M2 Growth Rate: Nothing Strange or Foreboding

Includes: UDN, UUP
by: Calafia Beach Pundit

Ever since late 2008 I have been making the point that whatever is wrong with the economy, it's not a shortage of money that is problem. That remains the case today. There are no signs that money is in short supply, either nominally or relative to the demand for money. Therefore there is no reason to worry about deflation or a deflation-induced slump in demand.
The best measure of money is M2, because its definition hasn't changed much over time and for decades it has had a relatively stable relationship to GDP. I think most economists would agree on this. The first chart above shows the level of M2 over the past 16 years. As should be evident, M2 has grown on average about 6% a year. Sometimes faster, sometimes slower, but it always seems to revert to something like 6% a year, which also happens to be very close to the annualized growth rate of nominal GDP over the past 20 years or so. The slower growth of M2 in the past year or so is simply "payback" for very rapid growth in 2008, when a surge in money demand pushed up all monetary aggregates.
It was therefore not a coincidence that the the peak in M2 growth coincided almost exactly with the bottom of the stock market (March 2009). That was a big turning point, because what occurred was a rise in confidence accompanied by a decline in the demand for money. Money velocity picked up as people started spending the money they had hoarded, and that process continues to this day.
Meanwhile, the Fed force-fed $1 trillion to the banking system, swelling the monetary base and bank reserves by an unimaginable amount. Most of the extra reserves are still sitting idle at the Fed, though, since the world's demand for dollars remains elevated. (When demand for money is high, the demand for loans is weak. That's another way of saying that the world is still trying to deleverage, so demand for bank loans is not very strong.)
The recent increase in the M2 growth rate (M2 is up at 4.6% annualized rate in the past three months reflects a bit of an increase in money demand over that period, and that is likely a reflection of the confidence shock that resulted from concerns over the possible collapse of the european banking system. It is also the case that renewed concern over the health of the economy helped drive yields lower, and that in turn resulted in a surge of refinancing activity, which in turn has a strong tendency to increase money in circulation temporarily.
In short, I see nothing in the money numbers that is strange or foreboding—except, of course for the massive amount of bank reserves that lie in waiting to accommodate renewed loan demand. They haven't presented a problem so far, but at some point they could result in a significant expansion of bank lending which in turn could feed the fires of inflation if the Fed doesn't react in a timely fashion to drain those reserves. That's been a big worry for a long time, but so far nothing untoward has happened.