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Sludge #155 – Introducing Recession 2003-2004

In This Edition: Introducing Recession 2003-2004 – Lookout, It's The Economy Stupid!

NOTE: Authors of this report will be anonymous and wide ranging, and occasionally finely balanced. Indeed you are invited to contribute: The format is as a reporters notebook. It will be published as and when material is available. C.D. Sludge can be contacted at The Sludge Report is available as a free email service..Click HERE - to subscribe...

Sludge Report #155

Introducing Recession 2003-2004

Back in 2000 Sludge wrote extensively about NZ's vegetable economy. At the time the NZ economy was stagnant and none of the usual explanations for why worked particularly well. Notably the US economy was still doing great guns at the time.

Sludge however noticed a confluence in circumstances. Also falling in mid 2000 were vegetable prices, and NZ money supply growth.

Sludge's diagnosis of the economic ills of the time was that the slowing growth in money supply was a leading indicator for the slowing economy.

As Figure 1 below shows Sludge was spot on, M3 growth reached its low point in September 2000 and annual GDP growth fell to a low point of 1% around April 2001.

What is significant about this analysis is that, as Figure 2 below shows, M3 growth is tending towards 0 again.
FIG 2. NZ M3 GROWTH JAN 1998 – MAY 2003

Lookout, It's The Economy Stupid!

Economists will tell you – should you dare ask them – that money supply growth is demand driven - and that it tends to follow the same path as GDP growth as a consequence of that growth. That is they do not beleive that money supply per se has any significant use as an economic indicator, except as a tracker of the current state of things.

However the above two graphs show fairly clearly that this is analysis is rather back to front.

Sludge maybe experiencing some sort of visual distortion, but from the looks of the two pictures above M3 growth seems to be about as good a leading indicator of growth as you could find.

The economic reasons for this are also obvious should you dare to examine them (which bank economists won't for fear of realising that bank lending policies have very serious economic impacts.)

On a long term basis money supply growth needs to exceed the interest rate by at least the rate of annual growth. Otherwise there is insufficient money in the system to pay the interest on the existing stock of outstanding debt.

Therefore when money supply begins to fall, as it has been in the New Zealand economy since Christmas, then over time more and more of what money there is in the system is being allocated to paying interest and paying off loans.

This leaves less cash over to purchase goods and services, hence a stagnating economy.

What this all means for us here and now is that - barring a sudden explosion in credit creation – New Zealand can expect annual GDP growth to fall close to zero in coming months and possibly into recession.

Why none of this has happened yet is probably due to the magnitude of credit creation over the last three years - you can see the peak of this in late 2001 -and the impact of recent declines in interest rates.

That said, what remains of that surplus cash in the system will be being fast used up as we have experienced negative money supply growth year on year as at the end of June. The last time that happened was in May 1999 just before the economy dipped into a technical recession.

Anti©opyright Sludge 2003

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