Federal Reserve Money Supply Data & the CPI

After supplying M1 and M2 money supply data weekly since the 1970s, the Federal Reserve announced earlier this year that it will discontinue this practice and will only publish this data monthly in the future.

“Chairman Powell has very explicitly claimed that money doesn’t matter in recent testimony. He’s basically said that money and the measurement of money doesn’t really matter because it’s unrelated to inflation,” Hanke said.

Some believe that this change reflects a change in attitude by the Federal Reserve on the importance of money supply and demonstrates a shift in worldviews. They base their view partly on the fact that the measurement of money supply is not really important.

For the Federal Reserve, inflation is also less of a worry because it believes that the increase in money supply is unrelated to inflation.

In other quarters, though, this move by the Federal Reserve is worrying, especially since money supply has increased by 500%, and they believe inflation is a significant threat to the economy. As a result, they think that the Federal Reserve did this because they will need to produce more money to aid in economic recovery, bringing with hard-hitting inflation.

The Facts

The Federal Reserve stopped supplying M1 and M2 data at a time when money supply has increased significantly. In fact, the M1 money supply has increased 450% in the last year…

…while the M2 money supply is up by 30% in the past year.

A significant driver of the increase in money supply has been fiscal stimulus packages implemented in the wake of the COVID-19 pandemic. These stimulus packages aim to stimulate the economy, which took a battering during the pandemic.

Critics of this move believe that a financial crisis is on the horizon and fear that the Federal Reserve stopped providing money supply data because they’ll need to produce even more money to pump into the economy

What Is the Federal Reserve’s Money Supply?

Before looking at the critics’ concerns in more detail, it’s necessary to shortly recap what the money supply is. In simple terms, the US money supply is all the physical cash in circulation throughout the country, including money held in bank accounts.

However, the money supply does not include any other forms of monetary assets like long-term investments, home equity, or physical assets. It also does not include various types of credit, like loans, mortgages, or credit cards.

The federal reserve measures money supply in three ways:

• Monetary base, which is the sum of currency in circulation and reserve balances.
• M1 is the sum of currency held by the public.
• M2 includes the M1 money supply and currency held in savings accounts, money market accounts, money market funds and some time deposits.

Over the course of history, the money supply expanded and contracted with the economy. For this reason, many economists like Milton Friedman pointed out that the money supply can be a valuable indicator of the state of the economy.

The Effect of Money Supply on Inflation

Critics of this now believe that inflation is currently a significant threat because the Federal Reserve has increased money supply significantly. As a result, these critics believe that the Federal Reserve is stopping this practice because it will increase money supply even further, and as a result, inflation will be a real danger. As we have seen since the decision was announced, inflation as measured by the CPI has indeed picked up substantially.

This is of particular interest to investors given the chairman of the Federal Reserve, Jerome Powell’s recent testimony where he, in summary, stated that the measurement of money supply doesn’t matter because it’s unrelated to inflation.

The critics’ core argument is that if the government increases the money supply, there will be a debasement of currency and inflation. So, in simple terms, as the money supply increases, it decreases the value of money.

This is based on the premise that if the money supply grows faster than the economic output, there will be an oversupply of money, and, as such, inflation will occur. The most discussed theory when looking at the link between money supply and inflation is the quantity theory of money (QTM).

This theory proposes that, like with any other goods, the value of money is determined by supply and demand. Here, the basic equation for the quantity theory is The Fisher Equation. It proposes that the money supply multiplied by the velocity of circulation equals the average price level multiplied by the volume of transactions of goods and services.

In other words, if the money supply is much larger but the velocity of money drops dramatically, the economy is very small. So, if the velocity of money increases, as is expected during the recovery phase after the pandemic, the price level of a currency needs to increase when the volume of transactions largely stays the same. This leads to inflation.

In fact, the 10-year Treasury Bond Yield note, which has risen from 0.51 in August 2020 to 1.31 in July 2021, is starting to show inflationary tendencies. Here, the market indicates that inflation is coming.

The Bottom Line

As the money supply increases, it’s worrying that the Federal Reserve stopped reporting the money supply data earlier this year. This is counter to what was taking place for years. It’s further amplified because the market shows that inflation is just starting to creep in, and the timing of inflation was very close to the end of the reporting of said data.

As a result, now might be an excellent time to look at investing commodities, especially gold and silver miners, as hedges against rising inflation. Typically, because commodity prices rise when inflation increases, they offer protection against the effects of inflation. In fact, they’re one of the few asset classes that benefit from rising inflation. In contrast, as the money supply increases, currencies will lose value.

Gold, for example, has increased significantly since the pandemic started, and the long-term outlook remains positive as a result of increased tax rates and a more accommodative approach to monetary policy by the Federal Reserve.

The key takeaway is, at a time when precious metals will increase in value, it is now the time to invest in gold and silver, or gold and stocks to not only offer a hedge but also ensure long-term returns.

How to Trade this

An excellent way to expose oneself to the movements in precious metals is to buy early stage mining explorers. We remain bullish on Etruscus Resources (CSE:ETR). The company recently announced their private placement, which was initially at $1.5M. Due to overwhelming demand from the investment community, subsequent press released by the company showed that they closed $2.6M and have started the summer exploration program. The company is still the cheapest in the Golden Triangle given the stage of the projects, and has had incredible exploration results. The summer exploration program is sure to be an important milestone and could significantly increase the size of the deposit. Keep in mind this is in a region with monster mines. We published our update report on the company showing that it is worth $1.50 given today’s information.

We also remain bullish on Nexus Gold (TSXV:NXS). The company has been exploring their 2 flagship properties. They recently completed a drill program at McKenzie Gold and had intercepts like: 24.7m of 4.05 g/t Au, 24.7m of 4.05 g/t Au, and 24.7m of 4.05 g/t Au. McKenzie Gold is in the highly prolific Red Lake region in Ontario, home of a recent producer and numerous deposits and past producers. The company also had another drill program in Dakouli 2 and had intercepts like: 10.87 g/t Au over 4 meters, 10.60 g/t Au over 1m and 4.87 g/t Au over 1m. These are incredibly mineralized intercepts, in regions majors are actively exploring and investing in. More recently the company completed a reconnaissance program at Manzour-Dayere, and is looking to have follow-up programs to expand the gold mineralization that has already been identified in the Northeast corner of the property and returned results of 9.60 grams-per-tonne (“g/t”) gold (“Au”), 7.07 g/t Au, 5.73 g/t Au, 3.84 g/t Au and 2.84 g/t Au. The company is trading at a steep discount. We published our report on the company showing that it is worth at least 24 c given today’s information.