US Money Supply Shrinks for 1st Time Since Fed Started Sharing Data

The Federal Reserve Board building on Constitution Avenue in Washington on March 27, 2019. Brendan McDermid/Reuters

The U.S. money supply has contracted for the first time since the Federal Reserve started publishing the data in January 1960.

According to the latest data presented by the Board of Governors of the Federal Reserve System, the M2 money-supply growth rate tumbled by 1.3 percent year-over-year in December 2022, down from 0.01 percent in November 2022. This is also sharply down from the February 2021 peak of nearly 27 percent.

In total, the national money supply stands at more than $21.2 trillion, which is still more than 37 percent above the pre-pandemic level of about $15.458 trillion.

M2 is a measurement of the U.S. money stock that includes cash, checkable deposits, traveler’s checks, small-denomination time deposits, shares in retail money market mutual funds, and other categories of deposits that can easily be converted to cash.

Ryan McMaken, an economist and senior editor at Mises Institute, recently alluded to the Rothbard–Salerno money supply measure (TMS, or “true money supply”). This metric, an alternative to the Fed’s official M2 gauge, was developed by economists Murray Rothbard and Joseph Salerno to be a more accurate depiction of money supply movements because it includes Treasury deposits at the central bank and excludes retail money funds and short-time deposits.

“The last time the year-over-year (YOY) change in the money supply slipped into negative territory was in November 1994. At that time, negative growth continued for 15 months, finally turning positive again in January 1996,” McMaken wrote. “During December 2022, YOY growth in the money supply was at -2.4 percent. That’s down from November’s rate of -0.55 percent and down from December 2021’s rate of 6.44 percent.”

Federal Reserve Chair Jerome Powell at the Federal Reserve Building in Washington on May 23, 2022. Olivier Douliery/AFP via Getty Images

Whichever measurement is used by observers, experts contend that the series of rate increases since March 2022 have been working.

Over the past year, the Federal Open Market Committee has raised interest rates by more than 450 basis points, lifting the benchmark federal funds rate to a target range of 4.50 to 4.75 percent. This influences the overall money supply because higher interest rates result in two crucial trends. The first is that consumers will fork over additional interest on loans, which can weigh on cash reserves. The second is that a rising-rate climate will nudge consumers into non-deposit investments, such as stocks, exchange-traded funds (ETF), mutual funds, bonds, and annuities.

Despite the contraction and the gradual slowdown in the expansion of the money supply over the past year, the financial system is still flooded with liquidity, suggesting that monetary policymakers at the U.S. central bank still have plenty of work to normalize market conditions.

One of these measures has been trimming the Fed’s balance sheet, which consists of everything from Treasurys to mortgage-backed securities to corporate bonds. But while this has become an instrumental component of the institution’s quantitative-tightening cycle, policymakers haven’t reduced it to pre-crisis levels.

In the early days of the COVID-19 public health crisis, the central bank juiced the economy through stimulus and relief efforts. This included its bond-buying initiative that increased the balance sheet by about 117 percent, bringing the total to a peak of more than $8.965 trillion in April 2022. Since then, it has declined by nearly 6 percent to below $8.5 trillion. Market experts purport that the Fed is refraining from accelerating the reduction in the balance sheet out of fear of upsetting the financial markets.

Does This Confirm a Recession?

Many economists will contend that a slowing or contracting money supply will typically trigger a recession.

This past summer, prominent economist Steve Hanke, a professor of applied economics at Johns Hopkins University, told CNBC that the U.S. economy would slip into a recession in 2023 because of flatlining money supply growth.

“We will have a recession because we’ve had five months of zero M2 growth, money supply growth, and the Fed isn’t even looking at it,” he said. “We’re going to have one whopper of a recession in 2023.”

Hanke reiterated this position in an October 2022 interview, telling Kitco News that the shrinking money supply will be responsible for worsening economic conditions, noting that the Fed’s tightening has reversed the annualized growth rate at an “unprecedented” pace.

“Where we’re going is determined by where the money supply is going,“ he said. ”The last seven months, the money supply has actually contracted by 1.1 percent. That’s almost unprecedented. That means, of course, you have a big change in the money supply and then there’s a transmission mechanism. There are lags between the thrusts in the money supply, whether it’s going up or it’s going down, and what happens to the real economy. Sometime, in 2023, we’ve got a pretty big recession baked in the cake.”

In the first half of 2022, the U.S. economy fell into a technical recession—that is, back-to-back quarters of negative gross domestic product—but the country recovered in the second half, growing by 3.2 percent in the third quarter and 2.9 percent in the fourth quarter.

The baseline scenario for many economists and market analysts is a recession in 2023 or 2024.

Many indicators point to a recession. The Conference Board’s Leading Economic Index (LEI) has slumped by nearly 4 percent in the June-to-December 2022 period. The 2- and 10-year Treasury yields have been inverted for several months, while the Fed’s preferred three-month and 10-year yields have been inverted since late last year. Multiple manufacturing Purchasing Managers’ Index readings, including the S&P Global Manufacturing PMI, have been stuck in contraction territory since late fall.

Bankrate’s Fourth-Quarter Economic Indicator poll of economists found a 64 percent chance of the United States facing an economic downturn this year.

“If a much-feared recession does emerge as the year unfolds, this would seem to be the most widely predicted contraction of the economy that I can remember,” said Mark Hamrick, senior economic analyst for Bankrate. “It would also be essentially self-inflicted by the Federal Reserve, which has been aggressively raising interest rates in the cause of slaying the inflation monster.”

But following last week’s January jobs report, some experts believe that the Fed can still engineer a soft landing, thereby averting a recession.