Key macro charts update: still looking good

Consumer confidence is low, and surveys find that the majority of the US population thinks the economy is getting worse. According to Rasmussen, only 43% approve of the job Trump's doing. Gas prices are high—the other day I paid almost $7/gal—and there are widespread reports of consumers cutting back on non-essential goods and services. Reported inflation has jumped, and the market fully expects the Fed's next move will be to raise rates. Despite this grim backdrop, the stock market is making new highs almost daily (the S&P 500 is up 28% in the past year!), and corporate profits are simply fabulous. I can't remember another time with such a disconnect. 

It's time to review some important macro indicators:

Chart #1

Chart #1 shows that the M2 money supply continues to grow at a moderate pace—up just 5.1% in the past year, and in the past two years up a mere 4.3% annualized. Headline inflation has jumped, however, thanks to the complications of the Iran war which have sharply reduced the global supply of oil. If the Fed under new chair Kevin Warsh stands firm, higher prices for energy will not trigger a broad-based rise in prices. Meanwhile, the market has effectively tightened monetary policy by pushing 5-yr real interest rates up by 50 bps since the end of February, and by pricing in the near-certainty of a one quarter point tightening over the course of the next 12 months. 

From 1995 through 2019, the M2 measure of the money supply grew at a compound annual rate of 6%, a period characterized by relatively low and stable inflation. The money supply then exploded by some $6 trillion from 2020 through early 2022 as the federal government sent out Covid "stimulus" checks that—at first—sat idle in bank checking and savings accounts. As consumers and businesses regained confidence and the economy emerged from the Covid shock in early 2021, that extra M2 eventually became monetized, and that in turn provided the fuel for a sharp rise in inflation.

Today, M2 is only about 5% ($1.2 trillion) above where it likely would have been in the absence of the great Covid monetary shock. The Covid-related explosive increase in money has been absorbed by higher prices and a growing economy. Monetary policy has been back on track for several years now. This is key to the inflation outlook.

Chart #2

Chart #2 shows real (blue) and nominal (red) 5-yr Treasury yields, and the difference between the two (green) which is effectively the market's expectation for what the CPI will average over the next 5 years. Just before Covid hit in early 2020, inflation expectations were relatively low—about 1.6%. The Covid shutdowns at first caused inflation expectations to plunge to near-zero, then to soar to 3.7%. Today the bond market is priced to inflation averaging 2.54% over the next 5 years—only modestly above levels that the Fed should be prepared to tolerate. People may be worried about rising inflation, but not the bond market. 

Chart #3

Capital goods orders (Chart #3) are key to economic growth and prosperity, since new machinery, factories, and computers are what will drive future productivity. In inflation-adjusted terms, capital goods orders have been usually weak since the turn of the 21st century. Is it surprising that the economy has managed only moderate growth in the current business cycle which began in 2009. The recent strength in this series is a welcome breath of fresh air, and a sign that economic growth may continue to improve in the months and years ahead.

Chart #4

Chart #4 breaks down the Personal Consumption Deflator (the Fed's preferred measure of inflation) into its three major components. Things to note: since 1995, when China's economy started opening to the world and unleashing a flood of cheap electronics and appliances, the prices of durable goods have fallen by 30%. Meanwhile, service sector prices have risen by 141%, a direct result of rising real wages and a growing economy. Until the start of Iran hostilities, non-durable goods prices rose a bit less than 1% per year since mid-2022. Bottom line: outside of wages, and prior to the Iran war, inflation was largely confined to service sector prices, which in turn are largely determined by wages. These facts suggest that in the past 35 years, an hour's worth of wages now buys almost three and a half times more durable goods and 30% more nondurable goods. Wow.

Chart #5

Chart #5 is one of my favorite charts. The dotted green line reflects the growth trajectory of the US economy from 1965 through 2007, when the economy grew at a compound annual rate of about 3.1% per year. The dotted red line in the trajectory since the end of the Great Recession in mid-2009, when the growth trend abruptly slowed to 2.3% per year. If our economy had followed the 3.1% growth path, it would be 23% bigger today. The likely causes of this dramatic underperformance? Inefficient green energy subsidies, a huge increase in transfer payments, and increased tax and regulatory burdens figure at the top of my list. The recent strength in capital goods orders is the first indication that the economy may be regaining its former vitality.

Chart #6

Chart #6 shows corporate profits as a percent of nominal GDP. Think of this as a proxy for corporate profit margins: for every dollar of GDP, corporations today capture more than 11 cents of after-tax profits. That's  twice as much as during the 1970s and 1980s (as indicated by the dashed green lines). No wonder the stock market is making record highs! Corporate profits have never been so healthy. Wow.

Chart #7

Chart #7 shows the year over year change in the overall Consumer Price Index as compared to its ex-energy version. Energy has always been the most volatile component of the CPI, and today is no exception. The important thing here is that energy prices do not cause inflation. Monetary policy is the chief determinant. And as we have seen in prior charts, there is no sign that monetary policy has become inflationary. The ex-energy version of the CPI is up 2.8% in the past year, and that is only marginally higher than the 2.5% inflation expectations priced into the bond market. Bear in mind that this number continues to be artificially inflated by the flawed measure the BLS uses to calculate shelter costs. Nationwide housing prices are up by a mere 0.7% in the past year; on an inflation-adjusted basis, housing prices are down 3.7% from their peak in mid-2022. These facts have yet to be captured by the BLS, which uses the year over year change in housing prices from 18 months ago to compute shelter costs.

If you focus less on the headlines in the media and more on the underlying statistics, the picture becomes clear: the economy is in good shape and likely to get even better.

M2 update: Ok for now, but the Fed should ease

This blog has the distinction of periodically tracking and analyzing the M2 measure of money supply for almost 2 decades. Unlike most other analysts, I focus not just on the supply of money but also on the demand for money. For background, see this post from October 2020 in which I noted rapid growth in M2 but was not alarmed given the huge increase in money demand at the time.

The key to understanding the relationship between money and inflation is to not lose sight of the demand for money. Milton Friedman famously taught us that inflation happens only when the supply of money exceeds the demand for it. When the M2 money supply accelerated in 2009 and 2020-21, it did not immediately ignite inflation because the demand for money also accelerated—with Covid shutdowns it was quite difficult to spend money. But when the demand for money began to decline in early 2021, the money that had been stored in bank deposits and under mattresses began to be released into the economy, and this was the fuel for rising inflation in 2021 and into early 2022. By mid-2022 the Fed had responded to rising inflation by raising interest rates and slowing the growth of M2, thus bringing money supply and demand slowly back into balance. This gave me the confidence in the summer of 2022 to predict that the peak of inflation was now past and it would begin to decline. Since then I have continued to believe that inflation would remain low, given that although the demand for money was declining to pre-Covid levels, M2 growth remained very slow.

The charts that follow are updated with the latest data. Fortunately, there has been no significant change in monetary conditions, and that is why I continue to see inflation remaining relatively low and stable.

Chart #1

Chart #1 shows the level of the M2 money supply. From 1995 to late 2019, it grew by about 6% per year. During that same period, inflation registered about 2% per year. M2 growth then exploded in early 2020, fueled by $6 as $6 trillion of transfer payments were sent to the public to compensate for Covid-related shutdowns—money that the Fed essentially "printed" and helicopter-dropped into the economy. M2 began to slow in mid-2022 as the Fed began to raise interest rates. Today M2 is only $1.3 trillion above where it might have been had we not suffered from the government's disastrous Covid policies and the Fed's failure to react to huge swings in money demand in a timely fashion.

Chart #2

Chart #2 shows the 6-mo. annualized rate of change in the M2 money supply. Growth has been below 6% since April '22, almost 4 years. Over the past year, M2 has grown only 4.9%. Milton Friedman would be pleased.

Chart #3

Chart #3 shows the the ratio of M2 to nominal GDP, which is arguably a good proxy for money demand. Think of it as the percentage of our annual income that we collectively prefer to hold in the form of readily spendable money (currency, checking accounts, time deposits, CDs, and money market funds). Money demand appears to have returned just about to where it was before the Covid era. Both M2 growth and money demand have now returned to "normal" levels, and they are roughly in balance. This is very good.

Chart #4

But, you object, inflation is still above the Fed's 2% target. Yes, the Core Personal Consumption Deflator is up 3.1% in the year ending January '26, and the overall Personal Consumption Deflator is up 2.7%. But the CPI is up only 2.4% as of February, and the CPI less shelter is up only 2.2%. We're not talking about a meaningful overshoot. Of course, I would prefer to see 0% inflation, but what we have today is the next best thing.

Chart #4 shows the 3 major components of the PCE deflator. Note that durable goods prices today are lower than they were in late 2022, and non-durable goods prices have only increased 2% since mid-2022 (which works out to an annualized rate of only 0.6%). The major source of inflation in recent years comes from service sector prices, which are heavily influenced by shelter costs and wages. As I've shown numerous times in recent years, the government has been systematically over-estimating shelter costs. The PCE deflator doesn't have an ex-shelter version like the CPI does; if it did it would likely show inflation being much closer to 2% than to 3%.

••••••••••••••••

So what about the Iran war and soaring fuel prices? Yesterday I paid $7.09 per gallon to fill my tank. Yikes! Surely this will upset the inflation apple cart, no?

Most likely we'll see an upward bump in the official inflation numbers in the months ahead, given the recent increase in energy prices. But that's not how inflation works. With the economy on a strict diet of 5-6% money growth, there is no reason to expect that the entire price level will jump higher. Energy prices will go up, but other prices will come down. Already we're seeing non-energy commodity prices softening. And with the recent uptick in 30-yr mortgage rates and the surge in new home sales for sale, real estate prices are more likely to decline than to rise. 

Most important, however, is this: wartime uncertainties are very likely to spark an increase in money demand. Without a corresponding increase in money supply—and especially since the Fed shows no willingness to lower interest rates—the economy will soon feel starved for money. That's deflationary. We won't see deflation for several months, but don't be surprised if it happens later this year.

My advice to the Fed would be to relax monetary policy soon in anticipation of a meaningful increase in money demand. But sadly, the Fed is usually reactive and rarely—if ever—proactive. 

All things considered, the outlook is getting brighter

Here's a selection of charts that I'm paying special attention to these days. If there's a theme emerging from these snapshots of the economy and financial markets, it's a generally upbeat one, featuring continued low inflation, moderate and improving growth, and a gradual improvement in the fiscal outlook. 

Chart #1

Chart #1 shows the 6- and 12-month growth rate of private sector jobs—the ones that really count. From a long-term perspective, it looks like the economy is growing at an unusually slow pace—barely a crawl. But considering the massive deportations of illegals and the virtual closure of our borders, it's not surprising. Some will argue that this shows an economy hovering on the brink of "stall speed," but I think that's an analogy that doesn't really apply to an economy. Economies have a strong tendency to grow if they are not burdened by abrupt and unforeseen changes in monetary and fiscal policy. Meanwhile, it is comforting to see that new claims for unemployment show absolutely no sign of any fundamental deterioration in the outlook for business profits. Firings are low and stable. The worst that can be said about jobs is that there aren't many new jobs being created. But that could be improving.

Chart #2

Chart #2 shows the monthly change in private sector jobs, which appears to have picked up in the past month. It's too early to claim victory after just one month of improvement, but some of the following charts also show recent improvement.

Chart #3

Chart #3 shows the results of a monthly survey of purchasing managers. It has shown pretty lackluster levels for the past several years, followed by an exceptionally strong January report. This could be the first sign of a long-expected surge in the outlook for business manufacturing activity. Historically, readings below 47 have frequently coincided with recessionary conditions. Readings north of 50 almost always occur during periods of decent economic growth. If the recent report is not reversed, then we could be on the verge of a very welcome growth spurt.

Chart #4

Chart #4 shows the level of the federal government workforce. The past year has been dominated by an astonishing 11% decline in the federal workforce—the by-product of Trump's aggressive attack on the Deep State, in particular the Dept. of Education. As the chart also shows, the federal workforce today is as small as it has been since 1966! There are now 324K fewer regulators of the economy. A small government workforce equates to a significant reduction in regulatory burdens, which are typically a cost that most businesses would be happy to avoid. This frees up resources for productive activity, and this is an unalloyed Good Thing. NO ONE came close to predicting that the federal government workforce would ever decline by as much as it has in the past year.

Note that the spikes in the data that occur every 10 years correspond to the temporary hiring of people needed to conduct the Census. 

Chart #5

Chart #5 shows the year over year change in the Consumer Price Index, compared to a version of the CPI that excludes shelter costs (which make up about ⅓ of the CPI). The gap between the two that shows up in the past several years is the direct result of an over-estimation by the BLS of shelter costs. That problem is now behind us, and we are left with inflation that is only moderately above 2%. 

Chart #6

Chart #6 focuses on shelter costs (which are called Owner's Equivalent Rent). This is what you would be paying if you had to rent the house you live in, and it is something that the BLS manufactures inside its computers, since nowhere does there exist such a thing in the real world. Here we see that in the past month and past 3 months, the annualized change in this measure of shelter costs has fallen back—finally—to what it has tended to average in normal times. That explains why the gap between the two lines in Chart #5 has disappeared. 

Chart #7

Chart #7 has been featured regularly on this blog for the past several years. It is designed to show that the BLS's calculation of shelter costs (OER) is highly correlated to the year over year change in housing prices (blue line) from 18 months prior. It took longer for OER to fall (given the prior decline in housing price inflation) than I thought, but the two lines are now back in sync at a level that is consistent with 2% overall inflation. I note further that national home prices rose only 1.2% last year, and, adjusted for inflation, they are 2.2% below their mid-2022 peak. Housing prices are thus quite likely to exert downward pressure on inflation in the months to come. 

Chart #8

Chart #8 shows the 6-mo. annualized growth rate of the all-important M2 measure of the money supply. M2 rose on average by about 6% per year from 1995 through 2019, a period during which the CPI rose by 2% or less per year. More recently, M2 growth in the year ending January '26 was 4.3%, but as the chart shows, growth on the margin has slowed to a mere 3.6% (annualized) over the past six months. In normal, pre-Covid times, most economists would have predicted that 3.6% M2 growth would lead to a slowdown in economic growth and a decline in inflation. Yet today the chatter is all about whether inflation is going to rise. This could be one of those times when the market is caught looking in the wrong direction.

Chart #9

Chart #9 shows what I consider to be a good measure of money demand: M2 divided by nominal GDP. This effectively measures how much of our annual income we like to hold in the form of readily-spendable money (currency, checking accounts, retail money market funds, etc). Money demand today is pretty much the same as it was prior to COVID. The Covid years were characterized initially by a gigantic increase in the demand for money, which was then followed by a return or "normal" levels. My interpretation of all this is that monetary conditions are just about right: money supply is matched by money demand, and that equates to the absence of monetary imbalances that might fuel higher inflation. 

Chart #10

Chart #10 compares the strength or weakness of the dollar (a rising blue line equates to a weaker dollar, while a declining blue line equates to a stronger dollar) with the inflation-adjusted level of a basket of basic commodity prices. Note the very strong correlation of these two variables over time—except for the period following the Covid crisis, when supply chains were disrupted but the consumers wanted to ramp up their spending. Commodity prices back then were much stronger than the strength of the dollar would have predicted, and they helped fuel rising inflation. Recently, however, the two variables have come back into line with each other. Commodity prices are no longer "too strong," while the dollar is still reasonably strong itself. Conclusion: commodity prices are not a source of inflation these days. Need I add that gasoline prices today are very close to their 20-year average ($2.88/gallon), and that they have fallen almost 40% from their 2022 high? Moreover, crude oil prices today are actually almost 10% lower than their 20-year average. 

Chart #11

Chart #11 shows the level of real GDP growth as it compares to two different trend lines (it's important to note the use of a log scale on the y-axis, which makes it easy to see growth trends). GDP rose by about 3.1% per year from 1966 through 2007, but since 2010 it has managed to grow by only a little more than 2.3% per year. Growth may be picking up of late, as noted in the comments above, but even if it does, the economy is still a lot less dynamic than it has been during most of our lifetimes. I think the "disappointing" growth of GDP since 2010 is due to several factors: 1) the $16 trillion the world spent on futile attempts to prevent global warming, 2) a huge increase in US transfer payments, and 3) a significant increase in regulatory burdens. All of which, I'm pleased to note, are in the process of reversing!

Chart #12

Chart #12 shows the level of federal government spending and revenues over the past 36 years. The difference between the two lines is, of course, the federal deficit, which is currently running at about $1.7 trillion per year. Note also the huge surge in federal spending triggered by the Covid crisis—that consisted of approximately $6 trillion in transfer payments which were effectively monetized by the Fed. It was all a nightmare, but it's fading rapidly. Note that spending has not reached new highs since 2022, and it has been flat for more than a year. The fiscal outlook is definitely improving.

Chart #13

Our national debt is just shy of 100% of GDP ($31 trillion), but we are not on the brink of a fiscal abyss. On the contrary, it is not unreasonable to think that Congress can manage some degree of spending control, and it is not the case that the economy faces a crushing burden of debt in any event, as Chart #13 shows. The true burden of debt is not the size of our national debt, but the cost of servicing that debt as a percent of our national income. Today that burden is significantly less than it was during the 1980s, mainly because interest rates are far lower than they were back then. If Congress exercises even modest restraint and the Fed doesn't have to raise interest rates (which they won't have to if inflation remains under control), then we can gradually reduce our deficits and the burden of our debt

All things considered, things don't look so bad at all!

UPDATE (2/27/26)

The Producer Price data for January '26 were released today. There are a lot of different versions of this data, (core, ex-energy, final demand, etc.) but I typically just focus on the aggregate index, which is shown in the chart below. From mid-2022, when inflation pressures generally peaked, the PPI is up at a 0.5% annualized rate through January '26. In other words, price pressures at the producer level have virtually ceased.

Chart #14

Slow M2 growth fuels stronger economic growth with low inflation

Yesterday's release of the December M2 money supply figures showed a continuation of the sub-6% growth trend that has been in place since inflation peaked in mid-2022. Despite over three years of very sluggish money growth, economic growth has exceeded most expectations. Why? Because money that was stockpiled during the Covid winter has been steadily released to fuel increased economic activity, while at the same time inflation has remained relatively low and federal deficits are shrinking.

The monetary and inflation fundamentals are pretty darn good these days, with the possible exception of the dollar, which has weakened on the margin in recent months. I am not worried about that, however, because the dollar remains substantially stronger than its long-term average in trade-weighted and inflation-adjusted terms. I'm not worried either about the surge in gold prices, which have recently surpassed $5,300/oz and appear to exist in an alternate universe. Abstracting from gold, commodity prices are well-behaved and show no sign whatsoever of inflationary behavior.

The following charts expand on these observations:

Chart #1

Chart #1 shows the level of the M2 money supply, plotted using a logarithmic y-axis to better illustrate how money grew at roughly a 6% annual rate from 1995 through 2019—a period during which inflation was well-behaved, averaging about 2% per year. M2 growth exploded beginning in 2020, as the federal government began "printing" some $6 trillion to fund massive transfer payments. The Fed finally woke up to this problem and began to hike interest rates in 2022, and money-printing ceased. Result: M2 is largely back to where it would have been had the Covid fiasco never happened.

Chart #2

Chart #2 is constructed to illustrate how inflation has tended to lag changes in money supply growth by about one year. The initial surge in money growth was not immediately inflationary because huge Covid-related uncertainty caused economic actors to stockpile money. In other words, Covid led to a huge increase in money demand—which meant that a huge increase in money supply was neutralized by a correspondingly huge increase in money demand. But after a year or so, money demand subsided and the money that had been stockpiled began to be spent, and that fueled rising inflation. Today we're essentially back to "normal," thanks to higher interest rates and saner fiscal policies. 

Chart #3

Chart #3 shows the 6-mo. annualized rate of change of the M2 money supply. Money growth has been very slow ever since inflation peaked in mid-2022, and although it has picked up in the past few years, it is still below the 6% trend that prevailed in the 1995-2019 period. The Fed made a huge inflationary mistake in the 2020-2022 period, but they now have the situation back under control. A flareup in inflation against a backdrop of 4-5% M2 growth, positive real interest rates (the 5-yr TIPS yield today is 1.3%), and declining federal deficits is therefore highly unlikely. Great news!

Chart #4

Chart #4 illustrates what I have called "money demand." It is the ratio of M2 to nominal GDP, and it can be thought of as a proxy for the amount of spendable money the average person or business wishes to hold relative to their annual income. Today money demand stands at just over 70%, having fallen from a peak of just over 90% in 2020. It is almost back to pre-Covid levels. Today there's no excess supply of money, and the demand for money has returned to levels that are much more normal. Result: low inflation for the foreseeable future. 

Chart #5

Chart #5 shows rolling 12-month totals for federal government spending and revenues. After exploding higher in 2020, federal spending has largely stabilized in recent years. Spending peaked at $7.62 trillion in March 2021, and last year spending totaled $7.05 trillion—that's almost five years of no spending growth! Over the same period, revenues surged from $3.52 trillion to now $5.38 trillion. As a result, the federal deficit has fallen from a high of $4.1 trillion in March 2021 to now only $1.7 trillion. That's still way too much, but it is almost certainly going to decline further. We're slowly getting back to normal. 

Chart #6

Over the past year, the dollar has fallen by roughly 10%. Normally that would be a cause for concern, especially since I believe that a strong currency is always better than a weak one. But as Chart #6 shows, when you adjust for inflation, the dollar is still trading about 15 to 18% above its long-term average. In a way, the dollar has gone from being very strong to just strong. I was relieved to hear Treasury Secretary Bessent today reiterate that a strong dollar is in our nation's best interest. 

Chart #7

Chart #7 shows the 75-year history of the S&P 500 index, which has grown by about 8% per year. It's a bit on the strong side of that trend, but nothing here looks particularly worrisome. Investors see a stronger economy, and they are voting with their feet. Makes sense.

Chart #8

Chart #9

Charts #8 and #9 are constructed in similar fashion. The blue line is the inverse of a popular dollar index (i.e., upward moves signify weakness, and downward moves strength in the dollar), while the red line in the first chart shows the inflation-adjusted price of gold, and in the second chart, the red line shows an inflation-adjusted index of a basket of 22 basic commodities. Note that in Chart #9, inflation-adjusted commodity prices have a strong tendency to move inversely to the changes in the dollar's value. (The nominal (non-inflation-adjusted) version of that same index has been flat for the past 4-5 years even as the dollar has weakened.) 

Gold and silver today are the only major commodity prices (with the notable exclusion of copper, which is facing heavy demand from AI-related industries) that are going up—and dramatically so. One important conclusion: gold and silver are fundamentally different from things like soybeans and sugar. Their rising prices do not necessarily imply a weaker dollar or higher inflation.

From this it follows that gold and silver should not be lumped together with other commodities. They just don't behave in the same manner. In any event, I wish I knew the cause and the implication for inflation of soaring gold prices, but I don't. It could just be rampant speculation, and/or heavy buying on the part of central banks trying to diversify their exposure to fiat currencies. In the latter case, I would be quick to add that central banks have a poor record when it comes to predicting inflation.

Lots of things are looking up

Valued readers, please excuse me. For the past few months I've suffered from writer's block complicated by a lack of government-produced data. I now have some facts to work with, and they look pretty good. I've assembled a baker's dozen of my favorite charts here, and I will try to keep the commentary lean and let the charts do the heavy lifting. It feels a lot like Christmas!

To sum up: The economy is in decent shape (2-3% growth) and inflation remains subdued (2.5% or less). More specifically, the M2 money supply is growing at a very moderate 4.5% rate and most if not all of the $6 trillion increase in M2 that was "printed" during the Covid era has been absorbed. There is still no evidence that Trump's tariffs have boosted inflation. The main source of slightly-above-target inflation in recent years can be traced to the government's faulty measurement of housing and shelter costs, and these have finally subsided and should remain low (if not negative) for the foreseeable future. 

Commodity prices (abstracting from gold, which appears to inhabit an alternative universe) are very well behaved, and haven't shown any meaningful increase for years. GDP growth was surprisingly strong in Q3/25, and Trump's Big Beautiful tax cuts, coupled with impressive deregulation and an actual shrinkage of the public sector workforce, have set the stage for continuing growth in the coming year. It is comforting to see a 4-5% increase in business investment so far this year (e.g., capital goods orders and shipments), and it is now common knowledge that AI is already contributing to improved productivity. Finally, it is also VERY comforting to see that federal government spending has not increased at all over the past 12 months, while revenues have surged by almost 10%! 

Chart #1

Chart #1 shows the level of the M2 money supply, arguably the best measure of readily-spendable money. It grew at a 6% pace from 1995 through 2007, during which time inflation averaged about 2%. Then all hell broke lose: M2 surged by some $6 trillion in a 2-yr period, fueled by Covid stimulus spending which was effectively monetized. That bulge now has all but disappeared.

Chart #2

Chart #2 shows the 6-mo. annualized growth rate of M2, now a mere 4.6%. The economy is now on a low-inflation monetary diet. As I have said about M2 many times in the past 5 years, this is arguably the biggest news that no one, not even the Fed, is paying attention to. 

Chart #3

Chart #3 shows the ratio of M2 to nominal GDP. I call this the "demand for money," since it essentially measures how much of our annual incomes we prefer to hold in the form of money. Money demand surged in the first year or so of Covid, because people were terrified and largely unable or unwilling to spend all the cash the government was doling out. Strong money demand effectively neutralized the surge in the M2 money supply, which explains why inflation didn't start rising for a year after M2 began to soar. Money demand then collapsed beginning in mid-2022, as things began to return to normal, and that effectively offset the collapse and actual shrinkage of M2—that's why a contracting money supply didn't cause the recession that was so widely anticipated. (Remember: inflation happens only when the supply of money exceeds the demand to hold it.) Now money demand is almost all the way back to where it was prior to Covid.

Chart #4

Chart #5

Chart #4 compares the strength or weakness of the dollar to the level of inflation-adjusted spot commodity prices, while Chart #5 shows the nominal level of those same commodities since early 2020. These are all very basic commodities, not the sort that are subject to speculative pressures (like gold can be). What we see here is a very strong inverse correlation between the dollar and real commodity prices. A stronger dollar tends to coincide with weaker commodity prices, and vice versa. Note that commodity prices over the past 33 years haven't changed at all in real terms, and the dollar has only strengthened modestly. Over the past several years, commodity prices have gone nowhere—a strong symptom of an absence of underlying inflationary pressures.   

Chart #6

Chart #6 is structured the same way as Chart #4, except that I've used the inflation-adjusted price of crude oil. In real terms, oil prices are relatively low, and that reinforces the outlook for low and stable inflation. Oil is the most volatile of all commodity prices, and the price of energy is an important contributor to the economy's health. Nationwide gasoline prices are currently just under $3 per gallon, and that is roughly what gasoline prices have averaged over the past 20 years. This is very good news for economic growth.

Chart #7

Chart #7 looks at the short-term, annualized rate of change in Owner's Equivalent Rent, which in turn constitutes about one-third of the CPI. In the past two months, this important component of the CPI has decelerated markedly; this will subtract meaningfully from reported inflation over the next 10 months.

Chart #8

Chart #8 compares the year over year change in the total CPI to its ex-shelter version. The gap between the red and blue lines over the past 2 years is largely due to the government over-estimating shelter costs. The gap has now all but closed. 

Chart #9

Chart #9 shows the long-term growth trend of real GDP (green line), which averaged about 3.1% per from the post-war period through 2007. Sadly, the economy has yet to return to those glory days; growth has averaged only a bit more than 2.3% per year since the Great Recession ended in 2009. Why this huge shortfall? I suspect a variety of culprits: massive increases in transfer payments (e.g., green energy subsidies, Obamacare), burdensome regulations (e.g., CAFE standards), and DEI hiring, to name a few. Stepping back, mankind has spent several trillions of dollars on inefficient energy projects in a vain attempt to "save" the planet from climate change. A return to efficient energy investment appears already to be underway. This is great news for the planet and its economies.

Chart #10

Chart #10 tracks the growth of private sector jobs in recent years, which are now growing at a snail's pace. Contrast this to the surprisingly strong growth of Q3/25 GDP (4.3%) and you must conclude that productivity is on the rise by more than enough to offset the drag of massive deportations of illegals. Meanwhile, federal government payrolls have shrunk by 9% (273K) so far this year! To my mind that's the equivalent of pouring much less sand into the wheels of commerce. 

Chart #11

Chart #11 shows the inflation-adjusted price of gold over the past 113 years. Monetarists like me have trouble reconciling soaring gold prices with an apparent absence of inflation pressures. Central banks have meaningfully increased their purchases of gold in the past four years, and that at least partially explains gold's rise to levels never before seen—or even imagined. On the other hand, this could be a classic case of speculative froth which eventually exhausts itself and collapses. The 30% collapse in Bitcoin prices since early October could be a harbinger of trouble ahead for other markets. 

Chart #12

Chart #12 paints a disturbing picture, suggesting that the recent collapse in bitcoin could be presaging a similar decline in equity prices. The market cap of crypto currencies peaked at $4.28 trillion on October 6th, and current stands at $2.95 trillion; $1.33 trillion of paper wealth has thus evaporated in a matter of weeks. Dabble in gold and bitcoin at your peril. I wouldn't touch the stuff—give me real, productive assets instead.  

Chart #13

Chart #13, in contrast, paints a hopeful picture; federal government finances look to be returning to some measure of sanity. Federal government spending has been flat for the past year, while revenues have increased by 10%. The days of $2 trillion dollar annual deficits are fading fast. Federal debt owed to the public has been 90-100% of GDP for over 5 years (it peaked at 103% in mid-2020) and may soon begin to decline. In the meantime, the true burden of our national debt is currently 3.7% of GDP, and that is significantly less than the 4.5-5% levels which prevailed during the 1980s. There is still reason to be optimistic.

Happy New Year!

P.S. Thanks to Larry K for the words of encouragement!

Charts of interest

Some charts I find of interest to the general public, and which you're unlikely to find elsewhere:

Chart #1

Chart #1 sheds light on an important input to the dollar's value: real yields. The red line shows the level of real yields on 5-yr TIPS. These are true real yields, since TIPS are bonds whose principal is adjusted by the CPI, and whose coupon is a "real" yield. (Their return to the investor is equal to the rate of consumer price inflation plus a real yield.) Real yields on TIPS are determined by market forces, and are in turn influenced by the market's expectation of future Fed policy. TIPS are not only safe from default, but also safe from the ravages of inflation. 

The blue line is an index of the dollar's value vis a vis other major currencies. That the two tend to move together suggests that higher real yields enhance the value of the dollar, while lower real yields detract from the dollar's value. The situation today suggests that the dollar is trading on the weak side of where it would normally be given the current level of real yields. This further suggests that investors aren't entirely comfortable with the outlook for the U.S. economy (e.g., tariffs, deportations).

Chart #2

Chart #2 shows my model of the Purchasing Power Parity of the dollar vs. the euro. Currently, the model suggests that the dollar is just about equal to its PPP value against the euro. That further suggests that an American traveling in Europe is likely to find that the dollar price of goods and services there is roughly equal to prices in the U.S.

Chart #3

Chart #4

Chart #3 shows the level of credit spreads on Investment Grade and High-Yield corporate bonds—higher spreads reflecting greater credit risk, and lower spreads reflecting lower credit risk. Spreads today are just about as low as they have been for the past several decades. Chart #4 shows the difference between the two, which is a simple way of judging how nervous the bond market is. Taken together, these spreads are excellent barometers of the health of corporate profits, and by extension, the health of the economy. Conditions are looking pretty good according to corporate bond investors.

Charts #5 and #6

Chart #5 shows the ratio of federal transfer payments (social security, medicaid, unemployment insurance, subsidies, food stamps, etc.) to disposable income. Transfer payments represent money the government gives people money for reasons other than to compensate for their labor. Chart #6 shows the Labor Force Participation Rate, which is the ratio of people working or looking for work divided by the number of people of working age.

The dotted vertical lines mark periods of time when transfer payments ratcheted up rather sharply. That the participation rate ratcheted down each time suggests that people are less willing to work when they receive more money for not working. Funny how that works!

Note the more-than-doubling of transfer payments as a percent of disposable income from 1970 to today. Today, one of every five dollars spent by consumers comes from the government. Viewed from another angle, taxpayers are funding 20% of consumer spending. 

Chart #7

Chart #7 shows the breath-taking growth of federal government spending and tax receipts. Revenues today are more than 5 times what they were 35 years ago, and have increased at a 4.8% annualized rate. Spending today is more than 6 times what it was 35 years ago, and has increased at a 5.3% annualized rate. Our problem is runaway spending, not a lack of taxes.

  

Chart #8

Chart #8 shows the major components of federal revenues. Individual, corporate, and payroll taxes have all increased relentlessly with the passage of time. What stands out here is estate and gift taxes, which today represent a paltry 0.6% of total revenues (~$30 billion per year), and which have not increased at all over the past 25 years. The net worth of the private sector has quadrupled over the past quarter century, but estate and gift taxes haven't budged. This tax could be abolished and the impact on federal finances would be less than a rounding error. Yet this tax gives rise to an army of tax lawyers and accountants, while at the same time diverting trillions of dollars to sheltered investments. It undoubtedly costs the economy far more than the value the government collects. We would all be better off without it.