This past summer, I wrote about an indicator that is frequently overlooked but that can actually provide a good read on the U.S. economy: the nation's money supply -- specifically, the narrowest definition of the money supply, M1.

M1 consists of the most liquid forms of money, namely cash in circulation and money in people's -- and companies' -- checking accounts.

When the economy is picking up, M1 tends to rise as businesses write more checks for wages and other expenses; conversely, when the economy is slowing down, M1 falls as businesses write fewer checks.

In the intervening six months, the Federal Reserve has taken a number of steps to pump money into the banking system. It has cut short-term rates three times. It has also intervened in the money markets, in a very pronounced way, via repurchase agreements.

These are arrangements to add reserves to the banking system by purchasing Treasuries and other securities from dealers for a specified period of time. Typically, dealers buy back the securities after one to seven days, but recent repos conducted by the Fed have been for much longer periods.

Normally, when interest rates fall, it becomes easier for consumers and businesses to borrow money -- money that ultimately ends up in people's pockets and in their checking accounts.

So you would expect that the central bank's actions would have registered in the lastest readings on M1. However, as you can see in the chart below, M1 has actually been pretty flat. Despite all of the stimulus, the money the Fed injected into the banking system has barely offset the money taken out.

Pushing On a String
The Fed can cut rates, but it can't force banks to lend money, which would increase the money supply.
Click here for larger image.
Source: tba

That suggests the central bank's actions are not helping the economy -- it may indeed be pushing on a string.

The longer-term trend I discussed in my previous story has not changed: The contraction of M1, which is indicated by the line dropping below 0.00%, is a sure sign of economic weakness, and that line has been breaking into negative territory on an increasingly regular basis from late 2005 to the present.


Growth in M1
M1
$ Billions
% Change
2005-Mar 1371.4 -0.28%
June 1380.7 0.68%
Sep. 1379.3 -0.10%
Dec. 1373 -0.46%
2006-Mar 1383.7 0.78%
June 1375.6 -0.59%
Sep. 1364 -0.84%
Dec. 1366.2 0.16%
2007-Mar. 1368.4 0.16%
June 1366.9 -0.11%
Sep. 1369.7 0.20%
Nov 1363.8 -0.43%

Sam Patel, CFA, is the manager of mutual fund research for the TheStreet.com Ratings.

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