PUL$E: U.S. Money Supply Plummets

Samson Jagoras 31.Jul.2023

Hold onto your seats, folks! The U.S. money supply is shrinking at an alarming rate, and it's the fastest decline since the 1930s.

Since December, we've seen a year-on-year decrease in money supply - something that has never happened before in modern times. And this could have serious consequences on growth, asset prices, and inflation.

So, how did we get here? It's mainly because the massive stimulus efforts following the pandemic are being reversed. The Federal Reserve is tightening its balance sheet, bank deposits are falling, and there's weak demand for credit. It's a perfect storm that's causing the money supply to dwindle.

Here's the kicker: this means the Fed has no reason to raise interest rates any further. In fact, it might even be a sign that they should be cutting rates. And here's why: the impact of money supply changes on asset prices and inflation can take one to two years to show. That's a long time, and we can't afford to wait.

In February, the M2 money supply, which measures how much cash and cash-like assets are circulating in the U.S. economy, fell by a staggering 2.2%. And that was before the recent failures of major banks that sent shockwaves through the markets.

This decline in the money supply is a red flag. It's affecting everything from asset prices to consumer inflation to equities and real estate. We can't ignore this negative signal, as it's likely to lead to broader economic weakness.

Money is what makes the world go round, and right now, it's disappearing. The post-pandemic stimulus frenzy and the Fed's tightening policies have caused banks' deposits, reserves, and overall liquidity to take a hit. We're seeing record outflows from banks, especially the smaller ones. And while money market funds are seeing massive inflows, they're not helping the situation.

There's a lot of cash in the system, but it's stagnant. Demand for credit is already weakening, and lending standards are tightening. We can't dismiss these signs. Money metrics tell us what's happening in the economy, and if money and inflation are falling at this pace, the Fed needs to stop raising rates.

Bottom line: The decline in money supply shouldn't be ignored. Convergence of rates, inflation, and M2 will be the lynchpin. As I said, last week debt rates are now higher than equity yield expectations, and these are the cross roads that will cause assets to decrease in price.