Thursday, July 7, 2011
As the above chart of the M2 measure of money supply shows, recently there has been a very unusual pickup in the amount of money in the economy: $76 billion, to be precise, in just the last week. Over the past several years and since 1995, M2 has grown about 6% per year on average, which would equate to about $10 billion per week currently; the latest surge thus stands out as a huge aberration, and one that warrants close attention. About 80% of the growth in M2 in the past week came from increased savings deposits at commercial banks and thrift institutions (mostly commercial banks).
This next chart shows the year over year and 3-mo. annualized growth rates of M2, in order to highlight just how significant the recent increase in M2 has been. A one week outsized jump in M2 has resulted in a 3-mo. annualized growth rate that is very high by historical standards. A few more weeks like this and we would have M2 growth that was only equaled during the panic of late 2009, when the world was desperate to hold as much liquid money as possible. This latest growth might be panic-related, but there is no other sign of panic that I am aware of.
Over a very long period, M2 growth is still averaging only 6% a year, as the chart above shows, and that is quite unremarkable. Indeed, the persistence of 6% annual M2 growth in recent years has been a significant argument against the likelihood of a meaningful rise in inflation. We may now be seeing a significant change in that important fundamental, but of course with only one outsized-growth week, it is premature to jump to conclusions.
Nonetheless, I add this last chart to the mix, since it shows that there has been a significant pickup in Required Reserves of late: in fact, required reserves have grown at a 32% annualized rate so far this year. Why is this important? Because the Fed has flooded the banking system with $1.6 trillion of reserves in the past few years, and until recently, the vast majority of those additional reserves were being held by banks as Excess Reserves. Banks were using only a very small portion of their additional reserves to create new deposits, which explained why the broad money supply was growing at only 6%, and leaving the rest on deposit at the Fed as excess reserves. That is now changing, as banks are putting more and more of their reserves to work, and thus expanding the money supply.
Strong growth in the broad money supply doesn't necessarily signal higher inflation, since the extra growth could be due to stronger money demand. But if the extra growth we are now beginning to see corresponds to an increased willingness on the part of banks to lend and borrowers to borrow, then it easily could lead to higher inflation down the road. I will be paying very close attention to M2 in the weeks to come, and I'll wager that others will too.
Posted by Scott Grannis at 4:10 PM