Written by Jim Welsh
Macro Tides Monthly Report 01 August 2020
Money Supply Growth and the Fed’s 2% Inflation Target
In the five months since February 24 the annual growth rate in the M2 money supply has exploded from less than 3% to 19.2% as of July 6 and 24.9% from a year ago. (Chart as of June 1). This extraordinary increase has led some strategists to say the Federal Reserve has planted the seeds of future inflation that will become apparent in 2021 and beyond.
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These forecasts are understandable since M2 is growing faster than at any time since 1945 and almost 50% faster than M2 growth in the 1970’s, which preceded a period of great inflation.
Inflation soared to more than 10% annually in 1974 and to a mindboggling 14.7% in April 1980. These levels are hard to comprehend since the Fed has geared monetary policy in the past decade to get Core PCE inflation above 2.0%, and failed to achieve that goal. The Fed has even gone so far as to employ forward guidance that includes allowing inflation run above 2.0% before responding with higher rates.
The big increase in M2 money growth played a role in the inflation spikes in 1974 and 1979-1980.
However, there were other factors that contributed significantly, which makes comparing the current surge in money growth to the 1970’s tenuous. The Organization of Petroleum Exporting Countries increased the cost of oil from $3 a barrel to $12 in October 1973, which led to general price increases and a deep recession in 1974. A second wave of inflation was spurred after oil prices rose from $16 a barrel in April 1979 to $39.50 in April 1980. A gasoline shortage created long lines at gas stations with consumers waiting hours to get a tank of gas. It was estimated that Americans wasted up to 150,000 barrels of oil a day waiting in line.
According to a poll by the Associated Press and NBC News, 54% of those surveyed thought the oil shortage was a hoax perpetrated by the oil companies to drive up prices, compared to 37% who thought the shortage was real. A Congressional investigation into price gouging by the oil companies was launched. Of the more than 30 investigations that have been paneled in forty years not one has confirmed gouging, but calling Big Oil execs in front of a Congressional Committee plays well back home.
The surge in inflation in the first half of the 1970’s led to the introduction of Cost of Living Adjustments (COLA) in union labor contracts and annual Social Security payments. The first COLA for Social Security was 8.0% in 1975 and would rise until it reached 14.3% in 1980. Unions were often able to secure multi-year contracts that included annual pay increases of 5% or more. These COLA increases allowed higher labor costs to become embedded and contributed to higher costs for manufactured goods in the U.S.
As a percent of employed workers, union membership peaked in 1954 at 28.3%, and the total number of union members peaked in 1979 at an estimated 21.0 million. Membership in unions in the U.S. has dropped from 27.0% as a percent of all workers in 1970 to less than 12% in 2018.
In the past decade most unions have focused less on wage increases and more on non wage benefits like health care costs. While the influence of unions has waned in recent decades, the push to increase the minimum wage to $15.00 an hour in recent years has lifted the earnings for the bottom quintile of workers.
The COVID-19 shutdown lifted the unemployment rate to 14.7% in April and well above the high of 10.0% in 2010 after the financial crisis. As discussed in the June Macro Tides, analysis of prior recessions indicates that up to 40% of the unemployed are not likely to be hired back, which could leave the unemployment rate near 10% at the end of 2020. With a high level of slack in the labor market well into 2021, workers will have no leverage to demand higher wages. This is very different than in the 1970’s when workers could use the high rate of inflation as serious leverage in obtaining big annual increases.
The IMF has forecast that global GDP will grow 5.4% in 2021 after falling -4.9% in 2020. The IMF estimate assumes there won’t be a second COVID-19 wave in late 2020 or early 2021. If another outbreak does materialize global GDP growth could fall to 0.5%. The IMF considers global growth under 2.0% as being recessionary, so growth of 0.5% would be recessionary. Crude oil (September contract) plunged from $61.00 a barrel in December 2019 to $22.00 in April and has recovered half of the shutdown decline. Crude oil supply could continue to weigh on crude prices as producers increase production if global growth proves stronger than expected, or weak growth keeps demand muted. Unless a shortage develops due to an act of war, crude oil prices are not likely to soar as in the 1970’s.
Inflation is best defined as too much money chasing too few goods. M2 money supply has soared from $14,829 trillion on February 24 to $18,522 trillion on July 6 an increase of $3.014 trillion. This represents 14.0% of first quarter GDP of $21,540 trillion.
That’s a lot of money and if it flowed into the economy in the next twelve months, economic growth would take off and inflationary pressures would emerge. The question is how much of the $3.014 trillion increase in M2 money supply is likely to be spent by consumers and businesses? To answer that question we need to look at the components of the M2 money data to determine the sources of the increase.
M1 includes currency in circulation, demand deposits, and other checkable deposits. M2 includes M1 plus savings deposits, retail time deposits, retail money funds, and some other categories. M1 growth is highly correlated with the growth in reserves generated by Federal Reserve Quantitative Easing asset purchases, since reserves held with the central bank are assets for banks.
The Federal Reserve has expanded its balance sheet from $4,159 trillion on February 26 to $7,009 trillion on July 1 an increase of $2,850 trillion. The Fed began to increase the size of its balance sheet last fall to address a liquidity problem in the repo market and in part to increase the amount of Free Reserves in the banking system. Initially the increase in Free Reserves was small, but zoomed in March after the Fed aggressively expanded its balance sheet.
Free Reserves are the amount of money each bank keeps on deposit with the Fed above their required reserves. U.S. banks are required to keep 10% of deposits as a reserve and can lend $.90 of each $1.00 of deposits. This ‘fractional’ banking system allows banks to leverage each $1.00 of deposits through lending to consumers and companies. Free Reserves have soared from $1,483 trillion on February 26 to $2,796 trillion on July 15.
The $1,313 trillion increase in Free Reserves accounts for 43.5% of the $3.014 trillion increase in M2 money supply. Free Reserves are not going to find their way into the economy and are effectively dead money.
The Federal Reserve cut the reserve requirement from 10% to 0% on March 26 so banks would have more money available to lend. But an increase in lending is not likely to develop anytime soon. In the second quarter J.P. Morgan, Wells Fargo, Bank of America, and Citigroup set aside a total of $32.0 billion for future loans losses.
As noted in the June Macro Tides, commercial banks increased lending standards in the first quarter and probably tightened more in the second quarter.
The increase in loan loss provisions by the largest banks only confirms that assessment. Bank lending is procyclical. When the economy is doing well banks lower lending standards and wind up lending too much money to less qualified borrowers, and tighten credit during a protracted slowdown or recession. Changes in bank lending and lending standards amplify the business cycle.
In response to the mandated government shutdown of most of the U.S. economy, Congress rushed to help the millions of workers who virtually overnight found themselves out of work. To address the unprecedented drop in wage and salaries Congress authorized the payment of $600 per week to every worker that applied for state unemployment benefits. State unemployment benefits typically cover 30% to 50% of a worker’s prior income up to a limit set by each state. Congress wanted to make sure workers received at least what they were earning previously.
As discussed in the June Macro Tides, Congress wound up paying many workers far more for not working. Economists at the University of Chicago found that 68% of those currently unemployed can now bring home more money than when they were actually employed. The University of Chicago study found that the average (median) replacement rate was 134%, so the median unemployed person is making 134% of their prior pay for not working. In 37 states the midpoint worker (median) will make at least 41% more not working. Congress’s largesse boosted unemployment benefits as a percent of personal income to more than 6%, five times as much as during the 2001 recession and a fourfold increase than after financial crisis.
Many employers have found it difficult to get former employees to give up the extra money and return to work which is a longer term negative. In the short run the extra money has enabled consumers to increase their savings dramatically. The savings rate soared to 32.2% in April from less than 8% in prior months when they were working. The savings rate fell in May as some states opened up and will continue to fall as consumers spend more.
The extra income has also led consumers to significantly pay down their credit card debt. In the past three months consumers paid down $104 billion in Revolving Credit (credit card) to less than $1 trillion. The last time credit card debt was this low was in December 2007. It took almost a year for credit card debt to decline this much during the financial crisis in 2008. Congress is likely to extend
Congress is likely to extend some portion of the federal bonus unemployment benefit beyond July 31, but it will be less than $600 a week. The reduction in cash flow will hurt the economy in the short run but the reduction in credit card debt and increase in savings will provide a cushion for consumers to increase spending in the future. Any increase in spending will be dictated by how quickly unemployment falls, consumer confidence rises, and a vaccine or proven medical treatments allow consumers to return to ‘normal’.
Consumers have placed a sizable portion of the increase in their savings in money market funds and checkable deposits, which are included in the M1 money supply. Total Checkable deposits have climbed from $2,247 trillion on February 24 to $3,407 on July 13 an increase of $1,160 trillion.
Assets in money market funds have soared to a record $4.77 trillion as of March 31, after investors poured $694.8 billion into money market funds. More than 75% of the inflow went to Treasury-only and other government funds amid a flight to safety by investors, according to Investment Company Institute data.
Companies large and small often have a line of credit with their bank so they can quickly borrow money up to a limit to take advantage of an opportunity or deal with an emergency. In 2008 banks suspended the lines of credit they had extended as the financial crisis unfolded so many companies were unable to access all the credit they thought was available. As the COVID-19 crisis erupted in March 2020, companies moved quickly to drawn down their lines of credit before their bank could limit access. Commercial and Industrial loans jumped from $2,358 trillion in February 2020 to $2,900 in June an increase of $542 billion. There is no way of knowing with certainty but some of these funds became checkable deposits.
After the Federal Reserve announced that it would buy high yield corporate ETFs and individual bonds, corporations rushed to sell a record amount of bonds. In the first five months of 2020 corporations have sold almost a year’s worth of bonds and will easily set an all time record for borrowing.
Some of the proceeds have likely been used to pay down lines of credit, bank loans, and higher yielding debt. But the primary purpose of issuing debt is to have enough cash on their balance sheets to tide them over while everyone waits for the economy to fully recover. The increase in liquidity from tapping lines of credit and selling bonds has increased the ratio of corporate debt to GDP to a record high.
In the short run the influx of cash will help companies manage a difficult economic environment. But the big increase in debt will consume a larger portion of their cash flow for years and make them more dependent on a strong economy.
The budget deficit was an astounding $864 billion in June and nearly as much as the $984 billion deficit for the 2019 fiscal year. In the past 12 months the budget deficit totaled $3.0 trillion, and at 14.0% of GDP will represent the second largest deficit in history only modestly less than in 1944 during World War II. During the Great Depression the budget deficit was never more than 7.5% of GDP.
The Treasury Department is issuing a record amount of Treasury paper to fund the deficit. The Federal Reserve is prohibited from buying Treasury paper directly from the Treasury department which sells bonds to primary dealers and the public. The Federal Reserve then buys Treasury bonds on the open market. The amount of Treasury debt from March 4 through May 11 was almost evenly split between purchases by the public and the Federal Reserve.
The vast majority of the offerings from the Treasury Department from March 4 through May 11 were in Treasury bills ($1.437 trillion) compared to only $170 billion of Treasury notes up to 10-years, and just $34 billion in bonds beyond 10 years in maturity. The Federal Reserve bought 5.5 times ($951 billion vs. $170 billion) as much as the Treasury issued in bonds with a maturity of 1 to 10 years.
Clearly this is part of the Fed’s strategy to keep longer dated Treasury yields down, which indirectly helps in keeping mortgage rates down.
The Treasury Department parks the proceeds of its bond auctions with the Federal Reserve, and has increased from $439 billion on February 26 to $1,675 trillion on July 6.
As primary dealers and the public pay for their Treasury bond purchases, money flows out of their accounts and to the Treasury so there is no net increase in the money supply. It just shifts from one bucket under M2 into a different bucket under M2. Over time though the Treasury’s cash balance at the Fed will decline as the Treasury distributes funds to consumers and companies through the numerous programs designed to provide a safety net under the economy. As the Treasury sends money to consumers and business M2 will rise. Some of those funds will be saved, used to pay down debt, or spent, while companies meet payroll, rent, or allow cash to sit on their balance sheets.
After falling in March to $18,694 trillion, Personal Income has recovered and through May was $825 billion higher than in January 2020. The government’s response has been more robust in offsetting the loss in wages and salaries during the COVID-19 crisis than during the financial crisis and the mild 2001 recession.
Personal income fell modestly during the 2001 recession and significantly during the 2008 recession despite income transfers from state Unemployment Insurance programs. During the recession in 2008-2009 the Federal government kicked in $25 per week compared to $600 per week in response to the COVID-19 pandemic. This has more than compensated for the decline in wages and salaries, and has created the unintended consequence of providing unemployed workers a disincentive to return to work. Personal income growth will gradually return to trend as Congress trims the weekly bonus amount from $600 a week.
Americans over the age of 55 represent 40% of GDP and are the most vulnerable demographic to the most severe outcomes from COVID-19. The fatality rate for those under the age of 35 is just 0.8% compared to 11.9% for those older than 55 and 20.7% for those over the age of 65.
This cohort will not spend at their pre-COVID-19 rate until they are safe and feel safe. Even if a vaccine is developed by early 2021 many in this group will not get vaccinated and will instead wait for 3 or 6 months or longer, until they see that others have done so safely.
Corporations are sitting on a pile of cash after tapping credit lines and bond sales so they can ride out a weak recovery and avoid layoffs as long as possible. For years companies borrowed money to buy back stock but that has changed. In 2020 stock buybacks could be $400 to $500 less than in 2019 as companies conserve cash.
The recession has caused a sharp decline in capacity utilization which will weigh on business investment for many months. Corporations won’t increase business investment until excess capacity has been eliminated and companies are certain that any pickup in demand will be sustainable.
COVID-19 is a dam that is containing the huge buildup in liquidity the Federal Reserve and Congress have created as the table below highlights.
Although the Federal Reserve has trimmed its balance sheet by roughly $200 billion in recent weeks, its balance sheet is likely to increase by year end. Free Reserves will never leave the banking system so they won’t provide any economic lift, even though they are included in M2. Some of the other ‘buckets’ overlap so there is some double counting occurring to arrive at $3,416 trillion, but the amount of money that could find its way into the economy is still significant.
Every other post World War II recession has been due to an oil price shock or the result of excessively tight monetary policy. This economic contraction is a health care crisis so the traditional tools of fiscal stimulus and accommodative monetary policy can only ameliorate the fallout.
Congress and the Federal Reserve cannot provide a cure.
Until there is a vaccine or a group of therapeutics that minimize the impact of the Pandemic, consumers and companies will husband their savings and cash and not increase spending significantly. In the short term the concern about inflation is misplaced and driven by perception more than reality, since most of the liquidity the Fed has created will not flood the economy with a surge in demand that drives prices higher. The caution that is curbing consumer and corporate spending could be reversed quickly should the health care crisis be solved. Once consumers and corporations are confident that it’s safe to return to normal activities, the economy has the potential of roaring back to life and create a completely different challenge for the Federal Reserve.
Federal Reserve
The financial crisis initiated a new era for the Federal Reserve as it launched 3 Quantitative Easing programs that expanded the Fed’s balance sheet from $900 billion in 2007 to $4.4 trillion in late 2014. The Fed thought it was necessary to take this unprecedented step after realizing pushing interest rates to 0.1% wasn’t enough to support and sustain an economic recovery.
As the COVID-19 Pandemic necessitated the closing of the U.S. economy the Federal Reserve expanded its balance sheet by $3 trillion in less than 3 months compared to 5 years after the financial crisis. The Fed also coordinated its efforts with the Treasury department to support a number of innovative lending programs to create a safety net under Main Street. In total the programs launched in conjunction with the Treasury department have the potential to add more than $4 trillion of lending capacity to support the Municipal bond market, corporate bond market, Paycheck Protection Program (PPP), and Main Street Lending Program.
None of these programs is close to being tapped out so the Fed and Treasury will continue to implement these programs, especially if the recovery falters. Since they have already been authorized the Treasury doesn’t have to go back to Congress to ask for more money or approval.
As long as COVID-19 continues to ravage the U.S. economy and prevent a full blown reopening, the Federal Reserve will pursue the most accommodative posture as possible. Although there is a risk that a medical solution will unleash a torrent of the liquidity the Fed has created, the downside risk to the economy if a vaccine remains elusive is too great not to take that chance. The members of the FOMC are keenly aware of this risk and how the Treasury market might over react with interest rates spiking higher should a vaccine become reality.
A sharp increase in Treasury yields would derail the stock market whose valuation is historically stretched but justified by Wall Street based on Treasury yields being so low. The S&P 500 fell by 20% in the fourth quarter in 2018 after the 10-year Treasury yield rose from 2.80% to 3.25%. A vaccine could inspire an echo of 2013’s Taper Tantrum when the 10-year yield soared from 1.61% in May to over 2.90% in August, a jump of 1.30% in just four months.
The large increase in M2 money supply has already sparked ‘talk’ that inflation could be a problem in 2021. The recent rally in Gold and Silver only confirms this risk to those that believe markets are a discounting mechanism. A vaccine and the big jump in GDP that would surely follow would be the perfect breeding ground to spur a sharp price decline in Treasury bonds and higher yields, as investors begin to price in the prospect of the Federal Reserve beginning to increase rates and less buying of Treasury bonds. The Fed understands the potential risk of an inflation scare, which is why a number of FOMC members in recent speeches and comments have said the Fed will tolerate inflation above 2.0%.
In a virtual event held by the Global Interdependence Center on July 16 Chicago Federal Reserve President Charles Evans noted he would favor the Fed maintaining an accommodative policy stance even after inflation was above 2.0%:
“I am hard pressed to think of reasons why we would need to move away from accommodative monetary policy unless inflation was well above 2% for an extended period of time, and the economy was just very different from what we are seeing right now. That doesn’t seem to be very likely.”
Evans’ comments followed a speech by Lael Brainard on July 14 at a webinar hosted by the National Association of Business Economics. Like Evans Brainard expressed a willingness to be patient should inflation climb above 2.0%:
“With the policy rate constrained by the effective lower bound, forward guidance constitutes a vital way to provide the necessary accommodation. For instance, research suggests that refraining from liftoff until inflation reaches 2 percent could lead to some modest temporary overshooting, which would help offset the previous underperformance.”
On July 17 Fed Chair Jerome Powell made the following comment which summarizes the Fed’s dedication to not only getting inflation to 2.0% but attempting to lift above 2.0% for a period of time:
“The Fed will not just emphasize actual inflation over forecasted inflation, but will also attempt to push the inflate rate above its 2% target. It’s a whole new ballgame.”
Last year the Federal Reserve introduced the goal of inflation averaging 2.0% over a complete business cycle. Since inflation typically falls below 2.0% during a recession, the FOMC would need to tolerate inflation rising above 2.0% during the expansion phase of the business cycle for inflation to average 2.0% over a complete business cycle.
These comments need to be put into the perspective of history and the Fed’s success in getting inflation to 2.0%. The Fed’s preferred inflation metric is the Core Personal Consumption Expenditures Index (PCE). In the past 24 years the Core PCE has been above 2.0% for less than 4 years, or less than 17% of the time.
Now that baseball has resumed this analogy is appropriate. When a Major League batter hits less than .200 they are said to be hitting below the Mendoza line and not likely to remain in the ‘Bigs’ for long.
Given the Fed’s 24 year track record one has to admire or laugh at the Fed’s hubris in believing their forward guidance can magically lift inflation above 2.0%.
Although the odds of Core PCE inflation getting above 2.0% are low, that may not matter to the bond market with Treasury interest rates at their lowest level since 1790. It wouldn’t take much of an increase in yields to create pain for investors who own the 30-year Treasury bond. If the 30-year Treasury yield rose from 1.25% on July 27 to 1.75%, the price of the Treasury bond would fall almost 10%, and would lose 20% if the yield spiked to 2.25%. The 30-year Treasury yield was 1.75% on June 6 and 2.25% in January, so a return to these levels is certainly possible. The Federal Reserve is trying to damp down any uptick in Treasury yields due to a perceived or actual increase in inflation should a vaccine appear.
Since 1996 the Federal Reserve has tried just about everything in their play book to get inflation higher. When all else failed they introduced negative real interest rates, Quantitative Easing, Forward Guidance, and the unprecedented step of buying corporate bonds. With so much effort and so little to show for all their huffing and puffing, one would think that the brain trust at the Fed might consider that the forces keeping inflation low may be beyond the reach of monetary policy no matter how accommodative.
The velocity of money is a concept that is integral to monetary policy. Here’s a simple formula.
(GDP / M2) = Velocity
Conceptually when consumers and business feel confident they spend more so GDP growth improves, even if M2 growth is flat. Demand increases since the velocity of money – how fast it turns over – increases, without an increase in M2.
During recessions consumers and businesses hold onto their money so velocity slows depressing GDP, even if M2 growth is modestly positive.
When M2 money supply increases and the velocity of money increases, inflationary pressures are likely to increase, and fall if M2 and velocity decline.
If M2 grows by 10% and velocity slows by 10%, inflation is not likely to change much.
This is all quite logical and makes perfect sense except it hasn’t worked in the real world as one would expect. Inflation has remained low since 1996 despite spurts in money supply growth, three extended periods of negative real interest rates, the lowest unemployment rate in 50 years in 2019, and all the heavy lifting by the Fed.
The decline in M2 velocity since its secondary peak in 1999 is nothing short of extraordinary. This decline followed a sharp run up in the 1990’s. To understand these swings we have to review the formula. From 1992 through 1999 GDP averaged 3.80%, but since M2 money growth was modest M2 velocity jumped. As velocity picked up GDP rose in the 1990’s. Since 1999 M2 velocity has slumped since GDP growth has been progressively slower than in the 1990’s as M2 money supply growth accelerated.
Since 1980 all forms of debt – Federal, Household, Corporate, and state and local governments – has soared as a percent of GDP from 150% to 280% at the end of 2019. (Federal 115%, Household 77.2%, Corporate 74.0% (public and non public), State and Local 14.0%)
Since the mid 1980’s the growth in debt has exceeded GDP growth as each new dollar of debt generated less than $1.00 of GDP. As current GDP growth was borrowed from the future, current growth has slowed as borrowers must allocate a portion of current cash flow to service their burden of debt. In the face of slower GDP growth the Federal government has accelerated the accumulation of debt, especially since 2000. The increase in Federal debt and to a lesser extent the buildup in corporate debt, added to the growth in M2 since 2000, even as GDP growth slowed after the 2001 recession compared to the 1990’s and slowed even more in the post financial crisis expansion. With M2 money supply jumping and GDP sinking in 2020, the decline in velocity is falling to a new low.
Since 2000 there has been a high correlation between M2 velocity and the Core CPI inflation rate, after moving the Y-O-Y change in velocity forward by 20 months. After bottoming in 2003, velocity began to rise as did the Core CPI with this inflation measure peaking in September 2006 at 2.90%. (Chart below)
The period from 2004 and 2007 is the only time since 1996 that the Fed’s Core Personal Consumption Expenditures Index (PCE) was above 2.0%. After peaking in 2007 velocity fell during the financial crisis and accelerated lower as the Federal budget deficit soared and the Federal Reserve launched and continued its Quantitative Easing programs.
Both of these actions led to an increase in M2 even as GDP growth was lethargic, which is why velocity continued to drop into 2011. The deceleration in velocity coincided with a decline in Core CPI and the Core PCE and a low in 2011.
As GDP growth strengthened in 2012 and 2013, velocity rose and the CPI ticked up to 2.3% in May 2012 as it topped. Velocity and Core CPI inflation began a slow rebound in 2013 that topped in August 2016 and January 2017 with Core CPI hitting 2.3%, before reaching 2.4% in February 2020.
Based on velocity, the Core CPI would have likely pushed a bit higher in the first half of 12 2020 if it wasn’t for the COVID-19 Pandemic. The plunge in velocity is likely overstated given the historic response by Congress and the Federal Reserve. As GDP growth rebounds in the third and fourth quarter, velocity will rise. Nonetheless, the long term correlation between velocity and Core CPI inflation suggests that there is likely to be strong downward pressure on inflation for potentially the next 20 months. In June the Core CPI was 1.2% and the Core PCE was 1.0% in May.
With debt levels at a record high, economic growth weak, uncertainty weighing on consumer and corporate spending, and a solution to the Pandemic still on the horizon, the risk of deflation greatly outweighs the risk of inflation anytime soon. The higher risk of deflation may be one reason a stronger and public level of inflation resolve has emerged from FOMC members’ statements, and why the FOMC has the hubris to try to get everyone to focus on the Fed getting Core PCE inflation not only to its target of 2% but above 2.0%. As Chair Powell stated on July 17:
“The Fed will not just emphasize actual inflation over forecasted inflation, but will also attempt to push the inflate rate above its 2% target. It’s a whole new ballgame.”
This sounds like a halftime speech a coach makes to a team that’s losing by a lot. “Let’s get inflation above 2.0% for the Gipper!“
MZM is another measure of money supply that quantifies money readily available for spending and consumption. It includes currency, checking and savings accounts, and money market funds. MZM includes M2 except it excludes certificates of deposit (CD) since the owner would incur a penalty for accessing the funds before the term of the CD is up. MZM derives its name from its inclusion of all the liquid (currency) and zero maturity money found in checking and savings accounts and money market funds.
Velocity is derived by dividing GDP by a measure of money supply whether it is M2 or MZM. Since 1900 and based on available data, there has been a good correlation between the 10-year moving average of the population growth of those 20- 54 and the velocity of MZM. The Baby Boom began in 1946 causing the 10-year average of population growth to bottom in 1962. MZM velocity growth really kicked into gear in the mid 1960’s and rose sharply until peaking in 1981, just as the growth rate of the working age population topped. Since the early 1980’s velocity and population growth have trended lower, irrespective of a number of short term bumps in velocity.
The U.S. Census Bureau has forecast that population growth will trend higher as the jump in births during the period of 1985 and 1999 reach their working ago of 20 find their way into the work force. However, the sharp decline in births since 2007 suggests there will be another drop in the 10-year population growth rate after 2027. This decline could extend to 2040 or later since population grew by the smallest amount since 1921 in 2019. The economic dislocation from the COVID-19 is likely to keep the birth rate low at least through 2020.
Population growth has clearly been a driver of velocity and velocity has been one of the drivers of inflation. These longer term forces will continue to work against the Fed in getting inflation above 2.0%. These factors do not preclude a bump up in inflation should a vaccine unleash some of the sideline cash that has built up. The expectation that a ramp up in inflation is a foregone conclusion in 2021 due to the increase in M2 money supply is premature, misguided, and based on a superficial understanding of what contributes to M2 and how money supply increases cause inflation.
COVID-19 Vaccine Challenge
In its post meeting FOMC statement on July 29 the Federal Reserve emphasized how important COVID19 is to the path of the U.S. economy:
“The path of the economy will depend significantly on the course of the virus. The ongoing public health crisis will weigh heavily on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.”
The course of the virus will be determined by whether a vaccine is developed and how quickly it can be deployed to contain the spread of COVID-19 in coming months and possibly years.
An analysis of 26 different studies estimating the infection-fatality rate in different parts of the world found an aggregate estimate of about 0.68%, with a range of 0.53% to 0.82%. An infection-fatality rate of roughly 0.6% is six times greater than the 0.1% estimate for seasonal influenza based on CDC data. Eric Toner is a senior scholar at Johns Hopkins Center for Health Security who studies healthcare preparedness for epidemics and infectious diseases who made this assessment:
“It’s not just what the infection-fatality rate is. It’s also how contagious the disease is, and Covid is very contagious. It’s the combination of the fatality rate and the infectiousness that makes this such a dangerous disease.”
Countries like Japan and Australia who were praised for their response to the initial outbreak of COVID-19 are experiencing a second wave of infection.
In Europe Spain, France, and Germany are seeing the number of cases rise. The increase in cases in countries that appeared to have COVID-19 under control underscores the infectiousness of this disease.
Herd immunity occurs when a large portion of a population (the herd) becomes immune to a disease after recovering and developing antibodies. This makes it increasingly difficult for the disease to spread from person to person. According to the Mayo Clinic more than 70% of the U.S. population (230 million people) would have to recover from COVID-19 to reach herd immunity.
The key to achieving herd immunity is the capacity to create antibodies that last for a long time ideally many years. This may be more difficult with COVID-19 based on research that attempted to measure how long COVID-19 antibodies last. Researchers at Kings College London in the U.K. have found that antibody responses to the coronavirus tend to peak three weeks after the initial onset of symptoms, but then begin to decline after as little as two or three months afterwards.
While 60% of the people in the study had a “potent” level of antibodies on average 23 days after the first onset of symptoms, that figure dropped to 16.7% of those tested 65 days after the first signs of symptoms.
This will make the challenge of developing a vaccine more difficult since it will have to increase the potency of antibodies beyond what the human body normally produces so that they last several years. Otherwise a vaccine may prove only as effective as the annual flu shot and outbreaks of COVID-19 could be an annual event. This is another reason why the optimism about a vaccine being developed in less than a year seems too optimistic and misplaced.
See also: Face Masks Really Do Matter. The Scientific Evidence Is Growing. (The Wall Street Journal)
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