Contracting U.S. Money Supply Doesn't Mean Economic Downturn

While there are many measures of the US money supply, two tend to get the lion's share of attention: M1 and M2.

Photo Insert: For the first time since the Great Depression, the US money supply is contracting.

The M1 money supply comprises everything that can be spent. M1 means cash bills, coins, money in your checking account, and traveler's checks. M2 takes into account everything in M1 and adds money market funds, savings accounts, and certificates of deposit (CDs) of less than $100,000 at financial institutions, Sean Walker reported for Motley Fool.

Dating back more than six decades, M2 has pretty consistently expanded. Between January 1959 ($286.6 billion) and April 2023 ($20.67 trillion), M2 has expanded by an average of more than 3% per year.

What is surprising is what the M2 money supply has done over the past two years.

Between the early part of 2020 and early 2021, the issuance of stimulus checks and other financial programs during the COVID-19 pandemic allowed the M2 money supply to balloon 26% in a single year, what Reventure Consulting founder and CEO Nick Gerli said was the largest expansion of M2 in 153 years.

A historic expansion in M2 allowed the inflation rate to surge above 9% in June 2022 -- the highest year-over-year increase in over four decades.

However, Since 1870, there have only been five instances where M2 declined by at least 2% on a year-over-year basis.

Four of these events occurred between the 1870s and 1933, leading to three depressions and one panic. The fifth instance is ongoing. Since hitting an all-time high of $21.7 trillion in July 2022, M2 has now declined by 4.8%, representing the biggest drop since 1933.

The reason declines in M2 are concerning is twofold. First, a decline in the M2 money supply is typically associated with a higher probability of an economic slowdown and a retreat of discretionary spending.

The three depressions and one panic all occurred between the 1870s and 1933, predating the formation of the Federal Reserve in 1913.

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