Money Supply No Longer Drives Economy

A reader asks:

What is the real rate that money supply growing (or shrinking)? Should movement in money supply be affecting inflation and housing prices?

The money supply is the amount of money held in cash, checking account deposits, savings accounts, cd's and money market funds. The official measurement of money supply (M1 and M2) does not measure money market funds held by companies, pension funds, and IRA's.

Money supply does not measure wealth, as held in stock, bonds and mutual funds. It also does not measure home equity. Since the 1990's, most families have kept their investments in either the stock market or their home.

Money supply does not measure credit or debt, which has really been behind the growth of the U.S. economy in the last 20 years. Therefore, whereas money supply has grown about 6% in the last year, it is not correlated with GDP growth, the stock market, or a feeling of wealth for the U.S. consumer. Therefore, it doesn't really affect inflation or housing prices.

What It Means to You

The U.S. economy has really become debt driven. This is why the current credit freeze has become such an crisis. That is also why the stock market rose nearly 1,000 points when the Federal Reserve started its commercial paper lending program.