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There’s been lots of handwaving about the surge in money supply data recently. Here's a short thread on what I think it means.
First thing: there’s no doubting how unusual and possibly unprecedented these trends are. Both the narrow and broader monetary aggregates have grown at exceptional rates – particularly in the US.
Some have argued that this explains the rebound in risk assets since March. (Disclaimer: I’m generally of the view that M1 is a decent leading indicator of economic activity.) Others believe it heralds the return of inflation. I’m not convinced it does either of those things.
Why? Looking at the counterparts to the money supply provides some clues. This chart shows the changes in the asset-side of US commercial banks’ balance that have acted as the counterpart to changes in deposits.
A few things to take away from this. (i) Much of the surge in money growth occurred in March & April. By contrast, May, June and 1st half of July have been more subdued. The same profile is evident in the eurozone and UK.
(ii) Loan growth was a big contributing factor to the initial surge, as companies pulled down credit lines. But that has now gone into reverse. Those credit lines are being repaid.
(iii) The other big counterpart was the increase in cash assets, which is mostly the reserves banks hold at the Fed. But note the ‘leakage’ into wholesale liabilities (the cash that banks borrowed from the Fed) and foreign offices. These are parts of the same dynamic.
This highlights a couple of important things, I think. In most cases *money is credit*. The surge in the money supply is an side-effect of the huge amounts of borrowing that were necessary during the lockdown period. I’m not sure how this is truly bullish for risk assets.
One possibility is that larger money holdings for any given level of income depress interest rates. As @tomashirstecon has discussed, this might have helped raise valuations via the discount factor. But velocity will rebound as the economy recovers so ¯\\_(ツ)_/¯.
The Fed and other central banks have helped to accommodate this huge increase in borrowing requirements. From a monetary point of view, QE has worked differently to the post 2008 period in this regard. It has coincided with ballooning fiscal deficits, not austerity.
But because this money is also debt, the longer-run inflationary consequences will depend on how central banks behave under increased debt burdens. Will they shrink their balance sheets when/if inflation starts to pick up or not? We can’t possibly know the answer to that yet.
