Slow M2 means low CPI

Long-time readers of this blog know that I have been one of only a handful of observers who have linked rapid M2 growth (i.e., money printing) to the big inflation problem that hit the US economy beginning in the first part of 2021. The source of the M2 growth was the government's decision to send out some $6 trillion of checks to the public to compensate for Covid shutdowns and their damaging effects on the economy. At first, most of this money sat idle in consumers' checking and savings accounts as a hedge against great uncertainty and also because consumers had little ability and little willingness to spend it. This amounted to an enormous increase in the demand for money which effectively neutralized the enormous increase in the supply of money. But as life began to return to normal in early 2021, the demand for money declined, and the money was released (monetized) into the economy. Unwanted money fueled a dramatic increase in the price level (otherwise known as inflation). 

Fortunately, this problem began fading away more than two years ago, and it continues to do so. Money supply and money demand have returned to more normal levels, and inflation (abstracting from the government's flawed measure of shelter costs) has been 2% or less the for the past year or so. 

Regardless, it is still vitally important to monitor money supply and demand. So far, nothing out of the ordinary seems to be happening, and that implies no unpleasant inflation surprises for the foreseeable future. The following charts include M2 as of the end of September, and my estimate for Q3/24 GDP. 

Chart #1

Chart #1 shows how the surge in the federal deficit was mirrored by an increase in M2 growth. The link between the two dissolved in the latter half of 2022, with the result that ongoing deficits, though still quite large, are no longer being monetized.

Chart #2

Chart #2 tracks the level of the M2 money supply (currency, retail savings and checking accounts, CDs, and retail money market funds). From 1995 through late 2019 M2 grew at a fairly steady rate of 6% per year, and inflation was relatively low and stable. M2 then surged beginning in April '20 and peaked in early '22. M2 now is only about $1.6 trillion above its 6% trend growth line, and is growing at a modest 3-4% annual rate. 

Chart #3

As Milton Friedman taught us, inflation happens when the supply of money exceeds the demand for it. The Fed publishes the M2 measure of money supply once a month. But nowhere will you find a measure of money demand, except here. My measure of money demand is driven by dividing M2 by nominal GDP, which is shown in Chart #3. The best way to understand this is to think of it as the amount of cash and cash equivalents the average person wants to hold relative to his or her annual income. As the chart shows, money demand tends to rise during recessions, and to decline during periods of growth and stability—with the exception of the 2009-2019 period, when it steadily rose. 

Money demand soared in the wake of Covid shutdowns, then began to fall as Covid fears faded and the economy revived. It is now only modestly higher than in the pre-Covid period. Money supply and money demand, I would argue, are now back in balance, and that explains why inflation has declined and is likely to remain low.

Chart #4

Chart #4 shows M2 growth (blue line) and the year over year change in the CPI (red line, shifted one year to the left). From this perspective, inflation picked up about one year after M2 surged, and it began to decline a year or so after M2 growth peaked. The red asterisk marks the change in CPI ex-shelter costs, which is, I think, the appropriate measure to watch. The chart further suggests that inflation has fallen pretty much as you would expect, given the decline in M2 growth, and it is likely to remain muted for the foreseeable future. 

The enormous net worth of the US private sector

This post extends a series of similar posts I've made over the past 15 years. It highlights the net worth of the U.S. private sector: the net value of assets and liabilities of individuals and non-profit organizations.  As of June '24, the total net worth of the U.S. private sector was $164 trillion, and the net worth of the average person living in the U.S. was almost half a million dollars. 

Does the proliferation of billionaires distort the picture? Not much. According to Forbes, at last count the U.S. had 2,800 billionaires, whose net worth totaled in the range of $17-20 trillion. The net worth of the Forbes Top 400 billionaires totaled $5.4 trillion. If we exclude all billionaires from the total, the net worth of the average American would be about $425K, which is still pretty impressive.

Chart #1

As Chart #1 shows, private sector net worth has increased by 167% over the past 20 years, and now stands at $164 trillion. The biggest gains have come from financial assets (stocks, bonds, and savings accounts), which have increased 149%. Real estate assets have increased 144%, while liabilities have increased a mere 44%. The federal government is heavily indebted, but not so the private sector! 

Chart #2

Chart #2 shows the real, inflation-adjusted value of private sector net worth. Net worth peaked at 166.7 trillion in December '21, and has since declined to $164 trillion. The rather spectacular gains of the stock market and housing in recent years have been diluted by inflation. Still, real net worth is still on a rising path, averaging gains of about 3.6% per year.

Chart #3

Chart #3 divides real net worth in Chart #2 by the U.S. population (about 342 million). Real per capital net worth peaked at $509,500 in 12/21, and fell to $481,000 through June of this year, due to the effects of inflation and an increasing population. Still, it has risen on average by about 2.4% per year. If this continues, by 2054 the average American will be worth $1 million in today's dollars. 

Federal spending is the problem, not taxes

Given the upcoming elections and all the "disinformation" floating around,  it's worthwhile clarifying some of the facts behind fiscal policy. 

As the following charts show, our biggest problem is too much spending, much more so than any shortfall of tax revenues. 

Chart #1

Every taxpayer should frame Chart #1 and put it somewhere prominent. This shows the staggering increase in both federal spending and federal tax revenues in recent decades. 

Chart #2

Chart #2 shows the major components of federal revenues, all of which—with the exception of the estate and gift tax—have surged in recent decades. Individual income tax receipts have almost quintupled since 1990! And by the way, eliminating the "death tax" would amount to a rounding error in the federal budget, since it collects only 0.6% of total federal revenues. Think of how much more efficient our economy would be if millionaires and billionaires stopped spending big bucks on tax attorneys in order to escape this onerous tax. The negative impact of this tax on the economy is an order of magnitude larger than the revenues it manages to generate. 

Chart #3

Chart #3 shows federal spending and revenues as a percent of GDP. Note that spending has averaged a bit less than 20% of GDP since WWII, while today it is about 23% of GDP. Bringing it down is going to be difficult, since interest payments on federal debt now add up to more than $1 trillion per year (3.8% of GDP currently) and are rising (see Chart #4). Meanwhile, revenues have averaged about 17.5% of GDP over the same period, and are currently a bit less than 17%. 

Note also that revenues have been a fairly constant share of GDP over the past 50 years, while income tax rates have been all over the map. Trump's 2018 tax cuts occurred at a time when revenues were about 16% of GDP, and since then they have surged both in real and nominal terms. Cutting tax rates does not necessarily add up to lost revenues. On the contrary, setting tax rates at lower and more reasonable levels can end up boosting tax revenues by stimulating investment and boosting the economy's productivity.

Chart #4

Today's edition of Steve Moore's Hotline (see bullet point #2) makes an important point which should be added to this discussion. "... even if you taxed every penny of income earned by millionaires, it wouldn't be enough to close the deficit." That refers to the current deficit, not the total debt owed to the public, which is closing in on $30 trillion. 

Steven Hayward, one of the contributors to the excellent Powerline blog, notes that it is NOT true that "the rich enjoy lower tax rates than the middle class." In fact, "The rich already pay higher federal tax rates. Those with higher income pay a larger share of the tax burden than their share of national incomes.”

UPDATE (10/23/24): Chart #5 below provides proof for my assertion above ("Cutting tax rates does not necessarily add up to lost revenues.)

Chart #5