By Evaldo Albuquerque

In 2006, the Fed decided to stop tracking one of the measures of U.S. money supply, know as M3. At that time, the Fed said M3 did not “appear to convey any additional information about economic activity that is not already embodied in M2”. It also said that the cost of collecting the data outweighed the benefit.

For those who are not familiar with measures of money supply, the Fed reports two measures of the money supply each week: M1 and M2. M1 includes currency held by consumers and companies for spending, money in checking accounts and travelers checks. M2 adds savings and private holdings in money-market mutual funds.

M3 is a broader measure because it encompasses M2 along with large time deposits, repurchase agreements, Eurodollar accounts and institutional money-market mutual funds.

Luckily, a few economists kept tracking the data. And it’s not pretty. In the past 12 months, M3 (blue line on chart) shrunk almost 10%, suggesting deflationary pressures are more intense than suggested by other measures of money supply. This accelerating decline is looking a lot like the pace of decline seen during the great depression.

The discontinuation of the M3 measures may have been another serious mistake made during the credit bubble years. Double-digit growth of M3 during the US housing bubble was a clear sign that the boom was out of control. In early 2008, just as the Fed talked of raising rates, the sudden slow down in M3 warned that the economy was about to go into a nosedive.

Perhaps the sharp decline in M3 explains why Larry Summers, President Barack Obama’s top economic adviser, has asked Congress to "grit its teeth" and approve a fresh fiscal boost of $200bn to keep growth on track. The government is about to embark on a road of even further stimulus if the economy really slows down.

For the currency market, the dollar will be the primary beneficiary of a deflationary scenario, while commodities currencies will take it on the chin. After more stimulus is implemented, it will be time to short the dollar against commodity and emerging market, just like in 2009.