The Money Supply Has Started to Grow Again: What Does This Indicate?

The US money supply, which was still falling at the fastest pace since the Great Depression a century ago at the end of 2023, rose for the fourth consecutive month in November. Before previous economic crises, the growth of the money supply has first slowed down, and the crisis has often arrived just after the money supply had turned around.

Money supply growth has accelerated for four consecutive months now, most recently in October 2022. The current trend suggests that the historical trend of large declines in money supply has reversed. In November last year, money supply grew by a total of 3.73 percent year-on-year, the last time annual growth was this fast was in August 2022. In November 2023, money supply fell by 3.3 percent year-on-year.

The broadest measure of money supply – M2 – fell by 5 percent in the US from April 2022 to October 2023. This downward trend has now ended, and the money supply has also started to grow on an annual basis. The Rothbard-Salerno measure of money supply, developed by Murray Rothbard and Joseph Salerno, meanwhile fell by more than 10 percent on an annual basis.

A Decline in the Money Supply Can Predict a Recession

Money supply is an indicator that reflects economic activity and, to some extent, also allows for the prediction of economic recessions by financial institutions. During booms, money supply tends to grow rapidly because commercial banks issue more loans.

Before recessions, money supply tends to grow more slowly or even fall because fewer loans are taken out and activity is lower

A halt or decline in the growth of the money supply tends to occur a few years before a recession. It is important to understand that the money supply does not necessarily have to fall to predict a recession, but rather a slowdown. The work of Austrian economist Ludwig von Mises has shown that recessions are often preceded only by a slowdown in the growth of the money supply.

Ryan McMaken writes on the Mises Institute website that recessions only become apparent after the growth of the money supply has started to accelerate again. This was the case with the recession of the early 1990s, before the bursting of the tech bubble in 2001, and before the Great Recession of 2008. The current trend may indicate that a recession is imminent.

The decline in the money supply in 2022-2023 was probably due to the Federal Reserve’s aggressive interest rate hikes and the anti-money printing process, which involved selling government bonds on the market instead of buying them. The money printing that took place after the corona crisis worked like this – the central bank created new money and bought government bonds with it. As inflation accelerated, these bonds were in turn sold, which meant that the same money was taken out of circulation.

Since Covid-19, the Growth of the Money Supply Has Been Insane

Although the money supply has been in a sharp decline in the meantime, the growth in the last five years has been faster than the long-term trend (recent decades). In order to return to a normal trend, the money supply would have to fall by another $3 trillion. And compared to January 2020, the money supply is still 35 percent higher.

Since 2009, the Federal Reserve’s M2 measure of money supply has grown by 150 percent. The amount of money in circulation has now grown to $21.45 trillion.

Almost two-thirds of the money supply has been added in the past 13 years

The Federal Reserve seems to have no problem with money supply growth. This is despite the fact that inflation has not returned to the central bank’s target. The central bank’s target is 2 percent annual inflation, currently various inflation indicators are at 3 percent. As the money supply has started to grow again, we can also expect inflation to accelerate in the long term.

An Increase in the Money Supply is Necessary to Devalue Debt

One of the reasons the Federal Reserve is already increasing the money supply is the United States national debt. It is predicted that the US government’s budget deficit could reach $3 trillion this year, which will put serious pressure on public finances and push up interest rates on bonds.

The Treasury Department probably expects the Federal Reserve to intervene because the country is paying more and more interest on its debt. So the central bank is forced to increase the money supply because it eases the country’s financial situation. The more money there is in circulation, the easier it is to repay every trillion in debt.

Despite the central bank’s desire to lower interest rates on US government debt, the yield on 10-year US Treasury bonds has actually risen during the rate cuts. While the central bank has lowered the base rate from a range of 5.25-5.5 percent to a range of 4.25-4.5 percent, the interest paid on 10-year US Treasury bonds has increased from 3.7 percent to 4.7 percent. It has not happened in the US for decades that bond yields have risen so much during a central bank rate cut.

This is an extraordinary process because it shows a decline in investor confidence in both the Federal Reserve and the US government. It shows that ultimately interest rates are determined by the markets, not the central bank.