Money Supply Growth Collapses To New Lows

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by: Eric Basmajian
Summary

M2 growth collapsed to 3.76% year over year from over 7% in 2016.

The Fed is tightening too quickly and growth will slow dramatically given the level of M2 growth.

Balance sheet reductions are having a substantial impact on the money supply.

Each and every week the growth rate in the money supply ((M2)) drops a little bit more. On Thursdays, the 'Money Stock Measures' report is released which includes M2 among other measures of the money supply such as M1 and cash deposits.

M2 growth is the most commonly used and the most important by most standards.

In year-over-year terms, M2 Growth + Velocity Growth = GDP Growth.

M2 growth has collapsed from a high of 7.7% in 2016 down to 3.760%, the lowest level since 2010.

M2 Growth Year Over Year:

Source: Federal Reserve, EPB Macro Research

As M2 growth falls, GDP growth by definition must fall without an offsetting rise in velocity. It is unlikely for velocity to recover the ~4% loss in M2 growth. Furthermore, if the Federal Reserve continues tightening policy at this rate, M2 growth will fall close to 0% by the end of 2018. GDP growth will fall near 0% as well should that be the case.

The Federal Reserve has been reducing its balance sheet and doing so with increasing intensity each quarter.

Federal Reserve Total Assets:

Source: Federal Reserve, EPB Macro Research

As the Federal Reserve reduces the balance sheet by selling bonds, the monetary base declines, contracting the base money in the economy. Interestingly, the monetary base expanded, as did the Federal Reserve balance sheet after the stock market crash in 2016.

Monetary Base, Total:

Source: Federal Reserve, EPB Macro Research

The monetary base has not reached the lows seen in 2016 and it will be interesting to see if the economy and the market hold up as the monetary base continues to contract.

In 2016, when the monetary base was sitting at the lows, there were serious recession fears and by many economic indicators, you can say the economy was in recession for a brief period of time. The monetary base was quickly expanded to counter this pending disaster. As the monetary base has started to come down once again, unsurprisingly, volatility has soared.

The monetary base has a long way to go with the careful plan of the Federal Reserve before reaching the 2016 lows, but with the increase in the pace of asset sales for Q2, we will get there faster than many investors will notice.

Higher volatility and market turmoil are likely to come as the monetary base contracts towards the 2016 lows with $90 billion of asset sales on schedule for this quarter.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.