U.S. Money Supply Is Doing Something Not Seen Since the Great Depression, and a Big Move in Stocks May Follow | VIDEO

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The U.S. money supply, or the amount of money circulating in the economy, is one of the most important indicators of economic activity and inflation. It can also have a significant impact on the stock market, as it reflects the availability and demand of funds for investment and consumption.

However, the U.S. money supply is currently doing something that has not been seen since the Great Depression of the 1930s: it is shrinking. According to the Federal Reserve, the M2 money supply, which includes cash, checking deposits, savings deposits, money market funds, and other liquid assets, has declined by about 3.6% since its peak in June 2020. This is the first meaningful drop in M2 money supply in 90 years, and it may have important implications for the future of the U.S. economy and the stock market.

What is M2 money supply and why does it matter?

M2 money supply is a broad measure of the money supply that includes both the most liquid forms of money, such as cash and checking deposits, and the less liquid forms, such as savings deposits and money market funds. M2 money supply is considered a key indicator of the liquidity and purchasing power of the economy, as well as the potential for inflation and economic growth.

M2 money supply is influenced by various factors, such as the monetary policy of the Federal Reserve, the fiscal policy of the government, the banking system, the demand for money, and the economic activity. The Federal Reserve can increase or decrease the money supply by changing the interest rates, buying or selling government securities, or adjusting the reserve requirements for banks. The government can affect the money supply by changing its spending and taxation policies. The banking system can create or destroy money by lending or withdrawing funds. The demand for money can vary depending on the preferences and expectations of consumers and businesses. The economic activity can affect the money supply by changing the income and output levels.

M2 money supply can have a significant impact on the stock market, as it reflects the availability and demand of funds for investment and consumption. A higher money supply can stimulate the economy by lowering the interest rates, increasing the spending and borrowing, and boosting the confidence and optimism. This can lead to higher corporate earnings, higher stock prices, and higher returns for investors. A lower money supply can have the opposite effect, by raising the interest rates, reducing the spending and borrowing, and dampening the confidence and optimism. This can lead to lower corporate earnings, lower stock prices, and lower returns for investors.

What caused the decline in M2 money supply and what does it mean for the economy and the stock market?

The decline in M2 money supply in 2020 and 2021 was largely caused by the unprecedented monetary and fiscal stimulus that the Federal Reserve and the government implemented in response to the COVID-19 pandemic and the economic crisis. The Federal Reserve slashed the interest rates to near zero, launched a massive bond-buying program, and provided emergency lending facilities to support the financial markets and the economy. The government enacted several relief packages, totaling over $5 trillion, to provide direct payments, unemployment benefits, small business loans, and other aid to households and businesses.

These actions resulted in a massive surge in the money supply, as the Federal Reserve injected trillions of dollars into the banking system and the government distributed trillions of dollars to the public. The M2 money supply increased by about 25% from February 2020 to June 2020, reaching a record high of $18.9 trillion. However, this surge in the money supply was not matched by a corresponding increase in the money demand or the money velocity, which are the measures of how often and how quickly money changes hands in the economy. The money demand and the money velocity remained low, as many households and businesses saved or paid down debt rather than spent or invested their money, due to the uncertainty and the restrictions caused by the pandemic. The excess money supply, therefore, accumulated in the form of idle cash balances, rather than circulating in the economy.

As the economy started to reopen and recover from the pandemic, the money supply began to decline, as the Federal Reserve and the government scaled back their stimulus measures and the public started to spend and invest their money. The M2 money supply decreased by about 3.6% from June 2020 to September 2021, reaching $18.2 trillion. This decline in the money supply was not accompanied by a corresponding decline in the money demand or the money velocity, which remained low, as many households and businesses still faced challenges and uncertainties due to the pandemic. The money supply, therefore, contracted faster than the money demand, creating a shortage of money relative to the economic activity.

The decline in M2 money supply may have important implications for the future of the economy and the stock market. On the one hand, it may indicate that the economy is recovering from the pandemic and the crisis, as the stimulus measures are no longer needed and the public is more confident and optimistic. This may lead to higher economic growth, higher corporate earnings, higher stock prices, and higher returns for investors. On the other hand, it may also indicate that the economy is facing deflationary pressures, as the money supply is insufficient to support the economic activity and the inflation expectations. This may lead to lower economic growth, lower corporate earnings, lower stock prices, and lower returns for investors.

What can we learn from the historical examples of M2 money supply changes and their effects on the stock market?

The historical examples of M2 money supply changes and their effects on the stock market can provide some insights and lessons for the current situation. The most relevant and comparable example is the Great Depression of the 1930s, which was the last time that the M2 money supply experienced a meaningful decline. The Great Depression was the worst economic crisis in modern history, lasting from 1929 to 1939. It was caused by various factors, such as overproduction, executive inaction, ill-timed tariffs, and an inexperienced Federal Reserve. It resulted in drastic declines in output, severe unemployment, and acute deflation in almost every country of the world. It also had profound social and cultural effects, as well as fundamental changes in economic institutions, policies, and theories.

The M2 money supply declined by about 30% from 1929 to 1933, as the Federal Reserve failed to provide adequate liquidity to the banking system and the economy. The money supply decline was exacerbated by the collapse of the banking system, the contraction of credit, and the hoarding of cash by the public. The money supply decline contributed to the deflationary spiral, as the prices of goods and services fell, the real value of debt increased, the purchasing power of consumers and businesses decreased, and the economic activity slowed down. The money supply decline also had a devastating impact on the stock market, as the Dow Jones Industrial Average (DJIA) plunged by about 90% from 1929 to 1932, reaching its lowest level in history.

The M2 money supply started to recover from 1933 to 1937, as the Federal Reserve and the government implemented various monetary and fiscal policies to stimulate the economy and to end the deflation. The money supply recovery was aided by the stabilization of the banking system, the expansion of credit, and the increase in spending by the public. The money supply recovery helped to reverse the deflationary spiral, as the prices of goods and services rose, the real value of debt decreased, the purchasing power of consumers and businesses increased, and the economic activity picked up. The money supply recovery also had a positive effect on the stock market, as the DJIA rebounded by about 300% from 1932 to 1937, reaching its highest level since 1929.

However, the M2 money supply declined again from 1937 to 1938, as the Federal Reserve and the government prematurely tightened their monetary and fiscal policies, fearing that the inflation was getting out of control. The money supply decline triggered a recession within the depression, as the prices of goods and services fell again, the real value of debt increased again, the purchasing power of consumers and businesses decreased again, and the economic activity slowed down again. The money supply decline also had a negative effect on the stock market, as the DJIA dropped by about 50% from 1937 to 1938, erasing most of the gains from the previous recovery.

The M2 money supply resumed its growth from 1938 to 1941, as the Federal Reserve and the government relaxed their monetary and fiscal policies, realizing that the inflation was not a serious threat. The money supply growth was boosted by the preparation and the entry of the U.S. into World War II, which increased the demand for money and the production of goods and services. The money supply growth ended the recession within the depression, as the prices of goods and services stabilized, the real value of debt stabilized, the purchasing power of consumers and businesses stabilized, and the economic activity accelerated. The money supply growth also had a positive effect on the stock market, as the DJIA rose by about 100% from 1938 to 1941, surpassing its 1929 peak.

The historical example of the Great Depression shows that the changes in M2 money supply can have significant and lasting effects on the economy and the stock market, especially when they are large and persistent. It also shows that the direction and the magnitude of the effects depend on the underlying causes and the policy responses of the changes in M2 money supply, as well as the expectations and the behavior of the public. Therefore, it is important to monitor and analyze the changes in M2 money supply and their implications for the economy.

What are the possible scenarios and outcomes of the current M2 money supply decline for the economy and the stock market?

The current M2 money supply decline is a rare and unprecedented phenomenon that has not been seen since the Great Depression. It is the result of the extraordinary monetary and fiscal stimulus that the Federal Reserve and the government implemented in response to the COVID-19 pandemic and the economic crisis, and the subsequent reversal of these stimulus measures as the economy started to reopen and recover. It is also the result of the low money demand and the low money velocity, as many households and businesses saved or paid down debt rather than spent or invested their money, due to the uncertainty and the restrictions caused by the pandemic.

The current M2 money supply decline may have different scenarios and outcomes for the economy and the stock market, depending on the future developments and the policy responses. Here are some of the possible scenarios and outcomes:

• Scenario 1: The M2 money supply decline is temporary and mild, and it reflects the normalization and the adjustment of the economy and the financial system after the unprecedented stimulus and the pandemic. The economy continues to recover and grow at a moderate pace, supported by the vaccination, the reopening, and the pent-up demand. The inflation remains transitory and moderate, as the supply and the demand imbalances are resolved. The Federal Reserve maintains its accommodative monetary policy stance, keeping the interest rates low and the bond-buying program intact, until the economy reaches its full employment and price stability goals. The government continues to provide fiscal support and infrastructure spending, but at a lower and more sustainable level. The money supply stabilizes and resumes its growth, as the money demand and the money velocity increase, reflecting the confidence and the optimism of the public. The stock market remains bullish and resilient, as the corporate earnings, the stock prices, and the returns for investors increase, driven by the economic growth, the low interest rates, and the positive sentiment.
• Scenario 2: The M2 money supply decline is persistent and severe, and it indicates the deflationary and the contractionary pressures on the economy and the financial system. The economy slows down and stagnates, hampered by the new variants, the lockdowns, and the weak demand. The inflation turns into deflation, as the prices of goods and services fall, the real value of debt increases, the purchasing power of consumers and businesses decreases, and the economic activity slows down. The Federal Reserve fails to provide adequate liquidity and stimulus to the economy and the financial system, either because it is constrained by the zero lower bound, the political pressure, or the inflation fear. The government fails to provide sufficient fiscal support and infrastructure spending, either because it is constrained by the debt ceiling, the budget deficit, or the political gridlock. The money supply continues to decline, as the money demand and the money velocity remain low, reflecting the uncertainty and the pessimism of the public. The stock market crashes and enters a bear market, as the corporate earnings, the stock prices, and the returns for investors decrease, driven by the economic slowdown, the high interest rates, and the negative sentiment.
• Scenario 3: The M2 money supply decline is moderate and gradual, and it reflects the structural and the behavioral changes in the economy and the financial system. The economy grows at a slower but more stable and sustainable pace, supported by the innovation, the productivity, and the diversification. The inflation remains low and stable, as the technological progress, the globalization, and the competition keep the prices of goods and services in check. The Federal Reserve adopts a more flexible and adaptive monetary policy framework, adjusting the interest rates and the bond-buying program according to the economic conditions and the inflation expectations. The government adopts a more balanced and prudent fiscal policy approach, balancing the spending and the taxation, and investing in the long-term growth and development. The money supply grows at a slower but more consistent and predictable rate, as the money demand and the money velocity adjust to the new equilibrium, reflecting the preferences and the expectations of the public. The stock market becomes more rational and efficient, as the corporate earnings, the stock prices, and the returns for investors reflect the fundamentals, the risks, and the opportunities of the economy and the financial system.

Conclusion

The U.S. money supply is doing something that has not been seen since the Great Depression: it is shrinking. This is a rare and unprecedented phenomenon that may have important implications for the future of the economy and the stock market. The direction and the magnitude of the effects depend on the underlying causes and the policy responses of the changes in M2 money supply, as well as the expectations and the behavior of the public. Therefore, it is important to monitor and analyze the changes in M2 money supply and their implications for the economy and the stock market, and to be prepared for the possible scenarios and outcomes that may follow.

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