Making sense of economics data-M2 money supply

The biggest repository for economics data in the US and probably the whole world is FRED, of the Federal Reserve Bank of St. Louis. It really has some wonderful data series, but the sheer amount of economics data available ( more than 500,000 total series) shows that the economics data generators are spewing out data right and left, and most of it has to be irrelevant, or noise.

Let us analyze some good data series, often misinterpreted by not just the public but even the Fed officials themselves. I will analyze only the US data.

M2 money supply

This is a very useful data series. Here's the chart of the M2 money supply, non-seasonally adjusted, from 1959 to the present (2019).




M2 is a good measure of how much savings US households (primarily, also includes non-profits) hold in near liquid money. Most is held in savings accounts and checking accounts. The amount of about $14 trillion in 2019, and as you can see from the graph above, it basically keeps going up with time, even during recessions.

I am against adjustments of seasonality, etc. it is best to just look at  the raw data.

M2 is a good indicator of the advancement of the country. As the country overall becomes wealthier, the amount held in liquid money goes up with time. However, this amount is a small part of the overall national wealth, which is about $109 trillion in 2019. The chart below shows that wealth.



M2 is about 13% of the total household wealth. The other major parts of US wealth of households consists in real estate, stock market, and government and corporate bonds.

You may hear of absurd arguments like the Fed lowering or raising the fed funds rate to affect the money supply. Here is the chart of the Fed funds rate.



As one can see from the two charts above, the fed funds rate has no effect on M2. The money supply M2 keeps going up, while the Fed funds rate is all over the place. The big trend is that M2 keeps going up, without much correlation with the Fed funds rate. 

You may also hear of banks increasing money supply by lending. Unless someone borrows money and puts it right back into a bank (and certainly the banks will offer them lower rate than their borrowing rate) and wants to lose money, it makes no sense that loans end up back in banks. People borrow money to use in productive purposes, e.g. buying a car, house, etc. Note that the people who are borrowing are not the same people who hold these savings of money which shows up in M2-it is a different set of people. A retiree will have a large amount of money in her savings account; a student only a little. Borrowers are normally younger, and savers are older. It is only the aggregate data for the whole US population which shows in M2 money supply.

Banks and Fed can't change M2, these are net savings of people, and it is preposterous to believe that banks or the Fed can change the value or purchasing power of what you save by changing interest rates, reserve ratios, etc. (notwithstanding the odd theories of inflation). M2 is also very stable because of the FDIC guarantee of deposits of $250K per depositor per bank, people feel safe holding funds in their savings and checking accounts because of this reason. 


Lastly, I will comment that another measure of money supply, M1, is an inferior measure of liquid money because of the large amount of money which people hold in savings accounts, which can have a check or debit card attached to it, which shows only in M2. One can safely ignore M1 in their analysis of the net liquid savings of the residents of  the US.

M2 and money supply in other countries

A growing M2 is certainly a good indicator of a steadily advancing country, but if M2 does not grow in a country, it does not mean that the country is not advancing. In certain countries, the banking system is not as reliable as in the US, and there you can have advancement without growth in M2-people will prefer to save their wealth in other forms like real estate, accumulating US dollars (as happens in Latin America) or Euros (as happens in Eastern European countries). 

Furthermore, some countries include government deposits in M2, and one must be careful about the definitions before coming to conclusions about M2 and what it means.




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