Power & Market

The Most Important Factor in The Economy Is Flashing A Huge Warning Sign

Since money is used in all transactions, including investments in physical goods and financial instruments, the supply of money is extremely important to the economy and financial markets.

Accelerating money supply growth typically leads to stronger economic activity and higher prices, while decelerating money supply growth (or decline) typically leads to weaker economic activity and lower prices.

However, the impact of changes in the money supply are always temporary. For example, if accelerating money supply growth always leads to a “stronger economy”, then why not always accelerate money supply growth? The short answer is because there is no such thing as a free lunch in economics.

As Ludwig von Mises, one of the greatest economists and monetary theorists in history noted about the mythical economic benefits of creating money out of thin air:
“If it were really possible to substitute credit expansion (cheap money) for the accumulation of capital goods by saving, there would not be any poverty in the world.”

And not only does creating money out of thin air not improve living standards, but it actually lowers living standards. This is because it causes the boom and bust business cycle, which wastes scarce resources that were used in failed investment projects undertaken due to artificially low interest rates.

Mises developed this Austrian Business Cycle Theory. As he summarized the problem caused by money creation out of thin air:
“The wavelike movement effecting the economic system, the recurrence of periods of boom which are followed by periods of depression is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion.”

Money Supply Is Now Falling Rapidly

As a result of the huge rise in interest rates over the past year or so, money supply growth is now falling at one of the fastest rates in history.

The best measure of money, called Austrian Money Supply (“AMS”), was down 9.7% year-over-year in March, the largest decline in over 35 years of available data, as shown below.


The next chart shows M2 money supply is down 4.1% year-over-year, the largest decline since the Great Depression, when M2 fell over 10%. Let me repeat that. M2 money supply is falling at the fastest rate since the GREAT DEPRESSION of the 1930s!


Source: thechartstore.com

With short-term interest rates on Treasury bills and money market funds now much higher than on bank deposits, many people have been pulling their money out of banks and investing it in Treasury bills and money market funds. As a result, bank deposits are now falling 5.4% year-over-year, the fastest decline in nearly five decades, as shown below.


In order to protect their balance sheets and limit their risk in the face of declining deposits and a coming recession, banks have cut way back on lending. The result is bank credit is now only growing 2.3%, the slowest pace in nearly 50 years, outside of the Great Recession, as shown below.


Implications Of Falling Money Supply

Money supply growth is the primary driver of the boom-and-bust business cycle and financial markets. With money supply now declining at one of the fastest rates since the Great Depression and the yield curve the most inverted in over 40 years following the steepest pace of Fed tightening since the early 1980s recessions, I believe there is an extremely high risk of a major recession coming this year, if it hasn’t already started. Forewarned is forearmed.

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
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