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Bank Lending, M2 And Inflation

|Includes: CPI, iShares 20+ Year Treasury Bond ETF (TLT)

The Situation

​​One of the main reason why inflation will remain subdued is that the growth of bank lending is small compare to the growth of monetary aggregates as we will see in detail below. The other reason is that the money injected by Central Banks is not creating demand in the economy enough (liquidity trap?) and velocity is tumbling.

Using August 2008 as a proxy: the approximate time of the Lehman bankruptcy which kick-started the new, more expansive era of central bank policy - as the base (i.e. index = 100);

1)​​The U.S. monetary base has grown to 347, but the money supply (M2) has only grown to 135.
2)The UK monetary base now stands at 433 with its money supply stuck at 110.
3)​The eurozone monetary base is at 157 while the money supply stands at 107.
4)​The Japanese monetary base is at 150 (and about to go much higher) but the money supply is only at 113.

From CreditWritedowns:

"At the end of the day, it is the money supply, not the monetary base, which sets the tone for inflation. Another way to illustrate this is by having a glance at QE's effect on bank lending (see the graph below).

​​There has been no growth in bank lending at all despite all the so-called money printing. Investors are quite right in keeping their eye on the ball but, through my lenses, it looks as if they are focusing on the wrong ball. "

Chart from CreditWritedowns

Even if the growth of the US M2 monetary aggregate exploded in 2009 after the first QE, it slowed tremendously since 2012 as shown by the chart below...

US M2 Money Stock Year-Over-Year %

Chart from FRED:

And the slowing of the monetary aggregate has been joined by a complete fall out of the velocity of money stock M2: ​​velocity has plunged with the M2 gauge dropping below 1.6 recently for the first time since records began in 1959 (as shown in the chart underneath from the Federal Reserve Bank of St Louis).

​The velocity of money (also called velocity of circulation and, much earlier, currency) is the average frequency with which a unit of money is spent on new goods and services produced domestically in a specific period of time. Velocity has to do with the amount of economic activity associated with a given money supply.

US M2 Money Velocity

Chart from FRED:

And just to gives us a sense of the slowdown in money growth/turnover, I took the M2 growth (year-over-year in %) times the velocity of money. Observe the huge slowdown since 2012...

US M2 Money Stock Year-Over-Year %
​​US M2 Money Velocity

Chart from FRED:


We should finally realize that not the quantity of money but the credit multiplier and velocity of money are signs of potential inflation. As a gauge, the Federal Reserve can be comfortable to continue to be accommodative. (NYSEARCA:TLT)

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.