If you have seen the general news that M2 Money Supply is contracting at the greatest rate in 50 years, then you may be wondering why it is happening and what it means. I hope you do, at least.
Money Supply is a general term that means the total money available to an economy in the form of cash money in the bank plus loans and short term deposits sitting in banks. It is the purest measure of "gas in the tank" for the economy.
If you are going on a long trip (economic growth), it is also helpful to have a tankful of gas to get you there. If you don't have it now, then clearly you will have to stop and get gas along the way.
The economy needs money the way we need air to breath, unless we revert to trading goods and services with each other and we all know that isn't easy at all. It is hard to "make change" in case the trade doesn't balance perfectly.
Either way, the amount of money in the system turns over a certain amount of times per year and that is called "velocity". The velocity of money is the fudge factor to figure the size of the economy and the amount of money in the economy. Obviously, it is very difficult to track as some money gets spent a hundred times or more and other money gets spent once or twice. It is constantly changing.
Net-net though, the quantity of money is the most common way of understanding what inflation "will do" in the future and has been extremely helpful. For now, the indicator points to lower inflation if not deflation in the coming months and quarters. It will take care of itself.
Need to correct you on one thing. There are no loans in M2. M2 is a measure of the money supply that includes cash, checking deposits, savings accounts, certificates of deposit (CDs), money market funds, and other short-term saving vehicles. But, given the fact that loans are contracting also, I agree with your assessment.
timwest
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@Dan_B_Cooper, I appreciate the additional points Dan. Yes! M2 includes those additional measures. Thanks. I put up the basics to get my point across. I get tired of the "inflation forever" crowd when clearly there are signs that inflation at current levels isn't sustainable. The big variable is velocity. And great point on "loans contracting" also which is also very important.
basictradingtv
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thanks a lot tim!
KennyLay
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Great explanation. I’ve always been familiar with this metric but struggled to understand how it plays into real life. The “gas in the tank” analogy explains this really well.
Superchip1979
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Its very interesting, is this your job ,or just a hobby , is the doller one huge Ponzi waiting to collapse