Thursday, July 7, 2011

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.


Benjamin Cole said...

Oh please, oh ye Deities of Lucre, before whom I pray now on bended knee, please let the Grand Satan on Inflation loose upon our land.

For years and years, many have predicted the coming, but always for nought.

Is it the global economy that scares the Grand Satan of Inflation away? Goods and services and labor and capital pour into America from every corner of the Earth. We print more money and we just get more output! No inflation!

Is it falling unit labor costs? Commercial rents that going down?

Tell us Grand Satan, how have we offended thee?

What chants, what sorcery could bring you back, especially in moderate form?

brodero said...

So The Guy down the street can raise the price of his house and
go into his boss and demand a raise?? No economist since the beginning of time has been able to
predict the amount of lag time between money
supply growth and economic growth.

TradingStrategyLetter - Weekly Summary said...

Inflation is very much alive and well. Have a peek at the National Debt Clock. That mind boggling pile of interest rate sensitive liabilities ensures that this generation will enjoy decades of brutal, wealth destroying, and demoralizing dollar devaluing inflation rates. It astonishes me that the 'so called' educated types regard this type of financial engineering as a solution as opposed to a major problem!

Fullcarry said...

Beware reading too much into that weeks number. It was quarter end and QE 2 was ending. There was huge demand for money. If we see a continuation into July, it will be telling.

Benjamin Cole said...

Please Dr. Copper and Mr. Money Supply, could you have a stern talk with Mr. Jobs?

And I don't mean Steve.

TradingStrategyLetter - Weekly Summary said...

Mr Obama needs to talk with Mr. Corporate America and convince him he won't tax his underwear off him then real domestic job growth will occur.

Jim Moser said...

Coincides with end of QE2. Banks figure that going forward lending will pay better than securities.

Hans said...

Ben-jamin, excellent post indeed!

According to the MMTers, banks reserves can not be lent and must stay on the books with the Central Bank...

They state, that with QE and QEII, the money supply has not increased and as such, no inflation..

Is this true or fiction? Thank you for any replies!