Morgan Stanley
  • Thoughts on the Market
  • Aug 3, 2020

Who’s Driving The Growth in U.S. Money Supply?

With Mike Wilson
U.S. Equities Research for Investors

Growth in money supply is one of the most powerful indicators for rising inflation—and its currently rising at record levels. How should investors position portfolios?

Each week, Mike Wilson offers his perspective on the forces shaping the markets and how to separate the signal from the noise. Listen to his most recent episode and check out those of his colleagues from across Morgan Stanley Research.

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Current Episode Transcript

Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief US Equity Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, August 3rd, at 11:30 a.m. in New York. So let's get after it.

With the U.S. and global economies in the midst of one of the deepest recessions and output gaps on record, most investors have ignored the rising risks of inflation. After all, how in the world are we going to get inflation with unemployment north of 10% and excess supply in everything from oil to hotel rooms?

While we are likely to experience big imbalances in the real economy for several more quarters, if not years, the most powerful leading indicator for inflation has already shown its hand: money supply. As renowned economist Milton Friedman famously said 50 years ago, "inflation is always and everywhere a monetary phenomenon." Currently, money supply growth is 22% on a year over year basis, the highest on record by more than 10 percentage points. If Mr. Friedman is correct, shouldn't the risk of higher inflation be greater than it's ever been too? Of course, money supply also grew rapidly after the Great Financial Crisis, and we never saw inflation appear in a meaningful way. This fact has emboldened the view that the Fed can print as much money as they want, and it won't lead to inflation.

We've argued for the past several months that the policy response to this health crisis has been very different than what was used during and after the Great Financial Crisis, or GFC. On the monetary front, the Fed reacted more swiftly, and aggressively, with its immediate response and direct intervention into credit markets. In short, they went all in from the beginning, showing no hesitation to do whatever it takes to support the markets and the economy. Part of that aggressiveness was also likely attributable to the fact that we didn't get any meaningful inflation after $4 trillion in quantitative easing after the great financial crisis. However, it's the fiscal response that's really different this time.

First, the government has been sending money directly to both consumers and small businesses as a means of supporting the economy during the lockdown and reopening. Such action has been called "helicopter money" because it's akin to dropping money from the sky. Second, the Fed has directly intervened in the lending markets by making loans via the Paycheck Protection and Main Street Lending programs. Finally, and perhaps most importantly for the inflation call, is a decision by Congress to guarantee loans made by commercial banks and to offer mortgage, car payment, and rent forbearance via the CARES Act.

To me, this means Congress is now the critical player in driving money supply growth rather than the Fed. If Congress decides to keep spending money, the Fed will be obliged to print it. Money supply growth can remain more elevated and drive aggregate demand and inflation, or nominal GDP growth.

But here's the punch line-- helicopter money and other stimulus programs are popular with the people, and popular programs are what politicians run on. Therefore, we find it highly unlikely that Congress will fail to extend the benefits currently being discussed in Washington, especially in an election year. Perhaps more importantly, we think Congress will have a hard time curtailing these programs even after the economy recovers. To quote Milton Friedman once again, "nothing is so permanent as a temporary government program."

And this is exactly how the Fed loses control of the money supply and inflation, something most investors think is a remote possibility, leaving very few portfolios prepared for such an outcome. Therefore, we would use near-term concerns about the stimulus and recovery to add to equities geared to higher inflation and economic growth. This would include banks, materials, commodities, industrials, and small cap or mid-cap equities.

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