Keep an Eye on Money Supply

One of the most important factors to watch for the U.S. economy and commodities is money supply. Put simply, money supply is the total amount of money available in an economy. This includes bills, coins, credit and all other forms of liquid financial instruments.

James Turk, founder of GoldMoney.com, wrote an interesting explanation of the basics of money supply that’s currently available on Kitco.com. In it, Turk explains the underlying supply and demand imbalance between the amount of money that is being printed and the overall demand for it.

There are a couple different measures of money supply but at U.S. Global, we follow M2 the closest because it is the broadest measure of money currently available—all money in circulation plus savings deposits and money market accounts for individuals.

As you can see from the chart below, M2 spiked in the fall of 2008 as the Fed sought to inject additional liquidity into the U.S. economic system.

click to enlarge

This particular chart focuses on the U.S. but the same is true on a global basis. Countries in Europe, China and other places around the world have seen a jump in money supply. According to ISI, global money supply now sits near 10 percent.

With so much excess money in the global financial system, the idea was that some of it had to find its way into financial markets.

What we’ve found is that some of that excess supply often ends up landing in riskier areas—which may help explain why the Nasdaq has outperformed other markets so far this year.

Over the same time period, many commodities have rebounded sharply.

Increases in money supply have fanned inflationary fears and pushed funds toward traditional inflation hedging instruments like gold, oil and other commodities.

Deflationary forces have been strong during the economic downturn and it may be some time before inflationary pressures set in. However, if the supply of money continues to grow faster than our economy can absorb it, the likelihood of higher inflation increases.

* The Nasdaq Composite Index is a capitalization-weighted index of all Nasdaq National Market and SmallCap stocks.

Comments

[John Galt:]

Deflationary forces have been strong during the economic downturn and it may be some time before inflationary pressures set in. However, if the supply of money continues to grow faster than our economy can absorb it, the likelihood of higher inflation increases.

- Look at the other side of the equation as well. Are banks lending? Why does that matter, we live in a fractional reserve banking world. Is money changing hands ( money multiplier), is money circulating?

You know how to answer those questions, and you can predict when that inflation will come. It's about the money supply AND lending and money circulation.

Aug 06 09:12 AM

[Moon Kil Woong:]

It is hard not to be worried about money supply or base money supply but the Fed keeps saying don't worry. I suppose Bernake and Geithner don't bother checking the value of the dollar which has been nosediving. When will they noticed the steep fall of the dollar?

I suppose they are too bury trying to dump US gold in order to keep it beloe $1,000. I can see why they are so busy. But rather than do that, why don't they just start consideing draining some of that cesspit of bonds the Fed bought to institute QE. Oh yah, sorry, I forgot that the Fed would take a loss because they are worth less than face value. Wouldn't that make the Fed and their backstopping kind of the same as AIG and Freddie Mac combined?

By jove, I think we have just found our bad bank model!

Aug 06 09:39 AM

[WhoisJohnGalt:]

It will be interesting to see how the next Fed meeting goes when they decide whether or not to extend the deadline of $300 purchase of Treasuries and TALF. Former Fed governors say that recent economic signs of life (up till yesterday) have encouraged Bernanke and his boys to cut the tap. As this is the larger looming problem, one can only hope.

Aug 06 10:00 AM

[Warm_Paw:]

A keen observer of the obvious.
I'll add Frank Holmes to the list of time wasting article writers.

Aug 06 10:31 AM

[Djay:]

m2/base money (or money multiplier) has plummeted to sub-5 levels the lowest since 1960s or so. The recent peak was around 9.
Large money supply reflects expansion in fed's b/s. but it is not circulating enough. the money multiplier has remain at sub-5 since last Feb.
Large money will find its way into asset price inflation, including commodities and other risk assets----aka asset bubble. Premature rise in commodity prices will create another pseudo infaltion.
Since the economy will fail to keep pace with this extrapolation, another bust will become inevitable.


On Aug 06 09:12 AM John Galt wrote:

> Deflationary forces have been strong during the economic downturn
> and it may be some time before inflationary pressures set in. However,
> if the supply of money continues to grow faster than our economy
> can absorb it, the likelihood of higher inflation increases.
>
> - Look at the other side of the equation as well. Are banks lending?
> Why does that matter, we live in a fractional reserve banking world.
> Is money changing hands ( money multiplier), is money circulating?
>
>
> You know how to answer those questions, and you can predict when
> that inflation will come. It's about the money supply AND lending
> and money circulation.

Aug 06 10:59 AM

[Mr. Big:]

It's easy to inject money into the system. It's not as easy to get the money out. That makes the Fed's exit strategy the single most important consideration if you want to make real predictions on inflation.

So far, I haven't heard anything plausible from the Fed regarding its ability to control money supply without sideswiping the U.S. recovery efforts. That puts the Fed on the top five of my list of the greatest risks to the global economy.

Aug 06 02:19 PM