Something very surprising just happened to the U.S. money supply

It’s been twelve years since we’ve seen this

Take a look at the chart below, which shows the monthly percentage change in the money supply, and see if you can’t spot the outlier:

If you noticed that the latest monthly result was negative, congratulations, you saw the surprising development!

The money supply almost always expands. In fact, it hasn’t contracted for over twelve years. You have to go back to March 2010 to see a negative reading.

This result is a critical development to the inflation picture. If there are less dollars, then the relative nominal value of goods will fall.

The rationale for this can be seen in an extreme example. Imagine if tomorrow the money supply shrank by 90%. Suddenly, so much cash would be sucked out of the system that goods would have no choice but to cost less because there wouldn’t be nearly as much money around to pay for things!

It’s almost like how a stock split doesn’t change the underlying value of a company - if we decided to just move the decimal of the dollar all at once and have everyone’s paycheck and bank account go to one tenth of what it is today then things like homes and vending machine candy would have to adjust in proportion to that change.

Obviously, this doesn’t just happen all at once. As the money supply expands or contracts month by month, the prices that people buy and sell things for and the compensation adjustment workers receive changes as money supply changes work through the system.

That’s why, when we pumped trillions of dollars into the economy for COVID stimulus prices for things went up - but not immediately. The lagged impact means that the current money supply comedown is a leading indicator for future inflationary developments. What is happening today will flow through the complex machinery of the economy and, eventually, make an impact.

What I’ve explained is somewhat off the cuff and may not be an exactly perfect description of how things work (yet who really knows how things truly work anyways??) so let me appeal to a more mathematical equation: MV = PQ, a fundamental equation from the Monetarist school of thought.

M is the money supply. P is price. If the money supply goes up then, if V and Q stay the same, prices will go up. It also works the other way. M down. All else equal, P down.

Thus, with this new, surprising development of negative money supply growth, we are about to see some serious downward pressure on inflation start to work its way through this complex economy we’ve got.