M2 growth continues at a rapid pace

Today the Fed released the M2 money supply numbers for January 2022, and unfortunately, they show continued double-digit growth. This means the Fed still has its monetary pedal to metal, and that all but confirms that we are in the midst of a genuine and ongoing period of high inflation. The Fed has made a major inflationary mistake, and it's going to take a long time to fix. If I had to guess, we will be seeing inflation rates of 10% or so through at least the end of this year. 

But as the Fed continues to tell us, they plan to move very slowly to raise rates. The bond market—still a believer in the Fed's ability to keep things under control—is projecting that the Fed will need to raise the Fed funds rate to only 2% or so within the next year or so, and that will fix the problem. That projection is almost certainly going to be very wrong. As a first approximation, the Fed needs to raise short-term rates to a level that is at least equal to the rate of inflation. See my last post for a more detailed explanation.

Chart #1

Chart #1 is the most important yet largely ignored chart in the financial world today. I've subtracted currency in circulation (which comprises about 10% of M2) because, as I explained earlier, currency is held only to the extent it is demanded, thus it is not a source of inflation. The rest of M2 (checking accounts, savings accounts, CDs, retail money market funds) is money that is held for the public (not institutional accounts) in our banking system. That is money that is created by the banks themselves, provided they hold sufficient bank reserves at the Fed. And as we know, bank reserves (currently about $4 trillion) far exceed what the Fed requires that banks hold. Which in turn means that banks have a virtually unlimited capacity for extending loans and thus expanding the money supply. And by the looks of the chart, they have been printing money with relative abandon for most of the past two years.

Since the pre-Covid days (February '20), the non-currency portion of M2 has increased by about $6 trillion, or 43%. Since early-summer '20, that same measure of the money supply has increased at about a 13-14% annual rate, a bit more than twice it's long-term average growth rate. Needless to say, this is all unprecedented. And very worrisome.

Recall Milton Friedman's famous dictum: "Inflation is always and everywhere a monetary phenomenon, in the sense that it cannot occur without a more rapid increase in the quantity of money than in output." To know why we have unusually high inflation today, you only have to look at this chart. Supply-chain problems undoubtedly had a roll to play (a spark, if you will), but the fuel for the broad-based rise in the general price level that we see today unquestionably has been supplied by an historic expansion of the money supply.

Chart #2

I have included Chart #2, which shows the total M2 money supply, because I want to dispel fears that I was massaging the numbers in Chart #1. Both charts show that over long periods the broadest measure of our money supply has tended to grow at about a 6% annualized rate. And we are soaring above that as I write. 

Milton Friedman also talked about a "helicopter drop" of money on the economy, and how a sudden and massive increase in the amount of money in the economy would almost certainly result in an increase in the general price level. Well, it's effectively happened, and we can observe the results. 

We should all be monetarists now.