M2 Money Supply is measured by the Federal Reserve to calculate the amount of Money in the financial system. The Fed defines M2 as: Seasonally adjusted M2 is constructed by summing savings deposits (before May 2020), small-denomination time deposits, and retail MMFs, each seasonally adjusted separately, and adding this result to seasonally adjusted M1.
Historically, the term inflation was defined as an expansion of the money supply that generally led to higher prices. Therefore increases in M2 is the measure of inflation. Increases in M2 will not directly align to increases in CPI for many reasons. This can be due to productivity gains, increase in population, and also modifications to how CPI is calculated. While the latest CPI generally understates a rise in prices by design, the CPI as measured in 1980s can be found at Shadow Stats.
M2 used to be released on a weekly basis, but in 2020 this was changed to a monthly frequency. The chart below shows the month over month changes in M2. The massive spike in 2020 can still be seen when the Fed blasted the system with $2.3T within 3 months during the shut downs. In the latest period, M2 only increased by 17B. This is a massive fall off compared to more recent periods as the chart below shows. In the month prior, M2 had increased 15x greater at $252B.
Figure: 1 MoM M2 Change
The table below shows the change in M2 over different period lengths. All numbers have been annualized for consistency. As can be seen, the growth in M2 was accelerating but has collapsed from 13.6% over the last 6 months down to 1% in the recent period. Over 3 years, the money supply has been growing on average at 13%.
Figure: 2 M2 Growth Rates
13 Week Annualized Money Supply
The late Robert Wenzel of Economic Policy Journal used a modified calculation to track money supply. He used a trailing 13 week average growth rate annualized as defined in his book The Fed Flunks. He specifically used weekly data that was not seasonally adjusted.
The table below mirrors how he published the values in his newsletter. It shows the weekly average going back in time with ‘1’ being the most recent week. Green numbers indicate accelerations in the money supply where red shows the money supply decelerating. As can be seen in the most recent 4 week period, the money supply is decelerating rapidly after accelerating for most of the previous 12 weeks.
Generally, Mr. Wenzel looked for large decelerations as an indication of potential market weakness. With the latest drop in money supply growth, it may be more challenging for the market to keep moving higher.
Please note: This calculation differs slightly from the Robert Wenzel calculation. This calculation uses the most recent data for all time periods rather than data published at the time (the historical data changes overtime). Additionally, Robert calculated the growth over a 12 week period and annualized the data. It should have been 13 weeks.
The plot below is another tool used by Mr. Wenzel. This chart helps show the seasonality of the money supply and compare the current year to previous years. The range of the y axis has been capped at 25% so that the massive spike in 2020 up to 60%+ does not skew the graph.
As shown, the money supply generally dips into mid summer, so the recent draw down is not uncharacteristic. The dip generally reverses by mid August, so it will be important to follow the trend to see potential impacts on rising prices. With the Fed pounding the table on “transitory” inflation, the fall in money supply growth could cause inflation to slow in the months ahead as the Fed expects.
That being said, trailing 13 week growth over 12% is still historically very high for this time of year. The economy also needs to continue digesting the massive surge seen last summer, so the current drop may not slow the rising prices seen in the CPI. Again, it is unfortunate this data is now published only monthly rather than weekly.
Figure: 6 Yearly 13 Week Overlay
The charts below are designed to put the current trends into historical perspective. As seen, the increases in 2020 were massive in scale and size. Please note, M2 did have changes to the calculation in May 2020. M1 went under a methodology change at the same time which explains the massive spike that can be seen on the Fred site. The M1 spike is simply a methodology change, don’t fall victim to misinterpretation.
M2 is a cleaner view. The changes to M2 calculation are not responsible for the massive surge shown below which actually started spiking 2 months prior to the modification. The orange bars represent annualized percentage change rather than raw dollar amount. As can be seen, even the recent periods remain quite elevated compared to pre-Covid, except the most current black bar that has collapsed.
Figure: 7 M2 with Growth Rate
Taking a historical look at the 13 week annualized average also shows the unprecedented growth seen over the past 18 months. This chart overlays the log return of SPY, an ETF that tracks the S&P 500. Mr. Wenzel proposed that large drops in money supply could be a sign of stock market pullbacks.
His theory, derived from Murray Rothbard, states that when the market experiences a shrinking growth rate of money supply (or even negative) it can create liquidity issues in the stock market, leading to a sell off. While not a perfect predictive tool, many of the dips in money supply precede market dips. Specifically the major dips in 2002 and 2008 from 10% down to 0%.
It could also be argued the pullback in 2018 could be due to an extended lead up of low money supply growth compared to previous years.
Figure: 8 Total Debt Outstanding
What it means for Gold and Silver
Inflation is an expansion of the money supply that generally leads to higher prices. Therefore, gold and silver can be used as protective assets to protect against dollar devaluation (higher prices). Money supply has been growing at alarming rates for years now, and absolutely exploded over the last 2 years. It is hard to imagine this will not bleed into the CPI in the months and years ahead, even being designed to understate price increases (e.g. Owners’ equivalent rent).
If price increases prove to not be transitory as the Fed promises, gold and silver could be the biggest winners. With money supply growing like it has, “transitory” becomes very hard to believe.
Data Source: https://fred.stlouisfed.org/series/M2SL and also series WM2NS
Data Updated: Monthly on fourth Tuesday of the month
Last Updated: Jun 2021