Recession Risk Grows After Money Supply Shrinks at Fastest Pace Since Great Depression

Printing Supervisor Donavan Elliott inspects sheets of one dollar bills run through the printing press at the Bureau of Engraving and Printing in Washington, D.C., on March 24, 2015. Mark Wilson/Getty Images

The U.S. money supply contracted for the third consecutive month, and is declining at the fastest pace since the Great Depression, new Federal Reserve data show.

In February, the M2 money supply—a benchmark for how much cash, bills, bank deposits, coins, and money market funds are circulating throughout the national economy—tumbled 2.24 percent from the same time a year ago, down from negative 1.7 percent in January. This represented the third straight month of a contracting money supply.

Early indicators point to another contraction in March, as the M2 money supply tumbled 3.13 percent year over year for the week ending March 6.

In total, the U.S. money supply stood at $21.099 trillion at the end of February.

Between 1929 and 1933, the money supply plummeted by 28 percent.

Despite the year-over-year percentage decline, the money supply remains nearly 38 percent above the pre-pandemic level.

The downward trend, which started in February 2021, resulted from the central bank reversing its pandemic-era liquidity injections, the Fed reducing the enormous balance sheet, and sliding bank deposits.

Across the globe, many economies are reporting slowing or contracting M1 money supply growth.

In the European Union, the M1 annual growth rate contracted by 2.7 percent in February, down from negative 0.8 percent in January. The United Kingdom’s M1 slowed to 1.55 percent in January. The M1 for Canada fell for three straight months to close out 2022, tumbling 3.57 percent in December.

Recession Confirmed?

So, does this point to a recession? Some economists warn that the collapse in money supply growth in the United States and other countries is a warning of an economic downturn.

“We have not seen money supply declines like this since the Great Depression,” said Mike Shedlock, an economist and registered investment advisor for SitkaPacific Capital Management. “The contrarian position isn’t that a recession will come later, but rather that it’s already started.”

According to Steve Hanke, the professor of applied economics at Johns Hopkins University and a senior fellow at the Independent Institute, thinks “a U.S. recession is baked in the cake.”

“Due to the Fed’s monetary mismanagement, the M2 money supply is falling at its fastest rate since the 1930s,” he stated. “The QUANTITY THEORY OF MONEY tells us that, w/ a 6-18 month lag after M2 drops, economic activity will slump.”

But others, like Fed Chair Jerome Powell, do not believe the money supply impacts the economy.

“When you and I studied economics a million years ago, M2 and monetary aggregates seemed to have a relationship to economic growth,” Powell told Sen. John Kennedy (R-La.) during his semiannual monetary policy report to Congress in 2021. “Right now ... M2 ... does not really have important implications. It is something we have to unlearn I guess.”

Federal Reserve Board chairman Jerome Powell speaks during an interview at the Renaissance Hotel in Washington, on Feb. 7, 2023. Julia Nikhinson/Getty Images

Meanwhile, many leading recession indicators have been flashing red again.

The six-month average of the Conference Board Leading Economic Index (LEI), which assesses credit, labor, and manufacturing, is negative 3.6 percent.

“While the rate of month-over-month declines in the LEI have moderated in recent months, the leading economic index still points to risk of recession in the U.S. economy,” said Justyna Zabinska-La Monica, the senior manager of business cycle indicators at the Conference Board, in a statement.

The widely watched spread between the two- and 10-year Treasury yields has been inverted since July 2022, trading at around negative 60 basis points as of April 11. This is considered the chief recession indicator, as it has called nearly all recessions since the Second World War.

The Fed’s preferred recession gauge—the three-month and 10-year yields—has also been inverted since the end of October 2022, trading at negative 167 basis points.

Typically, long-duration bonds yield better than short-term securities. However, the reverse occurs if the financial market maintains a weak outlook for the economy and a credit crunch in the banking system.

In addition, the Institute for Supply Management’s (ISM) Manufacturing Purchasing Managers’ Index (PMI) fell to 46.3 in March. Nearly every time this metric has tumbled this low, the U.S. economy was in or on the cusp of a recession. However, times have changed since the manufacturing sector only represents about 11 percent of the national GDP today.

Eric Lascelles, the chief economist for RBC Global Asset Management, believes a recession risk “has gone up somewhat.”

“Whereas the risk of a U.S. recession over the coming year was at around 70 percent a few months ago, perhaps it is now up to an 80 percent chance,” he wrote in a note. “A soft landing remains technically possible, but it is harder to achieve than before.”

Despite deteriorating economic metrics, Treasury Secretary Janet Yellen is confident the U.S. economy will avert a downturn.

“The U.S. economy is obviously performing exceptionally well with continued solid job creation, inflation gradually moving down, robust consumer spending,” she said at a press conference on Tuesday. “So I’m not anticipating a downturn in the economy, although, of course, that remains a risk.”