Money Supply Growth Rebounds But Trend Is Down
M2 Money Supply is measured by the Federal Reserve to calculate the amount of money in the financial system. Historically, the term inflation was defined as an expansion of the money supply that generally led to higher prices. Therefore increases in M2 is the measure of inflation. This analysis reviews the changes in money supply as a potential indication of future price increases.
M2 used to be released weekly, but in 2020 this was changed to a monthly frequency. The chart below shows the month-over-month changes in M2. The massive spike in 2020 can still be seen when the Fed blasted the system with $2.3T within 3 months during the shutdowns.
In the latest period, M2 increased by 147B. While this is a solid uptick compared to the relatively tiny 15B increase seen last month, this is still below the recent average. This is also very close to the 141B seen last July.
Figure: 1 MoM M2 Change
The table below shows the change in M2 over different period lengths. All numbers have been annualized for consistency. As can be seen, the growth in M2 was accelerating but has dropped from 12.1% over the last 6 months down to 9% in the recent period. Over 3 years, the money supply has been growing on average at 13.2%.
Figure: 2 M2 Growth Rates
M2 used to be published weekly, so the chart below shows the noisier weekly data that is not seasonally adjusted by the Fed (the chart and table above are seasonally adjusted).
The most recent week available ending Aug. 2 showed growth of 130B which is above the average since July 2020. The biggest difference lately has been choppier data with more up/down movement versus the steadier increase seen last year. The current period looks more like the activity seen pre-Covid.
Figure: 3 WoW M2 Change
The “Wenzel” 13 Week Money Supply
The late Robert Wenzel of Economic Policy Journal used a modified calculation to track money supply. He used a trailing 13-week average growth rate annualized as defined in his book The Fed Flunks. He specifically used the weekly data that was not seasonally adjusted.
The table below mirrors how he published the values in his newsletter. It shows the weekly average going back in time with ‘1’ being the most recent week. Green numbers indicate accelerations in the money supply where red shows the money supply decelerating. As can be seen in the most recent 8 week period, the money supply is decelerating rapidly after accelerating for most of the previous 12 weeks. (Note: the weekly data is on a lag – as of Aug 2).
Generally, Mr. Wenzel looked for large decelerations as an indication of potential market weakness. With the latest drop in money supply growth, it may be more challenging for the market to keep moving higher.
The plot below helps show the seasonality of the money supply and compare the current year to previous years. The range of the y axis has been capped at 25% so that the massive spike in 2020 up to 60%+ does not skew the graph.
As shown, the money supply generally dips into mid-summer, so the recent drawdown is not uncharacteristic. However, the dip usually reverses by this time of year. Considering the extreme activity of the Fed it’s hard to know if the trend will reverse course soon.
Money Supply growth is still well above where it typically stands this time of year at 9.8% versus historically being below 4%. Is this a new normal being established? As Peter Schiff often says, the patient needs more and more drugs to get the same high. If money supply growth simply returned to recent historic levels, would this be enough to prop up the market?
Furthermore, the massive deceleration alone poses a problem. Even though 9.8% growth is high compared to history, it is falling rapidly compared to recent history. The market has been driven by massive money supply growth, if the current values do not rebound then it could pose issues.
Figure: 7 Yearly 13 Week Overlay
The charts below are designed to put the current trends into a historical perspective. As seen, the increases in 2020 were massive in scale and size. The orange bars represent annualized percentage change rather than the raw dollar amount. As can be seen, even the recent periods remain quite elevated compared to pre-Covid, driving total M2 through 20T in April and now topping out at 20.4T.
Figure: 8 M2 with Growth Rate
Taking a historical look at the 13-week annualized average also shows the unprecedented growth seen over the past 18 months. This chart overlays the log return of the S&P. Mr. Wenzel proposed that large drops in money supply could be a sign of stock market pullbacks.
His theory, derived from Murray Rothbard, states that when the market experiences a shrinking growth rate of money supply (or even negative) it can create liquidity issues in the stock market, leading to a selloff. While not a perfect predictive tool, many of the dips in money supply precede market dips. Specifically the major dips in 2002 and 2008 from 10% down to 0%.
It could also be argued the pullback in 2018 could be due to an extended lead up of low money supply growth compared to previous years.
Figure: 9 13 Week M2 Annualized and S&P 500
Finally, it’s impossible to ignore the massive liquidity buildup in the system. The Fed offers Reverse Repurchase Agreements (reverse repos). Essentially this is a tool that allows financial institutions to swap cash for instruments on the Fed balance sheet.
Most banks have cash limits for their balance sheet, so they need to offload their cash to stay below limits. As the chart below shows, banks are having to offload record amounts of cash each night. This would simply never happen in a normal monetary environment, but the massive growth of the money supply last year is feeding into an excess of liquidity in the system.
Current Reverse Repo is hitting $1.13T dwarfing the old records of ~$500B in 2016-2017. With this much liquidity in the system and Fed continuing to print, it’s hard to imagine it won’t continue driving the CPI higher.
Figure: 10 Fed Reverse Repurchase Agreements
What it means for Gold and Silver
Inflation is an expansion of the money supply that generally leads to higher prices. Therefore, gold and silver can be used as protective assets to protect against dollar devaluation (higher prices). Money supply has been growing at alarming rates for years now, and absolutely exploded over the last 2 years. It is hard to imagine this will not bleed into the CPI in the months and years ahead, even being designed to understate price increases (e.g. Owners’ equivalent rent).
If price increases prove to not be transitory as the Fed promises, gold and silver could be the biggest winners. With the money supply growing like it has, “transitory” becomes very hard to believe.
Data Source: https://fred.stlouisfed.org/series/M2SL and also series WM2NS and RRPONTSYD. Historical data changes over time so the numbers of future articles may not match exactly. M1 is not used because the calculation was recently changed and backdated to March 2020, distorting the graph.
Data Updated: Monthly on fourth Tuesday of the month on 3-week lag
Most recent data: Aug 02, 2021