Money Supply Growth Rate Drops Below 2008 Level

Money Supply growth is falling rapidly. Two of the last three months have seen a decrease in the seasonally adjusted M2 Money Supply with the recent month dropping $17B. Given that April was the first contraction in 12 years, two of the last three months being negative is an ominous sign.

The recent numbers show that the 13-week annualized value has actually turned negative for the first time since 2009. This can be seen more clearly in Figure 5 below. First, a look at the seasonally adjusted monthly numbers in Figure 1.

Figure: 1 MoM M2 Change (Seasonally Adjusted)

Figure 2 below shows non-seasonally adjusted money supply. The current slowdown can be seen very clearly when compared to the growth since Covid. Three of the last seven months have seen reductions in the money supply. While the Fed does need to decrease the Money Supply to rein in inflation, the small decreases are not nearly enough to offset the massive increases during Covid.

Figure: 2 MoM M2 Change (Non-Seasonally Adjusted)

The table below shows this slowdown more clearly. Over the past three years, seasonally adjusted M2 growth has averaged 13.7% annualized. In the past year, that has fallen to 5.9%, dipping to 1.7% over the last 6 months, and falling to -0.9% in the most recent month. This is a dramatic slowdown.

Figure: 3 M2 Growth Rates

When looking at the average monthly growth rate before Covid, June historically expands at an annualized 6.4%. This compares to -0.9% for the current month.

Figure: 4 Average Monthly Growth Rates

The Fed only offers weekly data that is not seasonally adjusted. This can be seen below which actually showed a decent uptick of $103B in the most recent week.

Figure: 5 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. His analogy was that in order to know what to wear outside, he wants to know the current weather, not temperatures that have been averaged throughout the year.

The objective of the 13-week average is to smooth some of the choppy data without bringing in too much history that could blind someone from seeing what’s in front of them. The 13-week average growth rate can be seen in the table below. Decelerating trends are in red and accelerating trends in green.

Growth has now collapsed to -0.46% which is the lowest reading since November 2009. This is also the 25th week of negative or zero growth in Money Supply.

Figure: 6 WoW Trailing 13-week Average Money Supply Growth

The plot below helps show the seasonality of the Money Supply and compares the current year (red line) to previous years. For the month of July, this is the slowest 13-week Money Supply growth in at least 25 years. Only in 2009 at the depths of the Great Recession was Money Supply growth lower than -0.46%.

Wenzel often commented on his ability to guess the timing of the 2008 stock market crash based on the Money Supply that year falling from 11.6% to 0% in a matter of months. In 2022, growth has slowed from 12.2% to -0.46% in less than 6 months. Not to mention the collapse from 64% seen in 2020.

This is a major slowdown in Money Supply and could pose significant headwinds for the stock market and economy.

Figure: 7 Yearly 13-week Overlay

Behind the Inflation Curve

To combat rising prices, the Fed would need to undo most of the money it has created over the last several years. This would require bringing interest rates above the rate of inflation.

Unfortunately, the chart below shows that the Fed has never been further behind the inflation curve. A recession on its own will not cure this inflation problem because of the lagged effects. Looking at the period of 1970, inflation always moved higher on a delay after significant expansion in the money supply. Price increases are still waiting to feel the full effects of all the M2 growth from 2020 and 2021. Furthermore, history shows it required rates higher than inflation to bring prices back down.

The blue line below (Fed Funds Rate) has almost always gotten above the black line (CPI) to force inflation back down. The one anomaly was in 2011 after the Great Recession. The mainstream is now assuming this is the norm (i.e., a recession alone will slow inflation), but the chart below shows that it’s far more common that interest rates must exceed inflation to bend the curve back down. The recent period has made the Fed complacent. This is very dangerous!

Figure: 8 YoY M2 Change with CPI and Fed Funds

Historical Perspective

The charts below are designed to put the current trends into a historical perspective. The orange bars represent annualized percentage change rather than the raw dollar amount. The current slowdown can be seen on the right side.

If a few months of M2 slowdown can cause this much pain across the economy (stock market, real estate, bond yields, etc.), how much carnage would unfold in a prolonged fight against inflation where M2 had to shrink consistently for months?

Figure: 9 M2 with Growth Rate

Taking a historical look at the 13-week annualized average also shows the current predicament. 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 sell-off.

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%. The economy is now grappling with a peak growth rate of 63.7% in July 2020 down to -0.46%. This is a major collapse.

The latest stock market pullback is further evidence of this relationship. Based on the chart below, history would indicate that the market pullback is just getting started.

Please note the chart only shows market data through July 4 to align with available M2 data.

Figure: 10 13-week M2 Annualized and S&P 500

One other consideration is 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.

Current Reverse Repo exceeded $2T on May 23 for the first time in history. This dwarfs the old record of ~$500B in 2016-2017. Repos hit a record $2.3T on June 30th.

Bottom line, even though M2 has slowed there is still trillions of dollars in liquidity sloshing around. New money will not be available to prop up the stock market, but excess liquidity is still available to bid up prices and keep inflation elevated.

Figure: 11 Fed Reverse Repurchase Agreements

What it means for Gold and Silver

The market is currently experiencing an epic collapse in the Money Supply growth rate. Making matters worse is that growth doesn’t typically find a seasonal bottom until August, which means the growth rate is likely to fall further into negative territory by the next Money Supply data release. This is especially true given the extra super-sized rate hike the market is about to get.

Unfortunately for the Fed, the CPI remains extremely elevated despite crashing Money Supply growth. This means they are far more likely to break something in the economy and be forced to reverse course long before the CPI gets anywhere near 2%.

No doubt the fall in Money Supply has been able to hurt the market and certainly hold back gold and silver, but when the Fed pivots it will inject another massive dose of monetary stimulus to try and undo the damage it is inflicting right now. When that happens, gold and silver are likely to launch and never look back.

Data Source: https://fred.stlouisfed.org/series/M2SL and also series WM2NS and RRPONTSYD. Historical data changes over time so 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 the fourth Tuesday of the month on 3-week lag

Most recent data: Jul 04, 2022

Interactive charts and graphs can always be found on the Exploring Finance dashboard: https://exploringfinance.shinyapps.io/USDebt/