In Search of M2
The money supply is a vital part of the economy, yet seldom understood. Still both nebulous and contentious, the “M2 Money Stock” remains the most popular and broadest measure of money, now standing at $19.3 trillion. It’s understandable for the average person to not know much regarding its importance, but what excuse does the Chair of the Federal Reserve, Jerome Powell, have?
Before Congress, in the Feb 23 testimony, Senator Kennedy asked:
M2, the money supply is up. I think about $4 trillion over the past year, or $6 trillion. $4 trillion, $6 trillion, what’s a few trillion? It’s up 26%, the highest amounts since 1943. What does that tell you?
What reads like a joke between two bureaucrats, Powell responded:
Well, when you and I studied economics a million years ago, that M2 and monetary aggregates generally seem to have a relationship to economic growth. Right now, I would say the growth of M2, which is quite substantial, doesn’t really have important implications for the economic outlook.
And straight out of “left field,” as declared by one of the most powerful men in the world, M2 Money Stock no longer has an important role to play.
As if to reiterate, Powell followed with:
M2 was removed some years ago from the standard list of leading indicators, and just that classic relationship between monetary aggregates and economic growth in the size of the economy, it just no longer holds. We’ve had big growth of monetary aggregates at various times without inflation, so something we have to unlearn, I guess.
At last, M2 joins the ranks of other useful economic ideas we can “unlearn,” as we’ve seen with the likes of Say’s Law, the original definition of inflation, and the cause of America’s Great Depression, to name a few.
Nonetheless, there were hints, when, on December 17, 2020 the Fed announced “statistical release” changes which altered the definition of money as we know it. To be fair, this happens every few years; however, this revision appears significant as it now includes “savings deposits” and “other checkable deposits” as part of the M1 monetary aggregate. Whereas they were just part of M2 before. The frequency of reporting also went from a weekly to monthly basis, hence the M2 weekly chart has been discontinued.
The Fed even warned us:
This action increases the M1 monetary aggregate significantly while leaving the M2 monetary aggregate unchanged.
In the most Orwellian of twists, the Fed made a retroactive adjustment on May 2020, which explains why M1 Money Stock went from $4.8 trillion on April 2020 to over $16 trillion the following month, as seen below:
Per the latest release, M1 now stands at $18 trillion, just over $1 trillion shy of M2.
As for Chair Powell and the disconnect between money supply and the economy, other than measures of low inflation, his rationale remains unclear. Contrast this to the chart below, using M2 data (blue line/left axis) which began in 1959 vs. USD purchasing power (red line/right axis), indexed to 1960=100, reveals something interesting. Even without running data correlation, a purely visual perspective shows that for the last 60 years, money supply has increased while dollar purchasing power has decreased.
Of course, correlation does not equal causation. But, if money supply and purchasing power (and by extension the economy as a whole) are not inextricably linked there really should be no concern of printing a currency into oblivion, nor economic collapse that follows currency which perpetually decreases in purchasing power.
Often, we hear the importance of inflation, but rarely do we hear about it being the destruction of the US Dollar or increasing unaffordability of life. This becomes more ironic when, despite the low inflation narrative, we find the dollar’s purchasing power declines year after year.