The money supply in the United States is contracting for the first time since 1949, with the Federal Reserve tightening monetary policy and declining bank deposits.
The decline in money supply raises mixed speculation about the potential repercussions on inflation, asset prices and the broader economy.
Contraction of the money supply
The money supply represents an indicator of money and rapidly liquidating assets in circulation in the economy.
M2 is a broad measure of the money supply, which includes currency and various types of bank deposits and money market mutual funds, which are relatively liquid.
- The US money supply “M2” reached about $20.783 trillion last July, compared to $20.802 trillion in June.
- The money supply in the United States is significantly lower than the peak recorded in July 2022 at $21.578 trillion.
- On an annual basis, the money supply witnessed the fastest pace of decline since the 1930s.
- Despite the recent strong decline, the US “M2” is still $5 trillion higher than pre-pandemic levels.
Why is the money supply declining?
- The decline in money supply largely reflects the marked shift away from the massive fiscal and monetary stimulus policy during the height of the “Corona” epidemic.
The US government pumped billions of dollars into the economy by sending money directly to Americans and approving support packages for companies, to overcome the repercussions of the pandemic and stimulate the economy.
- The US money supply grew at a record pace during the “Covid-19” pandemic in the period between March 2020 until July 2022, reaching $5.7 trillion.
The annual growth rate at the beginning of that period exceeded what happened during the quantitative easing programs in 2008 and 2015 or the strong inflation in the 1970s and 1980s.
But as inflation accelerated, the Federal Reserve turned to monetary tightening while raising interest rates to cool spending.
The Federal Reserve raised interest rates from near zero in March 2022 to a range of 5.25% and 5.5% currently.
The Federal Reserve also reduced its balance sheet, in addition to a decline in deposits in banks and weak demand for credit.
The money supply began to decline sharply at the end of last year, with M2 witnessing its first decline on an annual basis since at least 1949.
The American banking sector also witnessed strong turmoil last March, as Silicon Valley and Signature Bank collapsed, causing a credit crisis and fluctuations in the financial markets.
The withdrawal of deposits from American banks - especially local banks - contributed to a noticeable impact on the acceleration of the decline in the money supply.
Are we seeing inflation slowing?
During the height of the Corona epidemic, analysts blamed the acceleration of US inflation on the historical growth of the money supply.
Morgan Stanley analyst Mike Wilson said at the time that the Fed's lack of control over money supply growth meant it would have no control over inflation either.
Indeed, the US inflation rate in the middle of last year rose above 9% for the first time in 40 years.
But the decline in the money supply leaves consumers with less cash available to spend on goods and services, which may help calm inflation.
Indeed, US inflation has witnessed a sharp slowdown in recent months, reaching 3.2% last July on an annual basis.
Stephen Anastasio, an economist at Economics Uncover, said that the decline in the money supply means that inflation is likely to slow over time.
Donald Luskin, chief investment officer at Trend Macrolytics, believes that the continued decline in the money supply will have a noticeable impact on prices, which, in conjunction with raising interest rates, may lead to a shift into price deflation.
Potential impacts on assets and the economy
Historically, a broader money supply decline is rare in the US economy.
- The decline of "M2" was usually associated with an economic recession, a strong rise in unemployment rates, and a decline in asset prices.
Matt King, an analyst at Citibank, said that the M2 is a driver of inflation in asset prices, consumer prices, stocks and real estate, which means that its decline represents a negative signal for all of these assets and feeds the weakness of the broader economy.
A decline in the money supply would reduce the cash available for spending, which could harm companies and lead to layoffs and a subsequent decline in the stock market.
But on the other hand, Manuel Abiaxis, an economist at Goldman Sachs, believes that major monetary measures such as “M2” have not been reliable for predicting the economic situation for several decades.
Policymakers' interest in the money supply has declined for most of the past 30 years, since central banks began using interest rates as the main tool for achieving inflation targets.
A combination of weak inflation and financial deregulation in the 1980s and 1990s helped loosen the relationship between money supply targeting and GDP growth, making money supply a less reliable basis for policy making.
Financial innovation has also helped change things, as credit and debit cards have reduced the amount of cash needed to make transactions, and it has also become easier and cheaper for families to purchase financial assets, which means that a smaller share of savings ends up in the form of deposits that are included in monetary metrics numbers. .
External demand for the dollar also distorted the relationship between monetary measures and economic results, as foreign demand for the US currency has risen steadily since the beginning of the 1990s.
- The demand for the dollar does not mean that there will be more transactions in the United States. On a parallel note, Lynn Alden, a macroeconomist, believes that the decline in the US money supply is unlikely to continue for a long time.
Alden pointed out that if the broader money supply does not rise, asset prices are unlikely to rise as well, which will consequently lead to stagnant tax revenues and a widening of the fiscal deficit, which will push the federal government to issue more bonds to finance the deficit, which will lead to To increase "M2" again.
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