There’s much ado in the financial media about the recent collapse in money supply. The steepest since the 1930s. Financial Armageddon surely awaits, right?
Not so fast. Let’s look at the actual data.
First, we focus on the locus of concern. Here’s a one year chart of M1:
Pretty scary, at least if you’re up to your neck in stocks or fretting about deflation. But wait … who says just the past year is all that matters? Let’s zoom out to the last ten:
Okay, now I have a little problem getting worked up about collapsing money supply. The past year hasn’t even undone the increase since 2021, let alone the post corona crash explosion in 2020. Money supply is about five times what it was barely three years ago, when the economy and financial markets were humming along quite nicely, thank you. Again, what time frame gives the proper perspective? I don’t pretend to have an answer for that, but does the Cassandra crowd? Do the latter’s denizens even bother to ask the question, never mind try to answer it?
This recency bias, incidentally, is not restricted to money supply. If the stock market, for instance, declines by 10% from top tick, it’s treated as a crisis, even if it leaves prices 20% above where they were a couple years ago. Pick the data that express you how you feel.
Is it possible? Is it possible that this longer term outsized money supply expansion helps explain why, despite the purportedly huge increase in monetary tightening over the past year, why the FOMC is still mystified as to the grudging progress on reducing final inflation? Why, even after 500 basis points of rate increases?
There are still multiple trillions of dollars more floating around in the system than in March 2020.
Money is not tight.
There just isn’t any shortage of the stuff. John Hussman does a deep dive in a recent article:
Hussman puts some otherwise absent perspective on the current situation. You’ll want to read the article, but the gist of it is this: Money supply matters. The famous Volcker tightening was, for example, due to Volcker’s targeting of the money supply. Soaring rates, including Fed funds, were an effect of the tightening, not the cause. The Fed now imagines it can blast the system full of money and rely on rates alone to effect a tightening.
Don’t get me wrong. Rates desperately needed to rise, after being nailed to zero for most of the past decade and a half. That policy wreaked untold damage on the economy, blowing out the wealth gap and creating unstable bubbles and stultifying debt among other things. And the process of readjusting to more normal rates isn’t likely to be without trauma. You don’t shoot heroin for years on end and suddenly stop without severe withdrawal symptoms. For one thing, in combination with having reduced reserve requirements to zero in March 2020, it would be amazing if there weren’t problems with deposits leaving banks. Why keep your money in the bank earning a fraction of a percent when you can get 5% in a money market fund?
And if you stop shooting heroin and experience bad effects, is your misery due to a deficiency of heroin? Or the surplus that you got addicted to before? The Wall Street crybabies would have you believe heroin is an essential nutrient.
How do you uninflate a system without deflation? How do you unblow a bubble without a crash?
The damage inflicted by that huge spike in money supply on top of years of rate repression has yet to be fully felt. The yield curve is flashing red. So it shouldn’t surprise us in the least if indeed severe financial stress becomes obvious in the coming months. Just don’t blame it on that miserable little decline in money supply alarmists are crying about.
Blame it on the monster spike that came before. But either way, don’t blame it on whether the FOMC decides to hike another 25 bp in May or June or whatever. As we said before, rates are already plenty high. You can put me down in the camp that says the FOMC will indeed add another 25 bp to its Fed funds target. But not in the camp that thinks it’s a big deal.