Money Supply shrunk last month by $129B which is the largest monthly fall ever going back to 1959. April and June had also set records at the time from a gross change perspective. From a percentage amount, Feb 1970 had been the largest contraction ever (-6.5% annualized), but the current month even beat that number at -6.9% annualized.
Figure: 1 MoM M2 Change (Seasonally Adjusted)
Figure 2 below shows non-seasonally adjusted money supply which is a bit more erratic and is also one month ahead of seasonally adjusted. On a raw basis, September did not set a new record, ranking seventh overall with April still holding the top spot as the largest raw gross decline.
Figure: 2 MoM M2 Change (Non-Seasonally Adjusted)
Looking at seasonally adjusted, the latest month is well below the 6-month average growth rate (-6.9% vs -2.2%). This is way below the 1-year growth rate of 2.6% and well below the three-year annualized growth rate of 12.7%.
Figure: 3 M2 Growth Rates
When looking at the average monthly growth rate, before Covid, September historically expands at an annualized rate of 5.1%. This year missed by an incredible 1,200 bps.
Figure: 4 Average Monthly Growth Rates
The Fed only offers weekly data that is not seasonally adjusted. As the chart below shows, we have been seeing more frequent weeks of negative growth. The big fall occurred in April of this year, but since then the drops in money supply have been much more consistent.
Figure: 5 WoW M2 Change
The “Wenzel” 13-week Money Supply
The late Robert Wenzel of Economic Policy Journal used a modified calculation to track Money Supply. He used a trailing 13-week average growth rate annualized as defined in his book The Fed Flunks. He specifically used the weekly data that was not seasonally adjusted. His analogy was that in order to know what to wear outside, he wants to know the current weather, not temperatures that have been averaged throughout the year.
The objective of the 13-week average is to smooth some of the choppy data without bringing in too much history that could blind someone from seeing what’s in front of them. The 13-week average growth rate can be seen in the table below. Decelerating trends are in red and accelerating trends in green.
Growth has now collapsed to -2.3%. The numbers published by the Fed last month have since been updated. Last month, the data showed growth had bottomed at -2.57%. The current data shows the collapse a full percentage point worse at -3.52%. Although the growth rate is increasing, it is still deep in negative territory.
Figure: 6 WoW Trailing 13-week Average Money Supply Growth
The plot below helps show the seasonality of the Money Supply and compares the current year (red line) to previous years. For the months of September and October, this is the slowest 13-week Money Supply growth ever recorded.
The chart below shows the last 10 years. It is clear to see how different this year looks compared to last years.
Money supply does tend to pick up at this time of the year, but it’s impossible to ignore the dramatic difference. Even with the recent turnaround, the growth rate remains negative. With money supply still contracting, it will be challenging for the market to muster any strength.
Figure: 7 Yearly 13-week Overlay
Behind the Inflation Curve
Even with the contracting money supply, the Fed is still not doing enough to solve the inflation problem. To combat rising prices, the Fed would need to undo most of the money it has created over the last several years. This would require bringing interest rates above the rate of inflation to collapse the money supply.
The Fed has been talking a huge game, but everyone should know they are bluffing! They can’t actually raise rates or they would have by now! The chart below shows that the Fed has never been further behind the inflation curve despite the “jumbo” interest rate hikes seen so far.
The blue line below (Fed Funds Rate) has almost always gotten above the black line (CPI) to force inflation back down. The one anomaly was in 2011 after the Great Recession. The mainstream is now assuming this is the norm (i.e., a recession alone will slow inflation), but the chart below shows that it’s far more common that interest rates must exceed inflation to bend the curve back down. The recent period has made the Fed complacent. This is very dangerous!
Figure: 8 YoY M2 Change with CPI and Fed Funds
The charts below are designed to put the current trends into historical perspective. The orange bars represent annualized percentage change rather than raw dollar amount. The current slowdown can be seen on the right side.
If a few months of M2 slowdown can cause this much pain across the economy (stock market, real estate, bond yields, etc.), how much carnage would unfold in a prolonged fight against inflation where M2 had to shrink consistently for months?
Figure: 9 M2 with Growth Rate
Taking a historical look at the 13-week annualized average also shows the current predicament. This chart overlays the log return of the S&P. Mr. Wenzel proposed that large drops in Money Supply could be a sign of stock market pullbacks. His theory, derived from Murray Rothbard, states that when the market experiences a shrinking growth rate of Money Supply (or even negative) it can create liquidity issues in the stock market, leading to a sell-off.
While not a perfect predictive tool, many of the dips in Money Supply precede market dips. Specifically, the major dips in 2002 and 2008 from +10% down to 0%. The economy is now grappling with a peak growth rate of 63.7% in July 2020 down to -2.3%. This is a major collapse.
The market is currently seeing a bear market rally as a soft pivot was floated by the WSJ as a possibility in upcoming meetings. Unfortunately, the Fed has probably done enough damage that something has already broken. It’s now a waiting game to find out what.
Please note the chart only shows market data through October 3rd to align with available M2 data.
Figure: 10 13-week M2 Annualized and S&P 500
One other consideration is the massive liquidity buildup in the system. The Fed offers Reverse Repurchase Agreements (reverse repos). This is a tool that allows financial institutions to swap cash for instruments on the Fed balance sheet.
Current Reverse Repos peaked at $2.42T on Sept. 30. The value always tops out at quarter end so there probably won’t be a new record until late in December. Keep in mind, these numbers dwarf the old record of ~$500B in 2016-2017.
Bottom line, even though M2 has slowed there is still trillions of dollars in liquidity sloshing around. New money will not be available to prop up the stock market, but excess liquidity is still available to bid up prices and keep inflation elevated.
Figure: 11 Fed Reverse Repurchase Agreements
What it means for Gold and Silver
The market is currently experiencing an epic slowdown in the Money Supply growth rate. Based on historical data, Money Supply growth tends to bottom in August and start moving up in September. While this has happened, the growth rate is still negative and well below what is needed to support the market.
The Fed is playing with serious fire. They are raising rates and contracting the money supply, on an economy addicted to extreme liquidity and easy money. The Fed cannot continue this battle much longer without serious repercussions. The math simply doesn’t allow it.
The Fed is inching closer to a pivot. This is highlighted by a recent WSJ article that shows the market is now expecting higher inflation based on the Fed turnaround. As the hawkish talk is dialed down in the weeks ahead, the market will wake up to the new reality of high inflation going forward. This will finally give way to a sustainable rally in precious metals as they return to their place as the proper inflation hedge and safest insurance bet against expanding deficits and money printing.
Data Source: https://fred.stlouisfed.org/series/M2SL and also series WM2NS and RRPONTSYD. Historical data changes over time so numbers of future articles may not match exactly. M1 is not used because the calculation was recently changed and backdated to March 2020, distorting the graph.
Data Updated: Monthly on fourth Tuesday of the month on 3-week lag
Most recent data: Oct 03, 2022
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