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The amount of money in the US economy is decreasing. Why is this significant?

Published by Tavex Analysts in category Tavex News, Market News on 29.03.2023
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The amount of money in the United States economy has been decreasing for the third consecutive month in January. This decline in the money supply is quite an extraordinary event, last occurring 28 years ago, and is happening after a sudden surge in the money supply in 2020 and 2021.

Considering the current debt-based monetary system where debt is always greater than money in the system, the decline in the money supply is significant. To keep the system working, we need an ever-increasing volume of debt, and thus a continuous increase in the money supply. This is also why such an event rarely occurs.

The money supply largely reflects economic activity – during a boom, more loans are taken out, which also accelerates the growth of money in the economy, since more loans are taken out. Although this indicator is not the best predictor of the future, the current fairly extreme decline may indicate an economic downturn. Generally, the growth of the money supply has slowed before an economic downturn.

The decline in the amount of money in the US economy is not a big surprise, given that the Federal Reserve is raising interest rates at the fastest pace since the 1980s. This has significantly slowed the issuance of loans and raised short-term interest rates above long-term rates.

Since the central bank has been creating asset bubbles for years, the decline in the money supply creates problems primarily for those who have become dependent on cheap and readily available money. It may also mean that inflation will suddenly slow down or that the US economy may even face deflation.

First decline since 1994

Since April 2021, the growth of the money supply has rapidly slowed down, and since November, the amount of money in the US has been declining, which last happened in November 1994. At that time, the money supply fell for 15 consecutive months, starting to rise again in 1996.

M1 money includes cash, coins, and deposits that can be immediately exchanged for cash. M2 includes M1 money plus time deposits up to two years and savings deposits with a notice period of up to three months.

In January of this year, the amount of money in the US economy fell by just over 5 percent. Such a large decline has lasted only a few months in the past, last occurring in 1989 and 1995. For at least 60 years, the money supply has not declined by more than 5.6 percent in any month.

Murray Rothbard’s money supply (TMS, in blue) and Federal Reserve’s M2 money supply (in gray). Source: RyanMcMaken.

The graph above depicts the Rothbard-Salerno money supply measure. It was developed by Murray Rothbard and Joseph Salerno, and its goal is to better measure the fluctuations in the M2 money supply. The Mises Institute regularly updates this measure. Looking at the Federal Reserve’s official M2 indicator, it decreased by 1.7 percent in January and 1.1 percent in December. Fed data dates back to 1960, and prior to this, the money supply has not declined in any month (compared to a year ago) according to central bank data.

The amount of money has been growing particularly fast since 2020

Since 2009, the Rothbard-Salerno money supply has increased by 203 percent. Currently, it amounts to $20.2 trillion, and $5.9 trillion of this has been created since January 2020.

This means that a 5 percent decline is modest considering the amount of money created in recent years. The US economy is facing the hangover of recent years of monetary policy, and this is why, after nine months of a slowdown in money supply growth, there is no noticeable weakening in the labor market or consumption, writes economic expert Ryan McMaken on the Mises Institute portal.

At the same time, McMaken notes a decline in real estate prices, an increase in credit card debt, a decrease in new job creation, and the fact that people are increasingly struggling to repay consumer loans. Industry prospects have also worsened.

Inversion of the yield curve

The growth of the money supply is also partly related to the inversion of the yield curve, which is considered the best predictor of an economic downturn. The yield curve shows the difference in yield between government bonds of different maturities. When short-term bond yields rise above long-term yields, this is called an inversion of the yield curve. You can read more about it here.

An inversion of the yield curve is usually accompanied by a slowdown in the growth of the money supply – we saw this in 1999-2000, 2004-2006, 2018-2019, and the beginning of 2022. This is not surprising, as the growth of the money supply is strongly related to the shape of the yield curve. In his book “Understanding Money Mechanics,” Bob Murphy writes that a slowdown in the growth of the money supply often reflects a rise in short-term interest rates, which also changes the shape of the yield curve.

The rise in short-term interest rates is largely due to the fact that the Federal Reserve is aggressively raising interest rates. Since January 2022, the central bank has raised the base interest rate from 0.25 percent to 4.75 percent. In addition, money printing (buying bonds with newly created money) has been stopped and the central bank has been selling bonds (withdrawing money from the economy).

The decline in the money supply in the US economy has significant implications for the debt-based monetary system, as it reflects a slowdown in economic activity and may indicate an economic downturn. The Federal Reserve’s aggressive raising of interest rates has significantly slowed the issuance of loans and raised short-term interest rates above long-term rates, leading to a decline in the money supply. The inversion of the yield curve is also a significant predictor of an economic downturn, and the current decline in the money supply is partly related to it. While the decline in the money supply may create problems for those who have become dependent on cheap and readily available money, it may also mean that inflation will suddenly slow down or that the US economy may even face deflation.

 

Gold price (XAU-GBP)
1,833.74 GBP/oz
  
- GBP37.20
Silver price (XAG-GBP)
23.72 GBP/oz
  
- GBP0.49

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