U.S. Money Supply Is Shrinking the Most Since the Great Depression. Is an Economic and Stock Market Meltdown on the Way?

What happens when a guy wearing a hockey mask and holding a sharp object appears in a horror movie? Nothing good ever comes of it.

While they may not be as frightening as pop culture’s evil villains, there are definitely scary indicators in the current economic scene. The US money supply is at its lowest contraction since the Great Depression. Does this mean an economic and stock market meltdown is on the horizon?

terrible history

Economists pay close attention to the money supply, or the total amount of money in circulation. They measure money supply in several main ways. M1 is a measure used for the total amount of money Americans hold in coins and bills, easily accessible checking and savings accounts, and other accounts that can be quickly converted to cash. M2 includes all the funds in M1, plus funds held in short-term fixed deposits such as money market funds and certificates of deposit (CDs).

M2 money supply typically increases over time. When it shrinks, the decline is usually very small. But every time M2 has shrunk by a few percentage points in the past, it’s been bad news.

Nick Gerli of Reventure Consulting analyzed M2’s history dating back to 1870. He found that over the past 154 years there have been four times that this money supply indicator has fallen by more than 2%. Two of his cases occurred in the 19th century, in 1878 and in 1893. His other two incidents occurred in 1921 and 1931-1933.

What was the result? According to Gerli, every time M2 contracted by at least 2%, it was quickly followed by a recession with double-digit unemployment. As you can imagine, this is almost always a tough time for stocks.

What is happening to the M2 money supply now?

Let’s fast forward to today. The M2 money supply has shrunk the most since 1931-1933 (during the Great Depression).

US M2 Money Supply Depends on the data Y chart

To be sure, the current nearly 4% decline in M2 is nothing compared to the nearly 30% contraction in the money supply that occurred at the beginning of the Great Depression. But that’s nearly twice the decline experienced in 1921.

Why have large declines in M2 been such a problem in the past? When the money supply falls, there is less cash available to individuals and businesses. Consumer spending may decline. The same goes for investment levels. This could ultimately lead to deflation, which is a major concern for many economists.

Don’t be afraid?

So, with the M2 money supply contracting the most since the Great Depression, is an economic and stock market meltdown on the horizon? Probably not.

First, M2 seems to have stabilized in recent months. So far, there have been no signs of economic or stock market turmoil associated with historical declines of more than 2%.

US M2 Money Supply Depends on the data Y chart

There may be a simple reason why history is not repeating itself with the current M2 contraction. We don’t use cash as much as we used to. Many Americans are now using credit cards, debit cards, or other digital payment methods instead. apple pay, alphabetGoogle Pay, Cash app, PayPalVenmo, and Zell.

goldman sachs Economist Manuel Abecasis argued in a report published last year that the M2 money supply is “unreliable for predicting the economy for decades.” St. Louis Fed President James Bullard believes that lower M2 levels could help curb inflation and help the U.S. economy avoid recession.

The bottom line is that the current M2 decline may not be a horror movie for investors after all. Fear not — at least for now.