Slowdown in Money Creation Could Be Another Recession Signal

The slowdown in money creation could be signaling a recession.

The growth in the money supply has dropped precipitously over the last several months. As measured by M2, the money supply expanded by 6.6% year on year. That was down from April’s growth rate of 8.21%. In  May 2021, M2 grew by 14.30%. M2 growth peaked at a record 26.91% in February 2021.

Based on the “true” or Rothbard-Salerno money supply measure (TMS), money supply growth also dropped in May after rising slightly during the previous two months.

Between April 2020 and April 2021, money supply growth often climbed above 35% on a year-over-year basis.

Economists Murray Rothbard and Joseph Salerno developed TMS to better measure money supply fluctuations. TMS differs from M2 in that it includes Treasury deposits at the Fed while excluding short-time deposits and retail money funds.

As Mises Institute senior editor Ryan McMaken explains, changes in money supply growth can help measure economic activity and indicate looming recessions.

“During periods of economic boom, money supply tends to grow quickly as commercial banks make more loans. Recessions, on the other hand, tend to be preceded by slowing rates of money supply growth. However, money supply growth tends to begin growing again before the onset of recession.”

As you can see from the chart above, based on TMS, money supply growth already appears to be trending higher, the slight drop in May notwithstanding.

The gap between M2 and TMS is also revealing. Historically, TMS has climbed and become larger than M2 in the early months of a recession. According to McMaken, this occurred in the early months of the 2001 and the 2007–09 recession. A similar pattern appeared before the 2020 recession.

And it happened again in May when the M2 growth rate fell below the TMS growth rate for the first time since 2020.

As our technical analyst noted recently, even though inflation is unlikely to come down as the money supply continues to grow, the stock market and economy are built on a rapidly expanding money supply. With such sluggish growth, it will be very challenging for the stock market to hit new highs and the economy to avoid recession.

The Atlanta Fed recently lowered its Q2 GDP projection into negative territory. That would indicate we have been in a recession since the beginning of the year. Most people seem to think the recession will be short and shallow, but Peter Schiff recently said that is a fantasy.

The idea that this recession could be anything but severe is farcical. There is no way we can have a shallow recession.”