Why the US money supply is shrinking for the first time in 74 years (2024)

FAQs

Why the US money supply is shrinking for the first time in 74 years? ›

Why the US money supply is shrinking for the first time in 74 years. The U.S. money supply is shrinking for the first time since 1949, as savings deposits decline and the Federal Reserve shrinks its $8 trillion balance sheet.

Its decline —the most significant drop, of 4.5%, happened precisely one year ago—matched the narrative that the Federal Reserve's tightening of monetary policy was doing its job of taking money out of the financial system.

By contrast, if the Fed sells or lends treasury securities to banks, the payment it receives in exchange will reduce the money supply.

The gold standard. Some economists believe that the Federal Reserve allowed or caused the huge declines in the American money supply partly to preserve the gold standard. Under the gold standard, each country set the value of its currency in terms of gold and took monetary actions to defend the fixed price.

The newest reading, as of July 2024, shows U.S. M2 at $21.054 trillion, representing a decline of 3.07% in a little over two years. While this is well off the peak-to-trough drop of 4.74% from April 2022 through October 2023, it still marks the first sizable decline in U.S. M2 money supply since the Great Depression.

The U.S. money supply is shrinking for the first time since 1949, as savings deposits decline and the Federal Reserve shrinks its $8 trillion balance sheet.

The two biggest drivers are central bank policies (interest rates set by the U.S. Federal Reserve and its counterparts in Europe, England, Japan and elsewhere); and economic growth relative to inflation. Those factors often dictate which way money flows.

The Federal Reserve System manages the money supply in three ways: Reserve ratios. Banks are required to maintain a certain proportion of their deposits as a "reserve" against potential withdrawals. By varying this amount, called the reserve ratio, the Fed controls the quantity of money in circulation.

Government backs the money supply.

In the United States, the money supply is backed up by the government, which guarantees to keep the value of the money supply relatively stable. Such a guarantee depends mostly upon the effectiveness and management of silks of the government with regards to the money supply.

Increasing interest rates doesn't increase a nation's money supply because the two have an inverse relationship. Higher interest rates translate to a lower supply of money in the economy. The supply of money depletes so it raises borrowing costs and this makes it more expensive for consumers to hold debt.

Who got rich during the Great Depression? ›

Not everyone, however, lost money during the worst economic downturn in American history. Business titans such as William Boeing and Walter Chrysler actually grew their fortunes during the Great Depression.

Opposite effects occur when the supply of money falls or when its rate of growth declines. Economic activity declines and either disinflation (reduced inflation) or deflation (falling prices) results.

Banking regulation has changed over the last 100 years to provide more protection to consumers. You can keep money in a bank account during a recession and it will be safe through FDIC and NCUA deposit insurance. Up to $250,000 is secure in individual bank accounts and $500,000 is safe in joint bank accounts.

The depressed economy caused many banks (especially small banks) to go bankrupt. At that time there was no deposit insurance, so many people withdrew their deposits from banks and kept their money as currency. Many bank runs occurred, as depositors were wary of bankruptcy.

The Depression

Many of the small banks had lent large portions of their assets for stock market speculation and were virtually put out of business overnight when the market crashed. In all, 9,000 banks failed--taking with them $7 billion in depositors' assets.

The reason behind the fall in M2 is straightforward.

The Fed's reduction in its own balance sheet reduces the amount of money supply as the central bank is no longer reinvesting the proceeds from its matured bonds back into the system.

Have you ever heard the term “dollar shortage”? In case you haven't, it essentially means when foreign countries have a low supply of U.S. dollars in reserves needed to conduct foreign trade. Simply put, a dollar shortage occurs when a country's USD outflows exceed its inflows.

“Elevated prices have largely persisted, which means that Americans continue to face affordability challenges on a range of things both necessary and discretionary, including homes, vehicles, car insurance, food, electricity and travel.” Indeed, the rate of price increases for food has subsided.

Causes of the economic slowdown included workers becoming sick with COVID-19 as well as mandates and restrictions affecting the availability of staff. In cargo shipping, goods remained at port due to staffing shortages.

If interest rates are lower, borrowing will likely become more popular, which will increase the supply of money. Conversely, if interest rates rise, then the cost of borrowing will also go up which will deter people from taking out loans. This will decrease the M2 money supply in an economy.