A woman counts the US dollar banknotes.
Marcos Brindicci | Reuters
As the Federal Reserve and Congress push stimulus efforts to new heights, some investors are watching an increase in the US money supply closely for signs of the long-awaited return of inflation.
With a litany of measures showing rapid growth in the value of money waiting in banks and other liquid accounts, investors Ray Dalio Paul Tudor Jones warned that the era of warm price increases may be coming to end.
“It’s fair to say that we have never seen money supply growth as high as it is today,” Mike Wilson, chief US equities strategist at Morgan Stanley, wrote this week.
The “Fed may not control the growth of the money supply, which means it will also not have control over inflation, if it continues,” he added.
There are several different ways for economists to measure the size of the US money supply that are generally classified with the letter “M”, such as M0, M1, and M2.
Broad measure M2 includes cash, control deposits, savings deposits and money market securities. Because of its broad definition, economists and investors alike tend to view changes in M2 supply as an indicator of total money supply and future inflation.
More money, more inflation?
As Wilson pointed out, the year-over-year percentage change in M2 supply is now north of 23%. To put that into perspective, the year-over-year growth of M2 money supply had never exceeded 15% until 2020, according to Fed records dating back to 1981.
Normally characterized by slow and steady growth, M2 supply increased by 20%, from $ 15,330 billion at the end of 2019 to $ 18,3 trillion at the end of July.
“The risk of higher inflation may be greater than it’s ever been, too,” Wilson wrote. “Although this has not shown in the rear end rates yet, the very strong movement in addition breakeven [bond market inflation expectations] and precious metals suggest higher inflation may be on the way. “
This seemed to be the opinion of longtime hedge fund manager Paul Tudor Jones, who said in May that its concerns about inflation and the depreciation of the dollar had prompted him to invest both in the bitcoin and in ‘gold.
While the differences between bitcoin and gold are many, Wall Street pursued the two assets for weeks as hedges against inflation and a relatively safe place to hold wealth during a volatile year.
Gold, one of the best deals of 2020, broke historic resistance at $ 2,000 an ounce on Wednesday to hit a new high. Between the Covid-19 pandemic and inflation expectations, gold has gained nearly 35% this year, far ahead of the 3% of the S&P 500.
“If you take cash, on the other hand, and think about it from a purchasing power perspective, if you have cash in the world today, you know your central bank has avowed target of depreciating its value by 2% per annum, ”Jones said in May. “So you have, in essence, a debilitating asset in your hands. “
The source of this M2 expansion and these inflationary fears are not necessarily a mystery.
Congress and the Fed have worked in tandem to tackle the negative economic effects of Covid-19 with an unprecedented cocktail of budget spending, near-zero interest rates and subsidized loan programs.
These efforts, primarily designed to help companies keep workers on the payroll and lessen the impact of layoffs, have been applauded for keeping consumer spending afloat in recent months.
But between a lavish Congress and an empowered Fed, critics argue that “printing money” to stimulate the economy could backfire and spike prices. Banks are always full of reserves that could eventually be injected into the economy through credits and loans.
“Congress is now the key player in stimulating money supply growth, with the Fed fully committed to doing whatever it takes,” Wilson wrote. “It’s very different from the job [financial crisis] an era when aggressive monetary policy was unsatisfied with a borrower loan and spend. We believe this increases the likelihood of inflationary pressures building up. “
Need of speed
But while an increase in the money supply can pave the way for inflation, the relationship between M2 and inflation has been questionable over the years. Some, like PGIM Fixed Income Economist Nathan Sheets, has said he’s taking a stand and see approach.
Sheets, who served in the US Treasury Department until 2017, said investors were also worried about inflation in the aftermath of the financial crisis. These fears, he said, ultimately did not materialize.
“The rates were very low and the balance sheets of central banks (and money creation) surged. But liquidity was then remained in the banking system, including in the form of excess reserves at the Fed,” said he wrote in an email. “Money creation must translate into increased lending and spending for it to be inflationary. “
US Secretary of the Treasury Steve Mnuchin and White House Chief of Staff Mark Meadows at the United States Capitol on August 1.
Stefani Reynolds / Bloomberg via Getty Images
The idea that money creation will not necessarily generate inflation centers on another economic concept known as the speed of money.
The speed of money is, quite simply, the rate at which money is exchanged in an economy. High speed of money is generally associated with a healthy economy, with businesses and consumers spending money and increasing a country’s gross domestic product.
But the speed of money can slow down during recessions as corporations and families choose to save more for every dollar they earn. Demographic changes, such as an older population, also tend to dampen the speed of money.
According to Sheets, the Fed may go to extreme lengths to drain the economy of liquidity and bolster M2 supply. But if businesses and customers aren’t inclined to spend the extra dollars, the money will almost invariably end up sitting idle, not contributing to GDP or inflation.
This may partly explain why the United States has not seen headline inflation figures rise despite the surge in M2 supply in recent months.
The Ministry of Labor’s latest report on basic consumer prices showed the index declining for a third consecutive month in June for the first time since 1957. The price index of basic personal consumption expenditure, the The Fed’s preferred inflation gauge, rose 0.9% year on year. on an annual basis in June, the smallest increase since December 2010.
“Inflation was held back by some fundamental structural factors, including the aging population and high debt levels, which have dampened global demand and pressure on prices,” wrote Sheets in an email. “Workers struggled for higher wages, and companies – competing with the so-called ‘Amazon price’ – had little ability to raise their prices.”
“My hope is that these forces are likely to continue on the other side of the virus,” Leaves wrote. “In response, central banks will remain very stimulating, but meeting the inflation targets of 2% on a sustained basis will be a challenge.”
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