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U.S. Money Supply Shrinks at Historic Rate: Echoes of the 1930s

Published by Tavex Analysts in category Market News on 06.11.2023
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The amount of money in the US economy is shrinking at the fastest pace since the 1930s, which could put severe pressure on prices and lead to deflation. The Federal Reserve requires vigilance as this trend could alter their inflation targets and affect the financial system.

Consecutive Decline in Money Supply: A Ten-Month Trend

The fall in the money supply in the USA, which started in November of last year, has been going on for the tenth month in a row. Commercial banks have become more cautious, which impacts the reserves required and overall economic growth. The last time the money supply fell in the US was in November 1994.

As the U.S. money supply dwindles at a rate unseen since the 1930s, the Federal Reserve faces a critical test in steering the economy away from deflation and maintaining financial stability

From Pandemic Boom to Sudden Slowdown

The amount of money available in the economy started to increase more slowly in April 2021. The rate at which money was being added to the economy slowed down significantly. Previously, there had been a rapid increase in the money supply because of the extra money created during the COVID-19 pandemic. In 2020, this rate of increase will reach as high as 40%.

However, the money supply has been declining in annual comparison since November 2022, which was last seen in November 1994. At the time, the decline had lasted 15 months in a row.

In August of this year, the money supply decreased by 10.8 percent year-on-year; in July, the decrease was the same. The fall has been greater than 10 percent for some months, and the last time we saw it in the United States was during the Great Depression. Prior to this year, the annual decline in the money supply had not been greater than 6 percent in any month in the last 60 years. You can read more about this here.

Alternative Indicators: The Rothbard-Salerno Measure

Here, we provide information on the Murray Rothbard and Joseph Salerno developed Rothbard-Salerno measure of money supply. Compared to the M2 money supply that the Federal Reserve publishes, this measure might offer a better indication of changes in the money supply. The amount of official M2 money fell by 3.7 percent in August.

What Is M2 Money?

M2 money supply is a money supply measure that includes a broader range of financial assets than other measures, such as M1. Read More

M1 money supply, which itself consists of:

  • Physical currency (coins and bills) in circulation outside of the Federal Reserve Banks and the vaults of depository institutions
  • Traveler’s checks of non-bank issuers
  • Demand deposits at commercial banks (excluding those amounts held by depository institutions, the U.S. government, and foreign banks and official institutions) that are typically checking accounts
  • Other types of checkable deposits (OCDs) include NOW accounts and ATS accounts at banks, credit union share draft accounts, and demand deposits at thrift institutions.


M2 also includes near-money, which are financial assets that are not as liquid as M1 but can be converted into cash or checking deposits quickly:

  • Savings deposits (including money market deposit accounts)
  • Time deposits less than $100,000 (such as certificates of deposit that are under the stated limit)
  • Money market mutual funds held by individuals

M2 is considered a key economic indicator used by economists to estimate the money supply’s future inflationary effect. Policymakers and economists closely monitor it as a more comprehensive indicator of the economy’s liquid assets in order to assess the state of the economy and make decisions about interest rates and other monetary policies.

Read Less

Historical Parallels: Current Trends vs. The Great Depression

A decline comparable to the Great Depression: From the fall of 1930 to the winter of 1933, the amount of money fell by nearly 30 percent. At that time, prices fell at about the same pace.

A decline comparable to the Great Depression: From the fall of 1930 to the winter of 1933, the amount of money fell by nearly 30 percent

Deep deflation made it harder to pay debts because the value of money rose sharply, but the amount of debt remained the same. It also reduced consumption, increased unemployment, and led to the insolvency of many banks, businesses, and individuals. The current rate of decline in the money supply is now comparable to the Great Depression.

Money Supply as an Economic Health Indicator

The money supply is an indicator that reflects economic activity and, to some extent, also allows for predicting economic downturns. During an economic boom, the money supply typically expands quickly. This is because commercial banks give out more loans.

When more loans are issued, it effectively increases the amount of money in circulation. This can then encourage people to spend more. During economic downturns, the money supply tends to grow slowly or fall instead because fewer loans are taken out and activity is lower.

The Decline’s Mechanics: Understanding the Financial Institutions’ Role

The question may arise: how can the money supply fall? If money is already in circulation, where can it go? The decline in the money supply results from the nature of the monetary system, the money creation process, and the ability of central banks to manipulate the amount of money in both ways.


Loan Dynamics: Central to Money Circulation

The lending activities of commercial banks have a significant impact on the amount of money in an economy. When a bank issues a loan, it essentially creates new money. This money enters circulation and is used for various transactions. However, when the loan is repaid, the principal amount is removed from circulation, effectively reducing the money supply. The interest paid on the loan does not disappear; it is kept by the bank as profit, transferring existing money from the borrower to the bank without altering the overall money supply.

Turnaround in Loan Market Signals Economic Shifts

Since the loan market is about to turn or has already turned, we see a process where the volume of repaid loans exceeds the volume of new loans. This is the reason why the money supply has started to fall so quickly. In general, in the context of the current monetary system, this is a bad sign for the economy and the labour market and indicates an impending recession.

Deflation: A Potential Outcome of Monetary Contraction

Is deflation coming? Considering how sharp inflation was caused by money printing after the Corona crisis (rapid growth of the money supply), we can see the opposite process, at least in the short term; this would mean pressure on consumer prices and potentially lead to deflation.

Will the great depression be revisited?

Inflation: Not Solely a Product of Supply Chain Issues

There is a lot of talk about the fact that the cause of the accelerated inflation was supply chain problems related to the Corona crisis, the price increase of raw materials (especially oil and natural gas), and later also the war in Ukraine, which pushed up the prices of raw materials even further.

However, the Bank of England and other financial institutions are increasingly concerned that the current inflation is not just a result of supply chain issues but also of the massive increase in the money supply that occurred during the pandemic.

Central banks, such as the Federal Reserve Banks in the US, have tools to influence the money supply and hence inflation. For instance, they can alter the discount rate, which is the interest rate they charge commercial banks for loans, thereby affecting bank lending rates and, subsequently, the money supply.

Global Effects: Exchange Rates and Foreign Currency Implications

Changes in the money supply can also affect exchange rates, as differences in the growth rate of the money supply between countries can lead to changes in the value of their currencies. This impacts the cost of imports and exports, which in turn can affect consumer spending and economic growth.

COVID-19 Pandemic: A Unique Economic Scenario

The COVID-19 pandemic created a unique scenario where the Federal Reserve and other central banks around the world took unprecedented measures to increase the money supply to prevent economic collapse. This has led to increased consumer spending and partially shielded the economy from the pandemic’s impact.

The bottom line is that a shrinking money supply could potentially hinder economic recovery, as it can reduce consumer spending and slow economic growth. Financial institutions keep a close eye on these developments, as they can indicate the health of the financial system.

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Long-Term Economic Outlook: Monitoring Inflation Targets

Finally, central banks are monitoring these trends to adjust their inflation targets and strategies accordingly. They aim to ensure that the money supply is adequate to support economic activity without leading to high inflation or deflation, which can both be detrimental to the economy.

Tavex Analyst’s Comment:

The current contraction of the United States’ money supply, which is occurring at a rate reminiscent of the 1930s, does cast a shadow reminiscent of previous economic downturns and necessitates a nuanced approach from the Federal Reserve and other economic policymakers. This is not a minor situation; it recalls the years preceding the Great Depression, when a sharp reduction in the money supply over a number of years contributed to a deflationary spiral, catastrophic bank failures, and widespread economic hardship.

Unlike in the past, however, today’s economic landscape is supported by more stringent financial regulations, deposit insurance, and a central bank that is more proactive in its monetary policy measures. Nonetheless, historical lessons remain relevant. For example, during the Great Depression, the Federal Reserve’s failure to respond adequately to banking crises and provide adequate liquidity contributed to the severity and duration of the economic downturn.

The echoing decline of America’s money supply, harkening back to pre-Depression times, demands a vigilant and historically informed response to steer clear of the economic shadows that once loomed over the nation.

In more recent memory, Federal Reserve Chairman Paul Volcker intentionally reduced the money supply in the early 1980s. This was intended to reduce the rampant inflation of the 1970s, but it resulted in a severe recession. While the circumstances were different, with the goal of reducing inflation rather than an unintentional slide into deflation, the economic impact was significant, with soaring unemployment rates and business bankruptcies.

The Rothbard-Salerno measure expands our understanding of money by adding different types of liquidity to the money supply that are not included in standard measures like M2. It implies that a more nuanced approach may be required to fully comprehend the implications of monetary policy changes. This metric may indicate that the economy has reached a tipping point at which the Federal Reserve’s actions will have significant long-term consequences.

It is critical that policymakers consider not only the money supply but also employment rates, consumer spending, business investment, and other key indicators of economic health. This wide-angle lens approach will allow for a more informed and effective response, potentially averting the type of economic distress that previous money supply contractions have heralded.

To summarise, the contraction of the US money supply is a warning sign that should not be ignored. The risk of deflation is real, especially given that deflation can lead to a decrease in consumer spending as people wait for prices to fall further, which can then lead to a decrease in production, higher unemployment, and further price declines, creating a vicious cycle. To navigate this challenge effectively, policymakers must learn from the past, ensuring that the response is calibrated to support economic stability and growth.

Gold price (XAU-GBP)
1,838.28 GBP/oz
- GBP23.11
Silver price (XAG-GBP)
21.65 GBP/oz
- GBP0.80

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