The Fed’s “medicine” of lowering interest rates appears to be killing the sick American economy.
The credit crunch due to unprecedented tight monetary policy has led to a surge in bankruptcy filings, portending a vicious recession and soaring unemployment. The flow of money supply (the dollars the Fed prints) fell again in October, remaining deep in negative territory after turning negative in November 2022 for the first time in twenty-eight years. October’s decline continues a sharp downward trend from record highs recorded for most of the past two years, according to data from a Trust Economics study.
Since April 2021, money supply growth has slowed rapidly, and since November, we have seen the money supply shrink repeatedly on a yearly basis. The last time the annual change in the money supply slipped into negative territory was in November 1994.
At that time, the negative flow continued for fifteen months, finally turning positive again in January 1996. Money supply growth has now been negative for twelve consecutive months. In October 2023, the trend continued as the annual flow of money supply was -9.33%. This is a slightly higher level than September’s rate cut, which was -10.49% and well below October 2022’s rate of 2.14%.
With negative growth now hovering near or below -10% for the eighth consecutive month, the contraction in the money supply is the largest since the Great Depression of the 1930s and portends massive economic tremors in the global financial system and economies. Prior to this year, at no other time in at least sixty years had the money supply fallen by more than 6% (yearly) in any month.
The money supply index
The money supply measure used here—the Rothbard-Salerno money supply (TMS) measure—is the measure developed by Murray Rothbard and Joseph Salerno and designed to provide a better measure of money supply fluctuations than the M2 measure. *.
In recent months, the growth rates of the M2* index have followed a similar path to the growth rates of the TMS, although the TMS index has declined faster than the M2. In October 2023, the growth rate of M2 was -3.3%. This is lower than September’s growth rate of -3.35%. The October 2023 growth rate was also quite lower than the October 2022 growth rate which was 1.42%.
Money supply and recession
Money supply growth can often be a useful measure of economic activity and an indicator of upcoming recessions.
During economic booms, the money supply tends to increase rapidly as commercial banks make more loans. Recessions, on the other hand, tend to be preceded by a slowdown in the growth rates of the money supply. It should be noted that the money supply does not have to actually shrink to signal a recession and down cycle of the economy.
As Ludwig von Mises showed, recessions are often preceded by a simple slowdown in the growth of the money supply. But the fall into negative territory we’ve seen in recent months helps illustrate just how far and how fast the money supply has fallen. This is generally a red flag for economic growth and employment.
The fact that the money supply is shrinking is remarkable because the money supply in modern times almost never shrinks. The money supply has now declined by $2.8 trillion (or 13.1 percent) since the peak in April 2022. Correspondingly, the decline in the money supply since 2022 is the largest decline seen since the Great Depression. Since the Great Depression, the money supply has fallen 12% from a peak of $73 billion in mid-1929 to $64 billion in late 1932.
Despite this recent decline in the aggregate money supply, the trend in the money supply remains well above what it was in the twenty years from 1989 to 2009. In order to return to this level, the money supply would have to fall by at least another 3 about $1 trillion—or 15%—to a total of less than $15 trillion.
Additionally, as of October, the total money supply was still up 32 percent (or $4.6 trillion) since January 2020. Since 2009, the TMS index’s money supply has now increased by nearly 186 percent.
The M2* index has increased by 141% in that period.
Of the current money supply of $18.9 trillion, $4.6 trillion—or 24 percent—has been created since January 2020. Since 2009, $12.2 trillion of the current money supply has been created. In other words, nearly two-thirds of the total existing money supply has been created in just the last thirteen years.
Monetary surplus
With these figures, a 10% drop is a small amount in the huge edifice of newly created money.
The US economy is still running a very large monetary surplus from the past several years, which is partly why after eighteen months of slowing money supply growth, we are just now starting to see a slowdown in the labor market. For example, new jobs fell by 22% last year, but have yet to return to pre-Covid levels.
- The inflationary boom is not yet over. However, the monetary slowdown was sufficient to significantly weaken the economy.
- The Philadelphia Fed manufacturing index shows a clear recession.
- The Leading Indicators for manufacturing activity continues to look worse.
- The yield curve shows recession.
- The number of jobs offered has declined, year over year, which often indicates that a recession is on the way.
- Bankruptcy rates are rising.
Money supply and rising interest rates
The inflationary boom will start to turn into a bust once fresh money stops flowing into the economy, and we’re seeing that now.
Unsurprisingly, today’s negative readings come after the Federal Reserve finally took its finger off the money accelerator a little after more than a decade of quantitative easing and a general adjustment of the economy to easy money. Since early December, the Fed has allowed the federal funds rate to rise to 5.50%, the highest since 2001. That means short-term interest rates overall have also risen. In October, for example, the 3-month government bond yield reached 5.6%, the highest level measured since December 2000.
Credit suffocation
Without continued access to easy money, banks turn off lending and many companies will no longer be able to stave off financial problems by refinancing or taking out new loans.
Bankruptcies increased significantly in 2023 and continue to increase during the last quarter of the year.
WeWork’s bankruptcy filing in November was the most significant of November’s Chapter 11 business filings at 842, a 141% increase compared to the 349 filings in November 2022, according to data from Epiq Bankruptcy.
The request filed by WeWork on Nov. 6 included 517 related cases, according to an analysis by the American Bankruptcy Institute, representing the third major bankruptcy case since the U.S. Bankruptcy Code took effect in 1979. Overall bankruptcy filings increased up 21% to 2,252 in November, up from 1,864 filings in November 2022. Small business bankruptcies, filed as subchapter V cases in Chapter 11, rose 79% to 181 in November, up from 101 in November 2022 .There were 37,860 total bankruptcy filings in November, up 21% from the November 2022 total of 31,187. Individual bankruptcy filings also saw a 21% year-over-year increase, with 35,608 in November representing an increase from 29,323 filings in November 2022.
There were 20,250 individual Chapter 7 filings in November, up 23% from the 16,421 filings recorded in November 2022, and there were 15,280 individual Chapter 13 filings in November, up 19% from the 12,862 filings in last November.
- As money becomes more expensive, borrowing for private consumption also becomes more expensive.
- In October, the average 30-year mortgage rate rose to 7.62%, the highest point since November 2000.
Inflation and wages
All these factors are indicative of a “bubble” that is in the process of bursting. The situation is unsustainable, yet the Fed cannot change course without reigniting another burst of inflation.
While inflation may appear to some politicians to have almost disappeared, the prevailing climate says just the opposite as most workers believe their wages are not keeping pace with rising prices. Any increase in prices would be particularly problematic given the rising cost of living.
Americans face a similar problem with housing prices. According to the Atlanta Fed, the housing affordability index is now the worst since 2006 amid the housing bubble. If the Fed reverses course now and unleashes another flood of new money, prices will soar. It didn’t have to be this way, but ordinary people are now paying the price for a decade of easy money cheered on by Wall Street and politicians in Washington.
The only way to put the economy on a more stable long-term path is to stop the Fed from supplying new money to the economy. This means a drop in the money supply and a bursting of the “bubble” in the economy. But in parallel it also lays the groundwork for a real economy and a virtuous economic cycle—that is, an economy not based on successive bubbles—that is built on saving and investing rather than spending made possible by artificially low interest rates and easy money.
*Indices M0 and M1 (narrow money) include all assets that are in liquid form and usually include coins and banknotes in circulation (monetary circulation), demand deposits, cheques, banks’ reserves at the central bank and other money equivalents ( eg foreign exchange reserves) that can be easily converted into cash. They contain the most easily liquid assets. In other words, their amount shows the total amount of money that is in immediate circulation within an economic circuit.
The M2 (intermediate money) index includes M1 and any element of wealth that can be guaranteed to be converted relatively immediately into cash without losing its value. Indicatively, the M2 index includes short-term term deposits in banks, savings bank deposits and 24-hour money market mutual funds.
