Chart of the Month | The Surprising Relationship Between Money Supply and Inflation

April 14, 2021 |
2 minute read
|

The potential for rising inflation is becoming a top concern for many investors and consumers. Many believe that inflation is already here as evidenced by price increases in commodities, homes, shipping rates and used vehicles. Following a year of unprecedented monetary accommodation and fiscal support, markets are rightfully nervous as COVID-19 vaccination rates improve, sparking optimism about pent-up demand growth which would put more pressure on supply chains that are already strained. Among all the factors driving inflation rates, central bank liquidity creation is often cited as critical.

As a result, it is reasonable to ask whether the Fed’s massive stimulus during the pandemic might affect inflation. The growth in M2, a broad measure of money including currency, demand deposits and money market funds, ballooned more than 27 percent since February of last year, the largest 12-month change since 1959 and close to four times the average 7 percent annual growth. In this month’s chart, we show that inflation has exhibited no relationship to broad money growth historically.

The chart depicts 734 monthly observations of 12-month growth in M2 money supply on the X-axis and the corresponding 12-month inflation rate on the Y-axis. Perhaps surprisingly, both the dotted trendline in dark-blue and the R-squared coefficient, which measures the proportion of inflation rate volatility explained by the change in M2 growth, are close to zero. We also looked at these measures on a lagged basis to account for the possibility that it takes time for money growth to impact inflation. Again, the data shows no relationship between the growth in M2 and the 6-month lagged inflation, as shown by the light blue trendline.

For excess liquidity to create inflation, it needs to lead to a sustained increase in spending and loan growth. So far, bank lending has been anemic while the global velocity of money and the money multiplier (the ratio of broad money to base money) has fallen more than during the Great Financial Crisis. Given the rapid increase in vaccinations in the U.S., the expectations for spending recovery may lead to an improvement in demand for credit and banks’ subsequent willingness to lend. If that proves to be true, we believe that loan growth will depend more on economic outlook optimism, rather than the level of deposits banks hold. In addition, excess savings, which have been built over the last 12 months, may dampen demand for credit or be used pay down debt. At Commonfund, we believe that while supply disruptions, elevated commodity prices and base effects could result in higher 12-month inflation rates, these effects will be temporary and unwind once the bottlenecks are removed. In addition, we believe that the secular trends of automation and robotization, declining labor force participation, aging population and high debt levels will continue to suppress inflation over the long-term.

img-com-chart-of-the-month-2021-04-M2

Ivo C. Nenin

Author

Ivo C. Nenin

Disclaimer

Certain information contained herein has been obtained from or is based on third-party sources and, although believed to be reliable, has not been independently verified. Such information is as of the date indicated, if indicated, may not be complete, is subject to change and has not necessarily been updated. No representation or warranty, express or implied, is or will be given by The Common Fund for Nonprofit Organizations, any of its affiliates or any of its or their affiliates, trustees, directors, officers, employees or advisers (collectively referred to herein as “Commonfund”) or any other person as to the accuracy or completeness of the information in any third-party materials. Accordingly, Commonfund shall not be liable for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on any statement in, or omission from, such third-party materials, and any such liability is expressly disclaimed.

All rights to the trademarks, copyrights, logos and other intellectual property listed herein belong to their respective owners and the use of such logos hereof does not imply an affiliation with, or endorsement by, the owners of such trademarks, copyrights, logos and other intellectual property.

To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated herein. Forecasts of experts inevitably differ. Views attributed to third-parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Market and investment views of third-parties presented herein do not necessarily reflect the views of Commonfund, any manager retained by Commonfund to manage any investments for Commonfund (each, a “Manager”) or any fund managed by any Commonfund entity (each, a “Fund”). Accordingly, the views presented herein may not be relied upon as an indication of trading intent on behalf of Commonfund, any Manager or any Fund.

Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Fund. Such statements are also not intended as recommendations by any Commonfund entity or any Commonfund employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information or statements. Past performance is not indicative of future results. For more information please refer to Important Disclosures.

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Disclaimer

Certain information contained herein has been obtained from or is based on third-party sources and, although believed to be reliable, has not been independently verified. Such information is as of the date indicated, if indicated, may not be complete, is subject to change and has not necessarily been updated. No representation or warranty, express or implied, is or will be given by The Common Fund for Nonprofit Organizations, any of its affiliates or any of its or their affiliates, trustees, directors, officers, employees or advisers (collectively referred to herein as “Commonfund”) or any other person as to the accuracy or completeness of the information in any third-party materials. Accordingly, Commonfund shall not be liable for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on any statement in, or omission from, such third-party materials, and any such liability is expressly disclaimed.

All rights to the trademarks, copyrights, logos and other intellectual property listed herein belong to their respective owners and the use of such logos hereof does not imply an affiliation with, or endorsement by, the owners of such trademarks, copyrights, logos and other intellectual property.

To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated herein. Forecasts of experts inevitably differ. Views attributed to third-parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Market and investment views of third-parties presented herein do not necessarily reflect the views of Commonfund, any manager retained by Commonfund to manage any investments for Commonfund (each, a “Manager”) or any fund managed by any Commonfund entity (each, a “Fund”). Accordingly, the views presented herein may not be relied upon as an indication of trading intent on behalf of Commonfund, any Manager or any Fund.

Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Fund. Such statements are also not intended as recommendations by any Commonfund entity or any Commonfund employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information or statements. Past performance is not indicative of future results. For more information please refer to Important Disclosures.