The amount of Total Bank Credit is a direct result of Fed’s actions with regard to liquidity in the financial system. It represents the money provided by the Fed to commercial banks for lending and thereby supporting business in a credit-based economy. The chart is a fascinating monetary mirror reflecting in panoramic view monetary policies and the many actions the Fed had to engage in response to a panoply of financial shocks and diverse economic/financial circumstances over a span of 28 years. From the steady dis-inflationary monetary policy of Chairman Volker evident on the left half of the chart to the first 13 years under Chairman Greenspan when multiple massive liquidity injections were necessary to stave off the aftershocks of various crises: Mexico crisis (1), Russian-Asian crisis (2), Long Term Capital Management crisis (3), Year 2000 computer software threat (4), 9/11 (5).After all these episodes, however, Chaiman Greenspan was careful and fast to withdraw the excess liquidity just created so that the average annual growth of Total Bank Credit did not deviate from the 7.8% that prevailed during the previous 20 years. However, with the onset of the Iraq War (6)the Chart clearly shows that the Fed was forced to embark on a higher and more sustained phase of increased liquidity provision. Thus, in the past 5 years Total Bank Credit has increased to an average 9.5% annual rate. Finally, since the onset of the current subprime debt crisis, Total Bank Credit has literally exploded with no evidence of slowing. Indeed, right now it is not far from challenging the historical high levels of the 70s when Chairman Volker started his clamp down monetary action.
It is left up to the readers to examine the Chart and judge for themselves if the Fed is withdrawing liquidity from the financial system at the present time.

Concerning the question about relationships between measures of money supply and inflation, any exercise to establish links between these two parameters is destined to be futile. These liks have been severed since long ago. In the early 80s, the theories of Prof. Milton Friedman, the Father of Monetarism, became so famous and popular that markets lived and breathed by the releases M1 money supply figures by the Fed. Prof. Friedman then tried to put into practice his ideas and teachings by publishing a weekly column in Businessweek magazine (or Newsweek, we don’t recall exactly) that gained considerable notoriety as it included a chart, continuously updated, showing the close correlation in previous years between M2 and inflation with a 6 months lag. The purpose of the chart was to inform readers in advance about how much inflation they could expect in the near future. The Fed made a similar attempt in the late 80s (does anyone remember the famous Greenspan’s P star?). Unfortunately for both Prof. Friedman and the Fed, the link stopped working and pretty soon Prof. Friedman had to discontinue writing his column and the Fed publishing its P star!. Later on, in his retirement , Prof. Friedman had to formally repudiate monetarism. Why?. Because monetarism can be successfully applied only to regulated, fairly closed economies as that of the US’ was in the 60s and 70s, it could not work in a globalized economy with huge wage differentials between developed and developing countries. Since labor costs are by far the most important determinants of prices (as much as 75-80 % for manufactured goods), it is increases of salaries and wages that mainly determine the rate of inflation. When the demand for such increases is muted by massive foreign labor supply shocks, unrestrained labor arbitrage across national borders, and weakened labor unions, as is the case at the present time in the US, it is impossible for inflation to be linked to money supply or Fed actions. If Greenspan and Friedman had to give up trying…..you fill in the dots.

About the third question as to whether the recent decline of Gold was due to a "deflating Fed", readers are referred to the GOLD BAROMETER update posted soon after the beginning of the Gold correction. This decline occurred within minutes from the release of the Fed’s latest announcement of a rate cut lower in size than expected by the markets. The nearly simultaneous occurrence of these two events leaves no doubts about their linkage. Since then, concerns about the falling dollar and its effects on Oil price and headline inflation appear to be influencing not only the Fed’ attitude toward future rate cuts but also that of other major Central Banks. In a report published today, Elga Bartsch, a member of Morgan Stanley’s respected Economic Team, writes "Non-conventional action by the Fed to address the liquidity crunch, hawkish comments from the ECB and sustained attention by the Bank of England to inflationary pressures have pushed markets to price in fewer hikes for these central banks". In addition, there is now a growing body of opinion among prominent economists against too drastic interest rates cuts by the Fed..

These are the factors that affected Gold negatively recently and that likely will cap its price at least in the short term. However, as important as they are, they cannot be equated by any stretch of the imagination to the effects of a "deflating Fed". At most, they could define a slightly less aggressive "re-flating" Fed. Thus, if the Fed’s guidance will develop in the direction of not cutting the target Fed Fund rate to below 2.0 in coming months, it is conceivable that Gold prices will remain capped within the recent range for the rest of the year, and perhaps longer.