With our dear monetary leaders only two days away from bestowing upon us their latest financial wizardry, we should be aware of the money supply dynamics in play. This week FOMC will either ramp the production of printed money, hang back and play coy while letting the existing $40 billion in MBS carry the load or heaven forbid, talk in some sort of austere manner in a bizarre game of brinksmanship.

Money Supply Discussion From NFTRH 215:

Moving on, here is how one money supply indicator got it wrong...

People who want to pump you up about hyperinflation will probably show you the stand-alone M2 money supply graph. See? They're inflating!

People who want you on Team Deflation will show you the chronic and impulsively declining view of M2's velocity.

In reality, the Adjusted Monetary Base seems to be the view that is most in line with reality. It has been stagnating since mid-2011. Here's a blown up view...

The ramp into spring of 2011 came in concert with a noisy time when inflation expectations were rising, the Bond King was going long on interest rates (short the long bond), a new Austerity movement had thrust Paul Ryan into the limelight and mobs with pitchforks were calling for "Helicopter Ben's" head.

What we have in the graph directly above is the resultant come down, with inflation blow horns being replaced with a deflationary backdrop. The Fed announced a QE operation in September, which was met by a burst of euphoria in the precious metals and markets in general. But the reality of Operation Twist and I suppose Dennis Gartman's theory of CDS maturing out the back door of the money supply shack has dampened the QE effect.

The graph is in consolidation within a massive uptrend. Just as if we were reading a stock chart, we have no reason to believe the trend is over. If the Base starts declining, then we should not stand above the data and we should not rally to a potential final slaughter. We should say "the Base is declining and maybe our current assumptions are wrong".

But as of now, to project a decline in Monetary Base would be pure wishful thinking from a deflationist's standpoint when we consider what the FOMC has repeatedly stated (not in so many words) it will promote inflation. FOMC has stated that inflation dampener Operation Twist is due to end in December, 2012. Gold and silver have been getting clobbered lately as some apparently big and powerful interests aligned against them into, and since the QE3 announcement.

Perceptions folks. If the big trends remain on track, then the current turmoil is simply about perceptions and perceptions management. Think back to 1.5+ years ago when, at the instigation of the gold bugs and inflationists they wanted to hang the great inflator, "Helicopter Ben" from the highest yardarm. "How you like me now?" says Ben.

Have patience with the process as the game changes. You can only have patience if you are strong and in this racket you can only be strong if you think like a predator. You can only think like a predator if you manage risk. See, it all comes back around.

Money Supply Discussion From NFTRH 216:

Op/Twist Ending? What next?

I learned early on not to trust a Central Banker who is wrapped up in lies and deceit. In the modern era, that would mean most of them. The outliers like Fisher, Bullard and other 'bad cops' are probably something better. But I wonder if they do not just serve as window dressing to maintain appearances of a fair debate.

FOMC has stated that Op/Twist will run through year-end, 2012 and has not indicated it will be renewed. If the selling of short-term Treasury bond instruments is removed from the current Treasury and MBS asset purchase regimes, the inflationary effect should by definition be amplified. That is because inflation is always an increasing money supply, not the knock-on cost effects that the media and the public will trumpet later on.

If FOMC drops the entirety of Twist however, including the purchases of long-term T bonds, this would leave $40 billion of MBS being sopped up per month and net of the current Op/Twist, this has not been ramping the 'adjusted' money supply as yet. Dennis Gartman says it is because as 'new' bonds are purchased old ones are maturing off the books, keeping the Fed's balance sheet stable.

The above is a more close up view of the Adjusted Monetary Base graph shown last week. Recall that the BASE is still within a consolidation that began in mid-2011 after ramping up into early 2011. The view above shows that while the BASE has not broken consolidation, it has increased since the Fed announced it would buy MBS to support the economy. A new uptrend would have to start somewhere, after all. Has it started?

The ending of Twist would leave the BASE to go on its merry way as money is printed to purchase mortgage 'assets'. Again, here we must tune out the hyper-inflationists who only want us to look at the straight M2 incline and the deflationists who would taunt us with M2's declining velocity. Absent additional asset purchases (like Twist-free long-term Treasury bonds), the BASE may have started to rise on its own.

NFTRH will keep the blown up short-term view of the BASE front and center going forward. Precious metals bulls... that 1.5+ year long consolidation in monetary base is the primary reason for the 1.5+ malaise experienced by the precious metals sector.

Regular stock market players have had an advantage that I think has to do with the strategic buying of long-term T bonds (keeping economically important long-term interest rates low, at the expense of less strategic short-term interest rates).

The stock market is a reflection of the equity of corporations and their ability to function within the economy, after all. Gold is a reflection of the monetary backdrop. Twist has provided the added benefit (for the stock market) of painting a gold-bearish picture while indicating that inflation is anything but a threat at this time.

Now we are on the brink of more honest and straightforward monetary policy operations if Twist is indeed about to end. At the least there should be $40 billion in MBS per month being monetized. FOMC could well hold off on adding straight, unsanitized monetization of Treasury bonds to keep up appearances for now. Or, they could simply let the short-term bond sales portion of Twist end while keeping up the long-term T bond purchases.

Either way, it looks like we are going to get inflation sooner or later. This inflation could be moderate or extreme. We should watch the adjusted money supply data like those above to see if the consolidation does indeed break to the upside.