Tuesday, March 31, 2009

MZM/M2 Post

Some things just can't be resisted -- such as using Pink Floyd's money to begin a discussion about money supply (note two things about the track. First, the main riff is in 7/4 which is a metrical oddity for pop music, and David Gilmour's always great guitar playing.)

This post will be discussing MZM which is:

A measure of the liquid money supply within an economy. MZM represents all money in M2 less the time deposits, plus all money market funds.


MZM has become one of the preferred measures of money supply because it better represents money readily available within the economy for spending and consumption. This measurement derives its name from its mixture of all the liquid and zero maturity money found within the three "M's."

In essence, what we're looking for is money that we can spend right now if we wanted to. First here's a chart of the absolute liquid amount of money in the system:

Click for a larger image

Note that the Federal Reserve has been pumping money into the system in order to stimulate demand. Notice this did not happen in the recessions of the early 1980s because the Fed was raising interest rates at that time. However, the Fed did pump liquidity into the system in the last recession (2001) as they are now.

Here is a chart of the year over year rate of change:

We are seeing a positive rate of year over year growth between 10% and say 16%. However, note the rate of year over year change that occurred in this recession compared to the last recession and you see a major difference. The last recession saw an increase in the year over year rate of increase in MZM whereas this recession is seeing a more controlled year over year rate of change. Interesting, to say the least.

But the tale becomes more interesting here:

This is a graph of the year over year change in M2, which is:

A category within the money supply that includes M1 in addition to all time-related deposits, savings deposits, and non-institutional money-market funds.

M1 is

A category of the money supply that includes all physical money such as coins and currency; it also includes demand deposits, which are checking accounts, and Negotiable Order of Withdrawal (NOW) Accounts.

First, notice the year over year increase in M2 -- which is spiking to around 10%. But let's ask ourselves why that is happening. Liquid money as represented by MZM is showing a year over year increase, but not at the same rate as we have seen in previous recessions. That means non-currency money is probably the primary reason for the increase in M2. And when we look at the spike in savings:

We get our probable answer as to what is causing the spike in M2 -- people putting money into demand deposits.

Let's ask ourselves a final question: will people spend this money or will they keep it in their accounts as a financial cushion? The answer is extremely important from an inflationary perspective. If the money is more prone to stay put then it will not add as much inflationary pressure or growth. If people are going to rush out and blow it then we'll have an increase in MZM, which will increase monetary velocity and thereby inflation and overall growth.

Bottom line: we don't know the answer to the preceding question. There has been a tremendous amount of wealth destruction over the last 6 quarters which would indicate people are more inclined to keep the money where it is. However, we've also seen weak personal consumption expenditures over the last two quarters indicating there might be some pent-up demand that will kick in when people feel a bit more confident in spending.

In other words -- we get to wait and see. What fun.