M1 decreases and the growth of the real GDP increases.
Finally, this law of free money supply is simple!
What is important is thus the reaction of Americans, i.e. the individuals, which is visible starting from the variation of the monetary aggregates, and not the relative variation of monetary aggregates and GDP in mass, in abstracto.
There is besides no observable correlation between the variations of the monetary aggregates and the GDP both deflated, i.e. in real values as opposed to what think the Austrian economists.
The behavior of the households is thus determining: it explains this almost perfect correlation between the free money supply M2-M1 in current prices (not deflated) and the growth of the real GDP on the 50 last years in the United States and the same results that one finds for example in the euro zone, in Thailand and everywhere else.
The reactions of the households are very fast and very elastic. The Fed publishes Thursday evening the data of M1 and M2 which makes it possible to know with only 10 days of delay the behavior of the households, and thus the most recent trends of the behavior of the Americans.
Thus, it is possible to know almost in live the trend of the GDP and thus to correctly anticipate the markets, before the investors who do not know this law of free money supply... from where its interest because the speculation is then winning!
The Fed raised its basic rate under its neutrality (4 percent) in December 2005. The T-bond markets reacted the first: the curve of the rates became flat, even reversed, which always announces a fall of the growth of the real GDP within 6 month.
Indeed, the growth started to lower 6 months later: as from June, which is observable on the data of M2-M1 which increases starting from this date because Americans smelled well that their situation would not improve in the near future.
They thus increased their saving (M2-M1) and relatively decreased their purchases what made decrease the growth of the real GDP.
The trend continues: the GDP growth decreases (it was at 2 percent in the third quarter compared to the precedent, but it was high in fourth quarter thanks to a wealth’s effect and the globalization).
The FOMC members raised too late and too slowly their basic rate, which involved a too strong GDP growth, higher than its optimal potential, therefore inflationary.
To make fall inflation in the ideal range from 1 to 1.5 percent, they are obliged to create a fall of the growth, and even a recession. However, as the American economy is very strong, the fall is slow but certain. As the stocks markets badly anticipate this slowdown of the GDP growth, there will be soon a collapse.