Money supply growth alert (cont.)

This is a follow up to some posts from last month, in which I noted the surprising jump in M2 growth. As this chart of the M2 measure of money supply shows, it has gone on to experience a gigantic surge in the past seven weeks. M2 has risen almost $420 billion since the week of June 13th, on average almost 60 billion per week. To put this in perspective, annual M2 growth has averaged about 6% per year since 1995, and growth at this rate would translate into about $10 billion per week. In other words, M2 normally would have grown by $10 billion a week, but instead has grown six times faster. M2 has never grown this fast in a seven week period for at least the past 50 years. No matter how you look at it, this is a major event.

Where is the growth in M2 coming from? Virtually all of the increase can be traced to savings deposits (up $267 billion) and checking accounts (up $148 billion). Now we know why several large banks have announced they will now begin to charge customers who have over $50 million on deposit—they don't know what to do with all the money coming in.

The last time M2 growth approached these levels was in the first quarter of 1983, at a time when inflation was still very high but starting to collapse, the dollar was booming, and the economy was just beginning its first of what would prove to be seven years of exceptionally strong growth. Rapid M2 growth back then was driven by a surge of confidence in the U.S. economy, but that is clearly not the case today. The recent growth of M2 surpasses even the explosive safe-haven demand for money that accompanied 9/11 and the financial crisis of late 2008. Something big is going on, and it can only be the financial panic that is sweeping Europe, as money flees a banking system that is loaded to the gills with PIIGS debt. In short, it looks like there is a run on the European banks, and the U.S. banking system is the safe haven of choice.

Given the lags between real time and when data hit M2, it's quite likely that Europeans already have shifted substantially more than half a billion into U.S. banks in the past two months. I suspect we haven't seen the end of this story either.

Money supply growth alert

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.

Money supply growth alert (cont.)

Over the most recent two-week period, the M2 measure of money supply has surged by $165 billion. Such rapid and sizable growth is highly unusual, and has happened in the past only during periods of panic-driven demand for cash liquidity (e.g., following 9/11 and in the wake of the financial market panic of late 2008). As I noted in my first post on this subject, normal M2 growth would be about $10 billion per week. From the Fed's data, we see that about $100 billion of this growth has come from increased savings deposits at commercial banks, $55 billion has come from increased demand deposits, and all the growth has occurred in the non-M1 portion of M2. What's going on? It's tempting to think that this is somehow a reflection of the end of QE2 and the beginning of Treasury's need to juggle funds since the debt limit is approaching, but I honestly don't know. Stay tuned.

UPDATE: (Aug. 4th) It now appears that this surge in M2 was the product of panic-driven demand for safe-haven cash as Europeans attempted to escape the potential contagion of PIIGS defaults.