The Motley Fool published a piece on May 5 regarding a statistical trend that could be starting to cause some to worry. The story seems to follow a script where it leads off with words to the effect of “markets are notoriously complicated” and “anyone trying to make predictions is an idiot” followed by “but here’s an interesting stat that seems to be fool-proof.”
Here’s the original piece:
The point of the story is that the M2 money supply has contracted a total of 4.06% since peaking in April 2022. There have been only four periods prior to the present in which M2 has dropped more than 2% and each of them was followed by a depression and double-digit unemployment rates. Those other instances were 1870, 1893, 1921 and 1930.
It isn’t just columnists at The Motley Fool expressing concern. Another story posted here on METAR cited Jamie Dimon’s recent note to shareholders stating concerns about the unprecedented monetary contraction being generated by the evolving strategy of the Federal Reserve.
Before everyone gets nostalgic for the 1930s and packs Ma and Pa Joad in the Model A and drives to California in a panic, it’s worth looking at this from a couple of different angles to divine what this statistic might be conveying about the economy.
First, a refresher on definitions. Economists analyze the total money supply using a model of concentric circles with the areas in the inner-most circle and the area of the outer rings representing each sub-category of money supply. (There are some wierd exceptions not worth explaining in this context…) The further out from the center, the less liquid the money is, meaning the hard it is to get at it and spend it on something immediately.
M0 = (total currency in circulation)
MB = M0 + (vault cash in banks) + (required reserves) + (excess reserves)
M1 = M0 + (checking) + (savings)
M2 = M1 + (time deposits ) + (money markets)
The statistic being cited in these stories is that M2 has declined 4% over the last two years and historically, when that happens, bad things happen afterwards.
Note that the DIFFERENCE between the pool of money termed M2 and M1 is (time deposits) + (money markets). Time deposits typically pay higher interest rates as compensation for tying up the money for specific periods of time so the bank can predict when it might need the cash back from some other loan to pay back the depositor. Money markets typically offer rates between lower-rate savings accounts and higher-rate CDs for larger sums of money not typically left in a checking account.
To surmise why M2 might be shrinking, it helps to first analyze why M2 might have grown in prior years. Two obvious factors come to mind. The Federal government and the Federal Reserve injected TRILLIONS of dollars into the economy to counter the original COVID contraction in 2020 and many argue that stimulus exceeded what was needed to keep the economy on an even keel.
If one subscribes to that analysis, many of those injected dollars went into the accounts of businesses and individuals who didn’t NEED those funds AND had no real way to productively INVEST those funds in something that could produce a safe return. Okay, so what are the options?
- leave it in checking? at 0.0% rates?
- leave it in savings? at 0.03% rates?
- put it in CDs? at 2% or 3% rates?
- put it in money markets? at 1% or 2% rates?
It seems obvious many individuals fearful of plowing a temporary surplus of cash into stocks during a market that seemed suspiciously strong after initially plunging around March 2020 decided to put the cash in CDs and money markets to at least earn SOME interest while watching other markets settle a bit after the pandemic shock.
It’s now four years after the initial shock and a couple of years after both the Federal governement and the Federal Reserve seem to have jointly decided the country escaped a pandemic crash and drastically cut stimulus spending and stimulative rate policies. So what are these individuals doing? It seems they are gradually burning down the surplus money they shifted to M2 category accounts and reverting to older norms. Or possibly they have waited long enough for the stock market to settle and are comfortable putting that extra money into stocks.
So why are bankers like Jamie Dimon expressing concern? First, money sitting in time deposits and money markets effectively acts as a supply of funds banks use to make other loans. While interest rates banks pay on these accounts have risen over the last two years (from the mid 3.5% range to the 5.3% range), those rates are still historically low given inflation over this period and ridiculously low given interest rates CHARGED by banks on loans. In short, this spike in M2 has helped banks generate ENORMOUS profits over the last couple of years. Now that “bubble” of cash is declining and reducing a source of easy revenue for banks. The Jamie Dimons of the world are merely talking their own book. Maybe the Jamie Dimons of the world are worried about their liquidity given recent stories about trillions in off-book assets not factored into their capitalization requirements.
Is this M2 contraction worth worrying about? Uhhhhhh… Me thinks not. If the economy tanks in the next twelve months, it won’t be because people cashed out some CDs and pulled money out of some money market funds. There’s a higher likelihood of the Jamie Dimons of the world finding a trillion dollar hole in their own books after a trader runs out of easy money to cover a bad derivative bet.
WTH
