LSA would like to offer a special thanks to renowned economist Brian Wesbury for taking the time to update us on his thoughts of his self-coined ‘plow horse’ economy. In this update, Wesbury addresses the notion that, in our current economy, the record gains in the stock market are a product of quantitative easing. He uses the chart above to refute this conventional belief.

The chart shows the growth of the monetary base and M2 designated money stock in the US. Monetary base is defined by the Fed as “the sum of currency in circulation and reserve balances (deposits held by banks and other depository institutions in their accounts at the Federal Reserve)¹.” M2 is widely regarded as the best representation of the money supply, and is defined as M1 (the sum of currency held by the public and transaction deposits at depository institutions) plus savings deposits, small-denomination time deposits (those issued in amounts of less than $100,000), and retail money market mutual fund shares¹.

It is easy to tell in this chart that the monetary base is accelerating, evidenced by the three distinct periods of rapid increase, caused by the massive bond purchases of the three stages of QE. Typically, the money the Fed spends to purchase these bonds is then used by the banking system to lend out and invest, promoting economic growth. When money is lent out in the form of cash, checking deposit or however, it is shown as an increase in the M2 money stock. In our current economy, however, M2 has not grown, meaning that banks are not using the money from the Fed’s bond purchases to lend and invest, but instead holding them as excess reserves. Therefore, Wesbury states, the Fed is not the driver of economic growth because, the dollars going into the banking system from QE is not being used to invest, but instead sitting in reserves and having no impact on growth.

If you would like to hear more insight from Wesbury, such as what he thinks is driving economic growth, his views on investing globally, and details of his one-on-one Q&A with Ben Bernanke, email us at info@lsaportfolios.com and send a request for the Brian Wesbury webinar. You can also follow his blog at http://www.ftportfolios.com/retail/blogs/Economics/index.aspx

¹ Source: http://www.federalreserve.gov/faqs/money_12845.h