Tuesday, November 13, 2007

Kudlow 101: The Run to Cash

All these subprime credit fears are real. The question is how long will it last? How deep is it going to run?

Here’s what’s happening right now—one of the key reasons stocks have been beaten up of late. There’s a huge run to cash going on.

Check out this first chart on money supply:

MZM, narrow money, is growing now at about a 20 percent rate. That is unbelievable. Most of that is institutional money funds. These are the big guys, the Fidelities of the world.

Now, should that be inflationary? No. It’s deflationary. Here’s why. Take a look at the second chart:

MZM velocity (the rate of turnover) is plunging.

During inflation, money burns a hole in your pocket. Nobody wants to hold it. During deflation, everyone wants to hold money, so velocity (turnover) goes down. Money demand goes up. That is anti-inflationary.

Check out the final chart:

The 10-year Treasury bond keeps falling. From 5.30 percent last spring all the way down to around 4.21 percent today. That is not an inflationary scare.

I believe we’ve had a big trading bubble in euros, oil, and gold. The real underlying issue here is a deflationary wave. People want to hold cash. The big guys are investing in money market funds, not stocks, for the time being. And that has caused the volatility.

I see more deflation, not inflation.