Money supply growth slows enough to burst the bubble; Not enough to cure inflation

by SchiffGold 0 0

According to seasonally adjusted data, M2 increased by $23B in May. With the exception of last month’s contraction (the first contraction in 12 years), this was the smallest monthly increase in M2 since the onset of COVID.

But despite the sharp slowdown in growth, the money supply is still expanding. It will therefore be very difficult for inflation to return to 2%.

Meanwhile, while inflation is unlikely to come down, the stock market and the economy rely on a rapidly expanding money supply. With such slow growth, it will be very difficult for the stock market to reach new highs and for the economy to avoid recession.

Figure: 1 MoM M2 Variation (seasonally adjusted data)

The graph below shows the not seasonally adjusted money income. The current slowdown can be seen very clearly against the growth since Covid. Three of the last six months have seen cuts in the money supply. This is clearly not enough to reverse the massive increases in money supply that took place in 2020 and 2021.

Figure: 2 monthly changes in M2 (unadjusted data)

The table below shows this slowdown more clearly. Over the past three years, M2 growth has averaged 14.1% annualized. Over the past year, this figure has fallen to 6.5%, then to 3.9% over the last 6 months and to 1.3% in the most recent month. It’s a spectacular to slow down.

Figure: 3 m2 growth rate

When looking at the average monthly growth rate per month before Covid, May is growing historically at an annualized rate of 6.3%. This compares to 1.3% for the current month.

Figure: 4 Average Monthly Growth Rates

The Fed only offers weekly data not seasonally adjusted. The chart below shows that May likely avoided going negative thanks to a $106 billion expansion in the most recent week.

Figure: 5 changes in WoW M2

The 13-week “Wenzel” money supply

The late Robert Wenzel of the Economic Policy Journal used a modified calculation to track the money supply. He used a 13-week annualized average growth rate as defined in his book The Fed Flunks. In particular, he used the weekly data which not seasonally adjusted. His analogy was that to know what to wear outside, he wants to know the current weather, not the average temperatures throughout the year.

The goal of the 13-week average is to smooth out some of the choppy data without bringing in too much history that might obscure someone from seeing what’s in front of them. The average growth rate over 13 weeks can be viewed in the table below. Decelerating trends are in red and accelerating trends in green.

Growth is now at 3.02%, which lowest reading in over 60 weeks and is the 19th consecutive week of money supply deceleration.

Figure: 6 WoW 13 Week Average Money Supply Growth

The chart below helps show the seasonality of the money supply and compares the current year to previous years. It shows that the current trajectory is descending quite rapidly. Money supply growth is now at the slowest growth for this time of year since at least 2013.

The rate of money supply growth usually only peaks in August, which means money supply growth could definitely turn negative in the coming months. Again, this reduction is not strong enough to stop inflation, but it will most certainly hurt the economy and the stock market.

Figure: 7 13 week annual overlay

Behind the inflation curve

To fight rising prices, the Fed needs to write off most of the money it has created over the past few years. This would require bringing interest rates down above the inflation rate.

Unfortunately, the chart below shows that the Fed has never been so far behind the inflation curve. A recession alone will not solve this inflation problem due to lagged effects. If we consider the period of 1970, inflation has always increased with a lag after significant expansion of the money supply. Price rises are still waiting to fully feel the effects of M2 growth. Moreover, history shows that it took rates above inflation to bring prices down.

The blue line below (federal funds rate) has almost always gone above the black line (CPI) to force inflation back down. The only anomaly was in 2011 after the Great Recession. The mainstream now assumes that’s the norm, but the chart shows that it’s much more common that interest rates have to outpace inflation to drive the curve down. The recent period has made the Fed complacent. It’s very dangerous !

Note: This chart does not reflect the latest 75 bps rise

Figure: 8 annual changes in M2 with CPI and fed funds

Historical perspective

The charts below are designed to put current trends into historical perspective. The orange bars represent the annualized percentage change rather than the gross dollar amount. The current slowdown is visible on the right side with the black bar at the lowest level since November 2018.

If a few months of slowing M2 can cause so much pain for the whole economy (stock market, housing, bond yields, etc.), how much carnage would occur in a protracted fight against inflation where M2 had to twitch constantly for months?

Figure: 9 m2 with growth rate

A historical look at the 13-week annualized average also shows the current situation. This chart overlays the S&P newspaper yield. Mr. Wenzel proposed that sharp declines in the money supply could be a sign of a stock market pullback. His theory, derived from Murray Rothbard, states that when the market experiences a declining (or even negative) money supply growth rate, it can create liquidity problems in the stock market, leading to a sell-off.

The current value of 3.0% is the lowest value since December 2018. Remember that the fourth quarter of 2018 is when the Fed had to pause the last tightening cycle due to the market pullback.

While not a perfect predictor, many declines in the money supply precede market declines. Specifically, the major lows in 2002 and 2008 went from 10% to 0%. The economy is now struggling with a record growth rate of 63.7% in July 2020, at 3%. It’s a major meltdown.

The latest stock market downturn is further evidence of this relationship. Based on the chart below, history would indicate that the market pullback has only just begun.

Please note that the chart only shows market data through June 6 to align with available M2 data.

Chart: 10 M2 annualized over 13 weeks and S&P 500

Another consideration is the massive accumulation of liquidity in the system. The Fed offers Reverse Repurchase Agreements (reverse repos). It is essentially a tool that allows financial institutions to exchange cash for instruments on the Fed’s balance sheet.

The current Reverse Repo surpassed $2 trillion on May 23 for the first time in history. This eclipses old records of ~$500 billion in 2016-2017. Repos hit a record high of $2.3 billion on June 23, but will likely see a new high on June 30 at the end of the quarter when reverse repos tend to peak.

Bottom line, even though M2 has slowed down, there is still trillion dollars in cash circulating. New funds will not be available to support the stock market, but excess liquidity is still available to drive up prices and keep inflation high.

Figure: 11 Fed reverse repurchase agreements

What this means for gold and silver

Inflation is an expansion of the money supply which generally leads to higher prices. To lower prices, the money supply must contract. So far, the market has seen only one month of contraction (April) and simply slower growth in recent months. This led to a bear market in stocks, a crash in Crypto, and a spike in bond yields.

The Fed and the mainstream are hoping that the next recession will do the Fed’s dirty work for them, but the data does not support that view. The money supply is not falling fast enough. Moreover, the Fed will have to pivot in order to prevent the “everything” bubble from completely imploding on itself.

The Fed will not wait for inflation to return to 2%, it will be forced to stimulate again well before inflation is brought under control. When this happens, gold and silver skyrocket. Smart money delivered regularly and released the metal from Comex vaults. When the rest of the market wakes up and demands physical delivery, prices will rise rapidly.

Data source: and also WM2NS and RRPONTSYD series. Historical data changes over time, so future item counts may not match exactly. M1 is not used because the calculation was recently changed and backdated to March 2020, distorting the chart.

Data updated: monthly on the fourth Tuesday of the month with a 3 week lag

Latest data: June 06, 2022

Interactive charts and graphs are always available on the Exploring Finance dashboard:

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