Tuesday, September 25, 2012

Absolute Money Growth versus Percentage Change in Money Growth

A commenter asks below:

Why do you consider the percent change in M2 more significant than the total M2? M2 has been consistently growing, has it not? That's despite how erratic the percent change has been.

The fact that M2 has been growing consistently is not as important as the percentage change. Here's the absolute growth since 1980:

Here's quarterly money growth on a percentage change basis since 1980:

Here's why looking at the percentage change is more meaningful. 

According to Austrian Business Cycle Theory, the economy gets distorted in favor of the capital goods sector whenever money is printed.  The money flows into the capital goods sector and distorts the structure of the economy away from consumer goods and towards capital goods .

For example, if the Federal Reserve prints up  $100 billion dollars on a base of a trillion dollar money supply (a 10% increase in money supply), this will distort the economy in favor of the capital goods sector by $100 billion dollars. But, this money eventually works its way through the economy with prices being bid up so that in order to maintain the distorted capital goods structure, the Fed will next have to print up $100 billion plus. It must be a $100 billion plus because the structure needs to be maintained and the increase in prices must be adjusted for to maintain the structure.

If the Fed only prints on the second round $50 billion (a 4.5% increase over the new $1.1 trillion in money supply), this will not be enough buying power to maintain the earlier Fed manipulated $100 billion capital  goods structure--even though it is an absolute increase in money supply.

Thus, it is very necessary to know the percentage of new money that is being printed rather than just whether new money is coming into the system. As can be seen by the charts, the Fed is almost always printing money, but it is much more erratic in the percentage of new money that it adds to the system. Just watching absolute money growth, without reference to percentage change will not provide any clue as to whether the Fed is shrinking or expanding the capital structure it is manipulating and thus provide no clue as to whether we are headed for a downturn or Fed manipulated boom. 


  1. While percent change in M2 might be a better indicator of problems in the capital structure, wouldn't total M2 be a better indicator of coming price inflation?

  2. Robert,

    Why do you not look at the Fed's Z1 report as well?

    Credit spends just as good as money in our economy...

  3. I'm a simple guy, and using real numbers -- $100B vs. $50B on the new base of $1.1T -- makes your argument on absolute vs. percentage much clearer.

    Thanks, sir!

  4. Do I get this right:
    If the Fed would expand the capital structure we would be headed for the next boom. In the case of a shrinking capital structure we would have another bust?

  5. Thanks for the insight, Mr. Wenzel (aka Mr. Economics Wizard)!

  6. I was toying witht these graphs last night at 12AM. So nice to seet his post. You are awesome.

  7. To eliminate the risk of the excess reserves being loaned out, why doesn't the Fed increase the reserve ratio? I think I read that there are now sufficient excess reserves to make it 100% .