The biggest collapse in M2 money supply since the Great Depression

If your measure of inflation is the money supply, then the economy is currently in a deflationary period.

Data for the chart above comes from the Fed’s H.6 Money Stock Report, released Jan. 24.

Monetary definitions

  • M1 consists of (1) currencies outside the US Treasury, Federal Reserve Banks and depository vaults; (2) demand deposits with commercial banks (excluding amounts held by depository institutions, the U.S. government and foreign banks and official institutions) less cash items collected and the Federal Reserve float; and (3) other liquid deposits, consisting of other checkable deposits (or OCDs, which consist of negotiable order of withdrawal, or NOW, and direct debit, or ATS, accounts with custodians, exchange accounts with credit unions, and demand deposits with thrift stores) and savings deposits (including money market deposits). Seasonally adjusted M1 is constructed by adding currency, demand deposits and other liquid deposits, each individually seasonally adjusted.
  • M2 consists of M1 plus (1) small denomination term deposits (term deposits for amounts less than $100,000) minus the Individual Retirement Account (IRA) and Keogh balances with custodial institutions; and (2) money market fund (MMF) balances less IRA and Keogh balances with MMFs. Seasonally adjusted M2 is constructed by summing small denomination term deposits and retail MMFs, each individually seasonally adjusted, and adding the result to seasonally adjusted M1.
  • ODL is described below

A better definition of money and Lacy Hunt’s thoughts on when a recession will start

I discussed ODL in A Better Definition of Money and Lacy Hunt’s thoughts on when a recession will begin

The main difference between ODL and M2 is that ODL does not include foreign exchange or retail money market funds.

Currency is accepted at fewer and fewer establishments and simply cannot be used for very large transactions. Individual money market funds have never become a major medium of exchange. Both are becoming a much less used medium of exchange.

ODL has the added benefit of being the primary source of funding for bank loans and investments, making ODL both a monetary and a credit aggregate. It would not surprise Friedman that the need for the best definition of what money is has changed over the years.

The above blocks courtesy of Lacy Hunt of Hoisington Management.

M1, M2, Other deposit liabilities Detail since 2019

M1, M2, other deposit liabilities Percentage change from a year ago

The Fed’s QE panic attack during and after the Covid pandemic has severely distorted the percentage changes in M1 money supply.

M2, other deposit liabilities Year-on-year percentage change

Monetary disruptions

In the mid-1990s, the Greenspan Fed greatly distorted the M1 measure through Sweep Account programs.

Sweeps are the process by which banks take money from checking accounts and move it to accounts that pay interest. The interest, of course, did not go to the consumer, but to the banks.

Simply put, unbeknownst to depositors, money that people believe is in their checking accounts and supposedly available on demand is not there.

The St. Louis Fed published Sweep Data for a while and then stopped in 2012.

I believe the increasing use of Sweeps caused M1 to remain negative on an annual basis from June 1995 to February 1998.

Reverse repositories

Reverse repos explain the rise of M1 over M2 in the lead chart.

The Fed has seriously distorted the money supply. and in the process gives huge amounts of free money to financial institutions.

Now that M1 is so distorted, let’s go back to ODL.

M2, Other deposit liabilities Percentage change from year ago Detail

Not since 1932


Lacy Hunt on what it means

From the last quarter of 2021 to the same quarter in 2022, nominal ODL is estimated to have fallen at a record annual rate of 2.8%, the largest annual decline in history. Also in real terms, the ODL contracted at a record rate.

Based on the Fed’s $96 billion monthly balance sheet reduction and lagging monetary policy, the pace of ODL decline will accelerate in at least the first half of 2023.

If the Fed sticks to its plan to raise Federal Funds rates by another 75 basis points, the pace of ODL decline will be enough to neutralize the 2020/21 money mountain by Q2 2023, taking into account with the speed.

The above is from Lacy Hunt ahead of the H.6 release on Tuesday.

Both Lacy and I think a recession started in November or December.

Loose ends

Old readers may remember that I came up with M’ (pronounced M-Prime) as a way to reconstruct M1.

M’ was my way of coming up with a better version of money that was supposedly available on demand, but in reality isn’t.

The process became impossible when the St. Louis Fed stopped publishing Sweeps data. Again, money that you think is in your account and supposedly available on demand is actually not.

Lacy’s ODL should not be confused with the Fed’s reporting on “other liquid deposits.”

In hindsight, a name like M2-, M2′ or “Prime M2” might be a better name to get the Lacy’s message across.

Free money

Finally, through all these manipulations, the Fed has bailed out banks over time, while the ECB, with its negative interest rates, has not. How much free money?

Confused? The central bankers want it that way.

The biggest collapse in M2 money supply since the Great Depression

Leave a Reply

Your email address will not be published.

Scroll to top