M2 Money Supply Indicates No Shortage

All measures of the money supply are at new all-time high levels. Since the Fed began its new "quantitative easing" program last September, the M2 measure of money supply has grown by over $400 billion, which is an annualized growth rate of almost 24%. That's a big deal, since annual growth in M2 has averaged about 6% a year.

A good part of the reason M2 has grown is that demand for money has surged. But it's equally important to note that the Fed has been very willing to accommodate this increased money demand. And by telling us that it will remain accommodative for "some time" the Fed is actively encouraging money growth. Borrowing costs for many people are now lower than they have been in a lifetime. "Come and get it!" the Fed is telling us.

We may still be in the throes of a credit crisis, but this is most definitely not a credit crunch. That's an important distinction. A credit crunch implies an actual shortage of money, like we had in the early 1980s when the Volcker Fed clamped down on the growth of money and interest rates spiked. But a credit crisis implies a shortage of confidence, a reluctance to lend. Confidence can return almost as fast as it vanished. The market's rally last week is one sign that this is now happening.

Comments

[Simit Patel:]

Agree, though I prefer MZM as a money supply indicator, which is a bit narrower than M2. Either way both are increasing, the TED spread is declining, dollar is falling and gold is rallying....all of which confirm your points.

Jan 04 01:11 PM

[prudentinve...:]

In addition to the fed's expansion of their balance sheet at an unprecedented and astonsihing rate (to about 2.5 trillion), there is an even greater deal of privately held liquidity on the sidelines (about 4 trillion in money market funds).

This suggests that there is no shortage of private liquidity in the system, and talk of markets seizing up due to lack of liquidity are exaggerated. Rather the credit markets are seizing up due to lack of balance between risk and reward, i.e. the private owners of this liquidity do not wish to invest it with those who need it on mutually satisfactory terms. The fed has conditioned borrowers to expect artificially low interest rates, and private holders of liquidity expect a return above inflation as well as a risk premium.

Ditto for stocks. Many stock market optimists point out to the pool of private liquidity which they believe is just waiting to pour into stocks and drive the market to new highs. It does not seem to have ocurred to them that this pool is waiting for what they perceive to be a better risk/reward balance manifested in lower stock prices, and may remain on the sidelines until they perceive better stock values.

Jan 04 08:33 PM

[flow5:]

"A good part of the reason M2 has grown is that demand for money has surged"

The "demand for money" has exactly the opposite connotation. The "demand for money" & the Liquidity preference curve are both false doctrines.

Part of M2 represents the "money supply", though a large part does not. Simit Patel has the right idea.

Jan 05 10:41 AM

[retired avi...:]

Good article. It's hard to tell for sure if money growth is good or bad, though. For credit-worthy folks taking advantage of historic interest rate lows to borrow, it's good. I'm also not worried about lenders standards for creditworthiness - not anymore!

What the M2 doesn't tell us is how much money growth has come from Fed open market purchases, rather than lending. This cash being created could be a bad thing, meaning the demand for Treasuries is partly artificial, and the cash creation is not from confidence of lenders and willingness of borrowers, but rather something potentially troubling going on with Treasuries.

Jan 05 12:25 PM