What is Narrow Money?
Understanding money supply requires familiarity with various types of money. Today, we’ll focus on U.S. definitions and the supply of U.S. dollars. At the most stringent end of money supply measures lies narrow money, known as M0. It encompasses physical currency in circulation and bank-held cash reserves, often termed the monetary base.
Moving to the next category, we encounter M1, which includes all elements of M0 along with demand deposits and traveler’s checks. Demand deposits are liquid funds in bank accounts available for immediate withdrawal by customers.
You might wonder if banks actually keep all this cash ready for withdrawal. The answer is no. This money is digitally recorded in the fractional reserve system. Banks utilize risk assessment to determine necessary cash reserves across branches, beyond what’s physically stored.
In essence, M1 comprises digital funds available for withdrawal, including traveler’s checks, marking it as narrow money.
What is Broad Money?
Broad money encompasses M1 and beyond, known as M2 and M3 in the U.S.
M2 consists of M1 plus money market savings, small time deposits under $100,000, and shares in money market mutual funds. Essentially, M2 covers all liquid and some less liquid assets.
Further expanding, M3, often referred to as near money, includes M2 plus larger time deposits, institutional money market holdings, short-term agreements like repos, and other highly liquid assets. M2 and M3 primarily represent money held as a store-of-value rather than for immediate transactions.
M2 Money Supply
Recent M2 trends highlight how M2 money supply can fluctuate drastically, the most recent example being a significant contraction in 2022 that followed a large expansion in 2020 and 2021. This raises questions about its implications and mechanisms.
You’ve likely encountered discussions on Quantitative Easing (QE) and Quantitative Tightening (QT) recently. QE involves the Fed and Treasury injecting liquidity into markets by purchasing assets like U.S. Treasuries and mortgage-backed securities, thus expanding the money supply. Conversely, QT involves reducing liquidity by allowing assets to mature without replacement or selling them.
The effects of these expansions and contractions, notably on inflation, are a subject of debate. M2’s rapid increase in 2020 coincided with subsequent consumer price hikes, exacerbated by supply chain disruptions and direct stimulus payments. The easing of price pressures in mid-2022 followed the Fed’s cessation of QE activities.
However, 2023 saw a rapid contraction in M2, which has direct implications for inflation. Economists often study year-to-year correlations, although these can be volatile. Lyn Alden suggests analyzing a rolling five-year per capita broad money versus CPI to discern clearer trends, noting how CPI reactions typically lag behind broad money expansions.
Considering recent trends, inflation may soon stabilize despite concerns that excessive tightening by the Fed could precipitate a severe recession. Should this occur, calls for renewed quantitative easing may resurface.
Where are we today? M2 is starting to increase again.
The issuance of U.S. Treasury debt is surging not only due to the expanding U.S. debt, fueled by a $1.7 trillion annual deficit, but also because approximately $9 trillion of maturing debt requires refinancing. This necessitates additional covert QE measures from the U.S., likely leading to higher consumer and asset prices. Most nations are inflating their respective debt bubbles, constantly rolling over maturing debt. Brace for the inflationary wave driven by stealth QE. However, this journey may encounter significant turbulence, influenced by a market dominated by fewer players (S&P 500 Mag 7), a decelerating economy, and sustained upward pressure on interest rates. There’s also the risk of the Fed being caught off-guard, potentially rushing to lower rates amid a looming recession.
In conclusion, monitoring monetary dynamics remains crucial amid evolving economic conditions.
