Is U.S. Money Supply Growing Due to Euro Panic?   (September 10, 2011)

Money supply is rising, but not just from money-printing by the Federal Reserve.

There are two articles of faith about U.S. money supply:
1) the Federal Reserve is printing scads of money
2) this expansion of money supply will weaken the dollar and fuel inflation.

So far so good, but as investors and traders it behooves us to be not just skeptical of received wisdom, but to also be wary of the infamous confirmation bias, in which we avidly seek data which confirms our already-set convictions.

This is a consequence of the human mind's resistance to changing its convictions once they are set.

Experienced traders have learned the hard way that they benefit much more from actively seeking evidence that they're wrong, not that they're right, i.e. that they've missed some key data that does not confirm their current position.

In this spirit, let's consider a data point submitted by long-time contributor B.C.:

Europe's Banking System: The Transatlantic Cash Flow into the U.S. (The Street Light)

In essence, the story suggests that U.S. money supply is surging because of external flows from Europe into U.S. banks as non-dollar assets are being liquidated and transferred into dollars in response to risk aversion (i.e. panic), and an understandable preference for dollar liquidity over increasingly risky assets held in euros.

Also of interest from the same source: Europe's Banking System: A Slow-Motion Bank Run in Progress?

Once again, avoiding confirmation bias, we might ask: what else other than external demand could spike the U.S. dollar above its critical resistance levels so quickly? If money supply growth is all Fed printing, then why is the dollar skyrocketing instead of plummeting? The dynamic offered above is the better explanation of how U.S. money supply can be expanding at the same time the dollar is spiking higher.

To ask another question: why can't gold and the dollar rise at the same time? Is their inverse correlation set in stone? Why can't the dollar and gold miners (HUI) rise at the same time? After all, if non-dollar assets are seeking a less risky home, wouldn't that explain both the demand for dollars and assets such as shares in gold mines denominated in dollars?

Just for context, global financial assets are estimated to be in the $160 trillion range. $1 trillion isn't such an overwhelming force in a foreign exchange market that trades $2 trillion or so per day.

As investors, we are better served by seeking data points and then constructing our positions on that contingent foundation rather than soldifying our convictions and then seeking data to confirm them. That's a good way to miss the dynamics at work and the opportunities they present.

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