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One measure that I've kept an eye on over the past few years is M2 money supply. In the short-run, M2 can be somewhat meaningless, but over a longer period, surges in M2 tend to predict surges in inflation. Keep in mind, a "surge in inflation" could merely be inflation going from -2% to +2%, so this is not always bad, but it certainly can be in the wrong circumstances.

One of the best examples to look at with M2 growth is Japan. In one of my prior articles, "14 Charts on Money Supply, Deficits, and Housing Prices", I examined Japan's M2 money supply, which began to collapse around 1990 and 1991. While it did somewhat rebound, it stayed at a very low level, with the 3-yr rolling average staying below 4% from 1992 onwards. Likewise, inflation has remained very low in Japan since then.

This article isn't ambitious as some of my prior endeavors. I merely want to examine M2 growth and see how it has progressed. One final note: due to the government shutdown, this data cuts off at September 30, 2013. While we lack two weeks' worth of data, that shouldn't be too big of an issue.

M2 Money Supply Growth

First off, let's take a look at the year-over-year ["YOY"] M2 growth. This is the least meaningful of charts to me, since it tends to be extremely volatile. On a YOY basis, M2 growth is around 6.3%, slightly above the long-term average of 6.0%.

(click to enlarge)Next, I want to take a look at the 3-year rolling average. This is my favorite metric, since it's long enough to be meaningful, but short enough so that it doesn't become too horribly distorted by old data.

(click to enlarge)As you can see, we are now at 7.8%. That's slightly higher than the 7.6% figure recorded in 2009 and it's the highest level since September 2003. Also note the black dotted line represents the average for the entire time period, which was 5.8%.

It's interesting to compare this data to nominal GDP growth on a 3-year rolling basis. However, note that we are only up to 2nd quarter data for 2013.

(click to enlarge)

My biggest concern here isn't actually the 7.8% 3-year M2 growth per se, but rather, the fact that M2 money supply has so greatly outpaced nominal GDP over the past half-decade. As economist Milton Friedman once said, "inflation is always and everywhere a monetary phenomenon, in the sense that it can only be produced by a more rapid increase in the quantity of money than in output."

We seem to have a long-term problem of increasing the quantity of money at a rate higher than output. The chart below compares the 3-year trailing growth in both M2 and NGDP. You can see a giant hump around the prime housing bubble years of 2002 - 2004. Likewise, the figure has stayed elevated for most of the period from 2008 - 2013.

(click to enlarge)

Let's also take a look at a 5-year trailing M2 money supply growth. Once again, note the black dashed line represents the average for the period. Right now, the 5-year M2 growth rate is 6.5%, slightly above the average of 5.7%.

(click to enlarge) Finally, we can take a look at velocity of money for M2.

(click to enlarge)

Velocity of M2 is now at a record low for the entire 54 year series (dating back to 1959) at 1.577. This may partly explain why inflation has remained moderate in spite of significant growth in M2 money supply over the past few years.

I have no dramatic conclusions to draw from this data. I'd merely say it's worth keeping an eye on, due to the heightened levels of M2 growth, coupled with below-average long term nominal GDP growth. It will be particularly interesting to see how new lending market regulations stemming from Dodd-Frank could impact these figures in the upcoming year.

Source: 3 Year M2 Money Supply Growth At Highest Level Since 2003