M2 money supply could be a better measure of inflation than CPI

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When mar­kets turn red and infla­tion starts soar­ing, both reg­u­la­tors and con­sumers turn to CPI as a gauge for the dam­age done by soar­ing prices but in the chaos that ensues as mar­kets enter into a reces­sion, one met­ric always seems to be over­looked — the M2 mon­ey supply.

The M2 is a mea­sure of the mon­ey sup­ply in an econ­o­my that includes cash and check­ing deposits, sav­ings deposits, mon­ey mar­ket secu­ri­ties, and var­i­ous oth­er time deposits. The assets includ­ed in M2 are less liq­uid than M1, which includes just cash and check­ing deposits, but are usu­al­ly liq­uid and can be quick­ly con­vert­ed to cash.

Cen­tral banks use M2 to shape mon­e­tary pol­i­cy when infla­tion aris­es, mak­ing it one of the most impor­tant met­rics when economies start to slow down.

Look­ing at the data from the U.S. Fed­er­al Reserve shows that M2 has been grow­ing expo­nen­tial­ly since 1980. Every time the Fed­er­al Reserve attempt­ed to reduce its bal­ance sheet reces­sion ensued. Peri­ods of reces­sion have his­tor­i­cal­ly sped up the growth of M2, as the Fed’s quan­ti­ta­tive eas­ing approach increased the sup­ply of mon­ey in the economy.

This is evi­dent in the Fed’s data — gray areas on the graph below indi­cate peri­ods of reces­sion and show the increase in M2.

fed m2
Graph show­ing the M2 mon­ey sup­ply in the U.S. from 1980 to 2022 (Source: The Fed­er­al Reserve)

Many econ­o­mists believe that M2 is a much bet­ter gauge for infla­tion than CPI. The cov­et­ed con­sumer price index tracks the aver­age increase across a bas­ket of con­sumer prod­ucts and is used to esti­mate the aver­age increase in prices con­sumers experience.

How­ev­er, CPI presents aver­age increas­es and has a ten­den­cy to show a much low­er price increase than con­sumers actu­al­ly experience.

The lat­est num­bers put the CPI increase at around 8%. How­ev­er, con­sumers have felt a price increase that far exceeds 8%. Look­ing at the increase in M2 paints a much more real­is­tic pic­ture of price increases.

The year-over-year increase in M2 cur­rent­ly stands at above 25% and feels more in line with what con­sumers experience.

m2 bitcoin
Graph show­ing the YOY increase in M2 (Source: BitcoinIsTheBetterMoney.com)

The grow­ing M2 mon­ey sup­ply isn’t only a gauge for infla­tion — it’s also a sol­id indi­ca­tor of Bitcoin’s performance.

The glob­al M2 plays a key role in Bitcoin’s price move­ments — when it shrinks, Bitcoin’s price drops. When the M2 grows, Bitcoin’s price grows as well.

Look­ing at the data for the Fed­er­al Reserve, the Euro­pean Cen­tral Bank (ECB), and the Bank of Japan (BOJ) shows the cor­re­la­tion between M2 and Bitcoin’s per­for­mance. Every time the glob­al M2 grew Bitcoin’s price saw a par­a­bol­ic run that trig­gered a bull mar­ket. Every time it decreased, Bit­coin expe­ri­enced a slump that led to a bear market.

In 2015, 2019, and 2022 the Fed­er­al Reserve embarked on an aggres­sive quan­ti­ta­tive tight­en­ing spree. Each of those years Bitcoin’s price hit a bottom.

global m2 bitcoin
Graph show­ing the M2 growth of the Fed­er­al Reserve, ECB, and BOJ com­pared to Bitcoin’s price from 2011 to 2022 (Source: MacroMicro)

It’s still too ear­ly to pre­dict how Bit­coin will react in this cycle of quan­ti­ta­tive tight­en­ing. The cur­rent M2 mon­ey sup­ply in the U.S. stands at around $21.5 tril­lion and is con­tin­u­ing to slight­ly decrease since peak­ing at $21.7 tril­lion in March this year.

The drop­ping M2 cor­re­lates with Bitcoin’s price slump. If it con­tin­ues the down­ward trend Bitcoin’s price could fail to recov­er and regain its year­ly high. How­ev­er, for the cur­rent cred­it-based econ­o­my in the U.S. to remain a cred­it-based econ­o­my, the sup­ply of U.S. dol­lars must con­tin­ue to rise. In the long run, the end­less cycle of print­ing mon­ey could be good for Bitcoin.

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